With Demand for High Quality Bulk Warehouse Space Expected to Continue Through 2014, Rents Are Finally Rising In Most Markets
With a burst of positive absorption in the fourth quarter, demand for U.S. warehouse space
moved from the recovery to the expansion phase in late 2012 as rising occupancy rates and limited new construction helped push rents a bit higher across a majority of markets.
Positive net absorption of warehouse space spread across the country, causing the U.S. vacancy rate to decline 30 basis points in the fourth quarter to 8.9% among the 210 markets tracked by CoStar, according to the company's 2012 Year-End Industrial Review and Outlook in a presentation by Rene Circ, director of industrial research for CoStar's Property and Portfolio Research (PPR), and Senior Economist Shaw Lupton.
CoStar markets logged 103.8 million square feet of net absorption in 2012, with positive space absorbed in 151 markets accounting for 120.7 million square feet and 59 still reporting negative absorption totaling an extremely low -16.6 million. The 7 million square feet of negative absorption in the fourth quarter was the lowest quarterly total since 2005.
Although leasing ticked up in the fourth quarter, current market sentiment suggests leasing velocity remains weak. However, the two real estate economists noted, conditions appear ripe for leasing improvement as both tenant move ins and move outs are running below their historical averages. CoStar believes those conditions will eventually set the stage for new demand growth and stronger net absorption next year, Lupton said.
"On net, this was a landmark [fourth] quarter in the sense that we’re finally in the black in terms of overall demand," Lupton said. In addition to demand gains in larger, newer building coveted by national distributors, "we’ve just recently started to see increasing improvements in the rest of the market as demand spills over in the widening economic recovery, including an improvement in the housing market."
"After everything the industrial market’s been through in this cycle, including the worst demand losses on record, this is one of the reasons we like this sector in a slow-growth economy," Lupton said.
"On the demand side, we’ve finally moved from the recovery period to the expansion period," Circ added. "There’s starting to be more activity in that smaller, older space."
Demand Fundamentals Gaining Steam
That said, 2012 was not a stellar year for absorption, at least compared with the mid-2000s, when quarterly absorption totals regularly exceeded the total for all of last year. But the fourth quarter accounted for 53 million square feet, or more than half of last year’s total.
Another strong example of improving warehouse fundamentals is the 80 basis-point decline seen in the U.S. vacancy rate at year-end 2012 of 8.9%. Among the 54 largest U.S. markets, the vacancy rate fell 40 bps to 8.4%, reflecting the stronger demand among national retailers and logistics companies.
Phoenix, Seattle, Chicago and Detroit led year-over-year occupancy growth at rates ranging from 1.6% to 1.8%.
Circ said the warehouse market has come a long way from peak vacancy rates in the mid-10% range in 2010. Fourth-quarter demand growth jumped well above the 20-year historical average of 0.4%. CoStar is forecasting that national warehouse demand should exceed available supply for another 12 to 18 months before vacancies hit bottom and start to rise again as speculative construction ramps up.
Warehouse Rents Have Turned The Corner
Asking rents averaged $4.69 per square foot nationally at the end of 2012, 1% higher than 2011, with 60% of the rental gains captured in the fourth quarter. Among the 210 CoStar markets, asking rents improved in more than half, a significant improvement over 2011.
Among the 54 largest U.S. markets where big-box warehouse stock comprises a larger percentage of the total inventory, rent growth was even more widespread, with increases in about 65% of markets.
The growth of national retailers seeking to increase their distribution channels and the expansion of third-party logistics firms as a result of corporate outsourcing has generated continuous demand growth since 2008 for large modern warehouses built since 1990 of greater than 100,000 square feet, CoStar statistics show.
While the supply of available smaller and medium-sized warehouses still often doesn’t justify new construction in many markets, the number of blocks of super-large big boxes of 500,000 square feet and above has dwindled to below pre-recession levels. Developers are scrambling to meet the demand for these ginormous new spaces, Lupton said.
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Newer, bigger buildings capable of attracting top credit tenants have seen occupancies recover much more rapidly than the broader market and are expected to generate some of the strongest income growth for investors, who are baking rent growth into their investment decisions in certain markets such as Miami and Houston, leading to strengthening capital flows.
That income growth is sustainable -- as long as the rush by developers to build new supply doesn’t derail rent growth in those markets, Lupton said.
Based on recent history, that’s a big assumption, and CoStar analysts believe there’s a significant upcoming oversupply risk in this larger "superior" segment of the market.
... But For Now, Most Developers Showing Restraint
Despite the demand for big boxes, construction has remained anemic in most markets, with only 52.5 million square feet of new space delivered during 2012, and only 40.4 million square feet under construction at year's end.
Compared to the previous cycle when hundreds of millions of square feet of speculative construction drove vacancy rates into double digits across the nation, the vast majority of new supply this time around are either strongly pre-leased or build-to-suit projects.
The latter includes more than a dozen huge fulfillment centers actively under construction or planned by Internet retailer Amazon.com in numerous markets from coast to coast. In January alone, Amazon announced plans to build massive new distribution centers in California and Texas,
and in Robbinsville, NJ.
The Inland Empire had 6.68 million square feet under construction at year end, followed by 4.25 million square feet in the I-78 corridor in Pennsylvania 3.3 million square feet under construction in Phoenix, where the housing market is starting to recover.
In Pennsylvania’s Lehigh Valley, five large buildings were completed in 2012 totaling 3.27 million square feet, while 3.87 million square feet was delivered spread across 86 buildings in Houston, the second-leading market for completions behind the Inland Empire’s 6.78 million.
In most markets, however, rental rates still don’t justify new construction for all but the largest big boxes. Most of the new projects now under way have already accounted for on balance sheets by REITs and other cash-flush developers.
While developers have now proposed some 160 million square feet of new supply, rents will have to rise in some markets before many projects break ground, and that is expected to take some time, Circ said.