Developers don't show any signs of easing up on new industrial projects, with steady demand coming from both space users and investors looking to acquire industrial assets.
Despite a big year of development in 2017, vacancy rates continue to point to a healthy balance between supply and demand. “Throughout this expansion period, development has been very controlled relative to past cycles, so you haven't necessarily seen a lot of overbuilding,” says Aaron Ahlburn, managing director of industrial and logistics research for JLL in Los Angeles. In fact, JLL data shows that the average U.S. vacancy rate dipped to 4.8 percent at the end of first quarter, which is 260 basis points below the low point in the last boom cycle that occurred pre-recession.
“We also have been seeing good pre-leasing rates. That lends credence to the fact that a lot of the new development is getting leased up at this stage of the cycle,” Ahlburn says. As of first quarter 2018, JLL was tracking 230 million square feet of industrial space under construction. Nearly 80 percent of that pipeline is dominated by small to midsize buildings ranging from 50,000 to 500,000 sf.
Although e-commerce continues to garner much of the attention in the industrial sector, demand for space is being fueled broadly by strong consumer spending and steady economic expansion. Consumers are shopping both online and in traditional stores, which is spurring activity along the entire supply chain. For example, Nashville is benefiting from its strategic position as a logistics hub serving the eastern U.S. Nashville continues to attract major third-party logistics providers including Geodis, XPO, and Federal Express, as well as large retail distributors such as Amazon, Lowes, and Under Armour.
“Nashville's growth continues unabated,” says Sue Earnest, CCIM, a principal at Avison Young in Nashville. At the end of the first quarter, vacancies remained at a low of 4.1 percent, with about 3.9 million sf under construction. Projects are underway in almost all the surrounding counties in Nashville by developers such as Panattoni Development Co., Distribution Realty Group, Huntington, and Ridgeline, among others. About 80 percent of the new space being built is speculative, with leasing activity following the old movie line from Field of Dreams, “if you build it, they will come,” Earnest says.
Developers Keep Foot on the Gas
Construction activity has been fairly robust for the past five years, and developers don't appear ready to tap the brakes. “The market remains very active. 2016 and 2017 were banner years for us, with 2018 looking equally strong,” says Angie Wethington, CCIM, JD, a director at Scannell Properties in Indianapolis. “We saw a slight slowdown in activity in the market in April/May of this year, but activity has picked back up, with build-to-suit RFPs coming in across the country and spec space that is leasing up during construction,” she adds.
Several factors are contributing to demand for new industrial space. The explosive growth of e-commerce certainly has played a major role. Online sales grew by 16 percent to reach $453.5 billion in 2017, according to data from the U.S. Commerce Department, and some industry forecasts are predicting an even higher growth rate this year.
One of the notable trends within e-commerce is expansion occurring within online grocery and food sales, which is driving demand for refrigerated/freezer space with facilities that are located closer to the end user, Wethington says. Infill locations are critical to answer that last-mile need, while suburban greenfield development continues to be active for the larger square footage requirements ranging from 500,000 sf up to over 1 million sf, she says. In addition, there is continued demand for more nodes that bridge the gap between the large 1 million-plus sf warehouses and the infill urban logistics locations, she adds.
“We're not seeing any slowdown in the demand for industrial in any of our markets,” agrees Jason Conway, CCIM, director of real estate development at Opus Development Co. in Minnetonka, Minn. Opus currently is developing about 4.5 million sf of both speculative and build-to-suit industrial space in Phoenix, Denver, Chicago, Minneapolis, Cincinnati, Indianapolis, Milwaukee, and Kansas City. For example, Conway is wrapping up the third spec industrial project the firm has built in Des Moines, Iowa, in the past few years, featuring a 200,000-sf warehouse with 32-foot clear ceiling heights.
Des Moines sits at the confluence of I-35 and I-80, which provides a good access point for companies distributing goods throughout the Midwest. “We're seeing not only local companies, but regional and national tenants that are actively looking for space in the Des Moines market,” Conway says.
Construction Activity Widespread
Development traditionally has been concentrated in the big five industrial hubs - New York/New Jersey, Chicago, Atlanta, Dallas, and the Inland Empire, and those industrial centers remain a key area of focus for developers. “From those locations, you can pretty much service 95 percent of the population within two days. That is really a catalyst for most major retailers to have distribution facilities in those areas,” says Matt Powers, CCIM, executive vice president of JLL's Retail/E-commerce Distribution Group in Chicago.
The desire to locate closer to population centers and last-mile delivery continues to influence location decisions. That being said, activity is widespread across the country. Supply chains need to supplement major national distribution facilities with other regional facilities. For example, retailers can't service Miami from a distribution center in Atlanta, so they have secondary locations in Miami or nearby Orlando, Powers says. “The size of warehouses may be shrinking in some of these locations, but the demand is fairly consistent for national-level retailers,” he says.
In addition, individual markets have their own unique drivers for demand that go beyond consumer-driven supply chains. Heavy industrial has been booming in southwest Louisiana, with more than $50 billion in new construction projects coming to the market, primarily concentrated in large, capital-intensive projects, says Andrew Vanchiere, CCIM, SIOR, commercial sales and leasing agent at NAI Latter & Blum in Lake Charles, La. Some of these projects, which largely are driven by liquefied natural gas (LNG) exports and chemical manufacturing plants, will be flipping the on switch in the not-too-distant future, he says.
The second half of 2018 and into 2019 potentially will bring another $25 billion or more in various stages of front-end engineering and design, Vanchiere says. Activity in the heavy industrial sector is being fed by abundant and inexpensive natural gas, as well as the region's proximity to the 40-foot deep Calcasieu Ship Channel leading into the Port of Lake Charles.
Heavy industrial activity is trickling down to drive light industrial land use and office warehouse deals. Currently, about 1,000 acres of light industrial facilities are either existing, underway, or available, with shovel-ready sites in the area. For example, NAI Latter & Blum is marketing the Calcasieu Industrial Park in Sulphur, La. The more than 100-acre industrial park kicked off in 2016 for spec and build-to-suit developments and has since broken ground on three spec industrial buildings. The first project is nearing completion and a fourth project will start later this year.
Utah is gaining attention for its growing Silicon Slopes tech sector in north Utah County. That tech sector is fueling demand for flex/research and development space to accommodate companies that are looking for office for front-end operations, along with R&D and warehouse space. Demand from the tech sector also is driving changes to the type of flex space that is being built, says Mary Street, executive vice president at Colliers International in Pleasant Grove, Utah. New flex buildings are being built with much higher parking ratios to the higher office and R&D use. Traditionally, local flex/R&D buildings would have one to two parking stalls per 1,000 sf, and now that ratio is as high as seven to eight per 1,000 sf, she adds.
The area is attracting cutting-edge firms that also are pushing more tech into industrial facilities. “Automation has become incredibly important in our area. Most warehouses are focusing on innovation, technology and energy efficiency,” Street says. Modern warehouses being built are featuring everything from wireless computer systems running conveyor belts to robots that are retrieving and handling packages and goods. “Technology is a critical component to our industrial growth,” she says.
Developers Navigate Market Hurdles
Developers continue to battle the usual challenges that include rising land and construction costs and obstacles to getting land entitled. For example, the industrial warehouse space vacancy rate in Utah County is at 3.4 percent. “With vacancy this low, you'd expect to see more construction on speculation. However, new construction is lagging way behind demand for product,” Street says.
One reason is that construction costs across the board are at an all-time high thanks to high levels of construction in the areas across the board in residential and commercial property development, which are straining supply of materials and workers. Utah's land costs also are increasing due to the demand and limited supply, Street adds. It has been a challenge to get industrial users to commit to sign leases 12 to 18 months ahead of a project completion. Given the fact that it is more expensive to build than it ever has been, that discourages a lot of developers from building spec, because they don't want to gamble, she says.
Developers are keeping a close eye on Washington and the rising costs of building materials that could emerge due to a trade war. The Trump administration announced in late May that it would impose tariffs on metals imported from Europe, Canada, and Mexico. “We're very cost-sensitive, and we're watching commodity prices, especially with all of these tariffs and the current politics that may influence the price of steel and concrete and everything else,” Conway says. It's hard to tell what's going to happen in the near future, but that could certainly become an issue, he adds.
Another challenge for developers is that tenants in many markets are reluctant to commit to lease space until projects are nearing completion. “We have responded to a number of RFPs on build-to-suit projects, but what we have found is a lot of the RFPs are exploratory and never completed or acted upon. Where we have had success is in leasing the spec buildings very close to completion,” Vanchiere says. “Once we have got slab on the ground and steel in the air, companies take notice and they can see time to market in terms of how quickly they can be in a facility,” he says.
Space users think they can go to a market and be able to find space. What they're finding is that they will go to a market, but the space that they need - whether it is the amount of space, type of space, or the way they need it configured - is not readily available, Conway says. “I think a lot of users could do themselves a favor and give themselves a little more time to find the space that they need,” he adds.
Given the demand and low vacancies in many metros, that scenario isn't likely to change any time soon. Earlier planning will continue to be key for end users, especially those that are looking to locate in new facilities.
Investors Compete for Industrial Assets
by Beth Mattson-Teig
Industrial remains the flavor of the month for investors.
The biggest complaint for many is not the continued cap rate compression, but
rather the limited supply of quality assets available to buy.
Sales remain robust even as for-sale properties become
harder to find. Rising prices helped to spur year-to-date sales volume through
May to $30.5 billion. That volume is just shy of the high watermark of $33.6
billion set in 2015, but is well ahead of the pace set in 2016 and 2017 at 26
percent and 15 percent, respectively.
property acquisitions are on top of my short list of property types that
interest me and my group,” says
Kamil Homsi, CCIM, president of Global Realty Capital in New York City.
However, scarcity of industrial assets for sale in high-demand markets, such as
the Northeast, compressed cap rates, and available capital are driving
investors to new markets that were not on their radar screen a few years ago,
Global Realty Capital is most interested in assets located
in secondary markets due to the more-attractive cap rates and yield spread
relative to primary markets, as well as the growing demand in secondary markets
that is being fueled by e-commerce. “We
are yield-driven, and are finding plenty of opportunities in midsize warehouses
ranging in size from 100,000 to 350,000 sf built in the last 15 years that meet
the tenant requirements of proximity to highways and thoroughfares, ceiling
height, sprinklers, loading docks, etc.,”
Despite rising interest rates, avid buyer demand continues
to put pressure on property sale prices. May sales data shows that prices rose
10.8 percent year-over-year, with cap rates dropping 40 basis points to average
6.4 percent, according to Real Capital Analytics.
Yet investors are finding a competitive marketplace even in
those secondary and tertiary markets. In Indianapolis, for example, cap rates
have continued to compress, with record-setting lows around 5.5 percent, notes
Angie Wethington, CCIM, JD, a director at Scannell Properties in Indianapolis.
For example, Granite REIT bought a 600,000-sf bulk warehouse facility in
southwest suburban Indianapolis for a reported $66 psf and an estimated cap
rate in the low 5 percent range, she adds.
Investors are looking to buy assets in secondary and
tertiary markets like Des Moines or Minneapolis, where they can get
investment-grade assets with good credit and terms, but the prices are not as
high as a bigger market like Chicago, agrees Jason Conway, CCIM, director of real
estate development at Opus Development Co. in Minnetonka, Minn. Opus is a
merchant builder that is actively building in markets such as Phoenix, Denver,
Chicago, Minneapolis, Cincinnati, Indianapolis, Milwaukee, and Kansas City. “We see investors with quite an
appetite to continue to acquire well-located industrial assets that have good
credit tenants and good terms,” he