CoStar presented their quarterly report for Industrial Real Estate on the national stage.  They present their quarterly findings based upon not only their own research, but that of other analytic companies such as Moodys and government entities like the Federal Reserve.  We’ll break down the graphs and highlights of the presentation and also show how local California Commercial is faring compared to the rest of the country.  Overall there seems to be a tug-of-war between the bears and bulls with some good news and bad news as it applies to the past quarter and also the near future.  Let’s break down the facts.

Business/Consumerism

First, let’s start with some good news.  As we begin to enter the Holiday season, many retailers are holding their collective breaths as the shoppers warm up the plastic and head to the 6am sales.  There has been a steady uptick in retail sales since the collapse in 2009 and this should continue into Christmas, although many believe the season will be driven by bargain hunters.  Many families have weathered the storm and personal savings are on the rebound.  If this stays steady then we could be in for a strong rebound for consumer durables.  Old cars in the driveway, springs coming out of the mattress, and older TV technology could have the consumer asking themselves, why not?  The consumer durables pent up demand seems to be a loaded gun ready for the right economic trigger.  This could bode well for manufacturers and importers over the near future.

While consumers have been stockpiling cash waiting for some good news, corporations have spent the past couple of years rethinking, reorganizing, and trimming the fat.  Many organizations have streamlined operations and found ways to do more with less of a workforce, increasing corporate profits.  We keep hearing about companies that are cash rich and sitting on profits and that makes for an interesting dichotomy.  Obviously the bad news is that the profits are not being reinvested and circulated into the economy, therefore keeping unemployment high.  The flip side is that corporations are going to be in a better position to weather any downturn in the economy, should that come to fruition.  For commercial real estate this means that there should be less defaults on debt and leasing if the economy heads south.

Furthermore, although there is a slight downturn in government jobs, the private sector is beginning to make gains, although not at the pace one would hope.  Moodys has a positive outlook on job growth, which is great for all economic factors and commercial real estate.  That being said, we have a long way to go to catch up to the jobs lost over the past three years.

Commercial Real Estate Factors

We’ve laid out the potential for economic expansion and job growth, if current trends continue.  Should we see this uptick on the demand side, there could be a potential for explosive growth on the construction side of Industrial real estate and here’s why:

Over the past couple of years, new construction has come to a near standstill across the country.  The average construction start has been in the 125,000 sq foot range for larger distributors/suppliers and there has been a shortage of smaller projects.  Also, there have been virtually no speculative commercial starts, with nearly all of the new construction coming in the way of build to suits and pre-leased spaces.  With the economy in tatters, it only makes sense that builders are going to start swinging hammers on a sure thing.  In 2008, approximately 40% of new construction was spec and today’s rate sits at about 10%.  The second graph is great news if you are in construction or are an industrial investor.  Vacancy for industrial has not been as wild as some of the other commercial sectors, such as hotel and retail nationwide.  That means that we haven’t seen a glut of available space in the market overall when compared to other commercial types.  This factor coupled with a lack of new construction means that we could see construction and pricing pressure, should increase for demand continue.

Are you an industrial investor?  Soon you could be patting yourself on the back.  As demand for warehousing grows, industrial investors could be in a prime position.  Traditionally, industrial real estate has not been as sexy as the other commercial sector types.  The thought of being a hotel mogul or owning a high-profile office building has usually been more appealing than the idea of owning a dirty distribution center or manufacturing facility.  But let’s look at the facts.  As you can see from the “Distress by Property Type”, the sexy investments are usually the first to fail.  Why is that?  Typically the shorter the lease term, the greater the risk.  Think about it.  Hotels lease out their space on a daily basis, meaning you could have vacancies as early as tomorrow.  Multi-family, although a hot commodity now, has short lease terms, usually on a yearly basis, meaning that you can have major turnover every 12 months and declining gross income.  Industrial leases are typically a longer term and have more stable tenants.  Owners that signed 5- year leases in 2008 are still sitting pretty and collecting rents, as long as their tenants did all right.  This point is re-emphasized when you look at the players that are beginning to look at industrial real estate, such as life insurance companies which traditionally stayed in the office arena:

Industrial Analytics

And now you can see why the fundamentals may be in place for a run on industrial…

We have seen positive absorption of industrial space for the last 6 quarters nationally, Northern CA being no exception.  The inverse relationship between vacancy rate and quoted rents is seen in graphs above.

It can’t be said that rents are on the fast track to increase, despite the consistent positive absorption and general lack of available space.  There have been several landlords who have been sitting on vacant space and would rather keep their rents competitive.

So where are the hot spots for Industrial nationally?

As far as markets exploding, the Inland Empire in Southern California has seen the greatest amount of growth among all markets in the US in net absorption.  They have also posted well in sales volume, which only makes sense when you follow the money.  The San Francisco Bay Area hasn’t been a slouch either.  With its traditionally stable economy, the Bay Area is usually one of the first markets institutional investors look to when putting cash in on commercial real estate.  We’ve seen this not only in industrial, but also in office buildings.

Conclusion

We don’t mean to paint a completely rosy picture of the industrial real estate market.  To be sure, we are cautiously optimistic.  Will continued high unemployment take its toll on retail and manufacturing?  Negative consumer sentiment is on the rise, how will this affect the economy?  Will the proposed ‘Cap and Trade’ have potentially negative consequences for U.S. business?  There are too many variables at play in the current economy to make any predictions and there are no crystal balls in commercial real estate.  Yet, the positive news is that there seem to be some stable fundamentals in place should the economy perk up.

What do you think?  Will we continue to see positive signs for growth, or will economic factors hamper a potential rebound?