The Peninsula Industrial Pros

By Randyl Drummer

With demand expected to outpace supply through 2014 and rents finally beginning to rise again, commercial real estate investors are increasingly interested in placing capital in the U.S warehouse sector.”If you look at which sector will be the next for capital to flow, industrial is a very good bet,” said Rene Circ, director of industrial research for CoStar’s Property and Portfolio Research (PPR) who with Senior Economist Shaw Lupton presented the First-Quarter 2013 Industrial Review and Outlook. “Multifamily is a bit too pricy, and the office recovery may be too early in the cycle, while office cap rates are below warehouse cap rates.

“We see more capital flowing into this sector than ever before, and more and more investors are interested in learning about it,” Circ said.

CoStar recorded just under 35 million square feet of positive absorption in the 210 largest metros across the country, with more than ¾ of those markets showing growth in demand.

While that’s down from the 53 million square feet during last year’s exceptionally strong fourth quarter — and still 20-30% below what absorption levels would be if GDP were running at, say, 3% growth — the main encouraging sign last quarter was the miniscule 8.4 million square feet of negative absorption spread across 54 of the 210 markets covered, the lowest since the recovery began.

With very little new space being delivered, demand is translating into quick occupancy gains and a deepening, widening recovery. Average asking rents have finally moved slightly off their recessionary bottom. The industrial vacancy was 8.6% in the 210 largest U.S. markets, down 21 basis points from the fourth quarter and down 91 BPS from first-quarter 2012. In the 54 largest markets tracked by PPR, the vacancy rate was an even lower 8.2%.

Markets with the strongest year-over-year occupancy growth in the quarter were Phoenix, Edison, NJ, and Detroit. Lack of supply pushed rents up in Portland, OR, Indianapolis and the East San Francisco Bay Area. The few markets that saw occupancy losses, such as Lehigh Valley, PA; Indianapolis and the Inland Empire, were mainly due to new product being delivered.

The marketplace is no democracy and the devil is in the details, of course. Picking the right markets and submarkets matters, and their performance varies widely. However, the numbers show that the percentage of U.S. submarkets with rent and occupancy growth is as high as it’s ever been, a clear sign that the recovery is spreading across the country.

Economic Prospects Bright for Warehouse

The employment picture looks promising for industrial properties, with manufacturing continuing to grow and job growth in transportation and utilities outpacing all service-related sectors. Movement of goods measured in truck tonnage is doing well, while intermodal rail traffic was up 5% in the first 13 weeks of 2013 compared to the same period last year, Circ said.

The not-as-good news is the traffic in virtually every U.S. seaport except Charleston is down, and containerized cargo growth measured in TEUs is significantly lower than last cycle. With China’s entry to world trade markets, the change is likely more structural than cyclical, and a return to 2006-07 traffic levels, is probably not likely, Circ said.

However, an important cyclical factor for the industrial market, housing, is finally on the mend. The increased spending, construction and other economic activity that accompanies the housing rebound imply considerably more opportunities for industrial investors in a more markets, Lupton said.

“This is the last piece of the puzzle we’ve been waiting for an improvement in. Households did not stop forming, and we’re adding 1.1 million households, but housing at only half that rate. Even Detroit and Las Vegas are seeing housing starts, and we think that’s going to be a big story for industrial investors.”

Surprising Strength in Mid-Size Box Demand

It might come as a surprise to some investors that newer bulk-distribution warehouses saw little demand decline during the recession, Lupton said.

Warehouses of at least 100,000 square built since 1990 have never posted a quarter of negative absorption, and their total occupied space is more than 200 million square feet above prerecession levels.

For investors, this has presented value-add opportunities in a wide range of markets. However, bigger assets – particularly in regional and national distribution hubs-struggle with new competition. In general, local/regional industrial hubs that tend to get less building post higher occupancies today and have done so historically.

To read entire CoStar article, click here.