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      Q3 2013 Industrial Market Trends

      Sluggish Demand for Warehouse/Distribution Persists

      Gains in occupancy remained subdued in the US warehouse/distribution market during the third quarter of 2013. Vacancy fell by just 10 basis points to 11.7%. Over the past year, the vacancy rate has declined by 70 basis points. This slow pace of vacancy compression is due to a combination of slowing net absorption and an increased pace of new construction. Occupied stock rose by 14.5 million square feet in the past three months, down 41.3% from one year ago. Construction activity reached its post-recession high in the third quarter with 7.4 million square feet completed. Rent growth maintained its modest pace during the past three months. Asking and effective rents increased by 0.4% and 0.5%, respectively, on par with gains posted in the second quarter. Over the past twelve months, asking and effective rents increased 1.3% and 1.6%, respectively. Not surprisingly, elevated vacancies and softer demand are constraining property owners from pushing through significant asking rent increases and pulling back on concessions. Plodding economic growth continues to depress overall demand in the industrial real estate market. Second quarter U.S. GDP growth estimates were revised up to 2.5%, but forecasts for the second half of 2013 are being ratcheted down due to heightened political uncertainty. Economic growth was likely to slow in the third quarter due to weak durable goods orders and a slowing housing market. Manufacturing was a bright spot for the domestic economy during the third quarter. The ISM Manufacturing Index held steady in the mid 50s for the quarter, well above the reading of 50 that indicates expansion. However, the government shutdown, irrespective of how long it lasts, has already done damage that will likely dampen fourth quarter figures. Moreover, the lack of clarity surrounding monetary policy and whether the Fed will taper its bond purchases has only added to the uncertainty. Q32013_WarehouseAbs

      Tight Market for Big Box Space

      While overall improvements in warehouse/distribution fundamentals have been lackluster, there is a stark difference between the performance of high quality, big-box space and that of small, inferior properties. Ecommerce firms are driving demand for bigger, logistically superior warehouse properties, resulting in a very tight market for quality space. Amazon currently has several projects of more than 1.0 million square feet under construction, including two in the Dallas area and one in Central New Jersey. At the other end of the spectrum are retailers like Walmart, who have yet to fully take advantage of the e commerce market. Firms like these are a potential source of future demand. Walmart is starting to expand its online order fulfillment capabilities; the company signed a lease on a 1.0 million square foot building in Bethlehem, PA, its largest distribution center to date. It also opened a brand new 800,000 square foot distribution center in Fort Worth. Prior to these facilities, Walmart had 130 distribution centers but just one dedicated to fulfilling internet orders. Q32013_IndRent The latest construction figures highlight the trend toward bigger spaces, largely to accommodate e-commerce users. Over 26% of all properties completed in the third quarter were 500,000 square feet or greater. Of all the warehouse/ distribution properties currently under construction, more than 25% will be 500,000 square feet or larger. For comparison purposes, just 2.9% and 6.2% of all properties completed in the 1990s and 2000s, respectively, were larger than 500,000 square feet. Quarterly construction figures are at a post-recession high as e-commerce firms find the market for suitable industrial space is incredibly tight in prime locations.

      The Investment Landscape

      With the office and retail markets struggling and some believing the apartment market may be at or nearing its cyclical peak, big institutional investors have aggressively jumped into the market for high quality industrial assets that are well situated near major transportation routes. Blackstone has built up one of the largest portfolios of US warehouse and distribution centers. In August it completed its acquisition of a portfolio of warehouse properties largely based in Reno from Lehman Brothers Holdings. Brookfield Asset Management made a large foray into the warehouse/distribution market in August with its $1.1 billion purchase of Industrial Developments International. IDI owns 27.0 million square feet of warehouse, distribution and other industrial space, much of it leased by internet retailers. Additionally, CalPERS is expected to become more active in the warehouse/distribution market.

      Flex and R&D

      The vacancy rate in the flex/R&D market declined by 20 basis points in the third quarter, a slight improvement from the 10 basis point drop of the previous three months. The decline was driven by positive net absorption of 2.2 million square feet, up from 1.4 million square feet last quarter. Completions were marginal during the quarter, totaling 308,000 square feet. Asking and effective rents grew 0.2% and 0.3%, respectively, slightly higher rates than the 0.1% recorded by both in the second quarter. Despite some minor improvements in occupancy and rent growth, flex/R&D properties remain handicapped by the underperformance of small– and mid-sized firms that make up a large portion of the segment’s users. With credit still tight for smaller firms, many are not looking to expand. On the plus side, technology firms are one of the primary users of flex/R&D space. The relatively strong performance of the technology industry is likely to continue to support the minor improvements in fundamentals the segment has recently exhibited. Q32013_FlexVac

      Metro Highlights

      Major large port and intermodal distribution markets with swathes of big box warehouse space continued to outperform the rest of the market in the third quarter. Houston, San Bernardino, Los Angeles, Chicago, Atlanta and Dallas were among the top ten warehouse/distribution markets ranked by year-over-year effective rent growth. With the technology and energy sectors continuing to outperform the rest of the economy, Houston, San Diego, San Francisco and Austin were among the flex/R&D markets with the highest effective rent growth over the past year. Aside from Atlanta, markets on the east coast have lagged the broad market. In particular, markets serving the nation’s capital and the surrounding areas have significantly underperformed over the past year. Suburban Virginia, Suburban Maryland and Richmond warehouse and distribution centers recorded annual effective rent increases of 0.4%, 0.1% and -0.2%, respectively. Clearly, federal budget cuts and political uncertainty have eroded demand for the region’s industrial space. During the second quarter, only 8 of 47 warehouse/distribution markets recorded negative rent growth; 9 of 47 flex/R&D markets experienced declines in rent.

      Topics: Industrial, Articles, All