Rising Demand For Industrial Real Estate


The leasing market for U.S. industrial real estate continues to show improvement but is not yet on fire. Rent declines are decelerating as consumer spending picks up, available warehouse and distribution space is absorbed, and companies emerge from the recession in growth mode. That’s the consensus of CoStar analysts, corroborated by recent reports from executives at the world’s two largest warehouse and distribution operators, ProLogis (NYSE: PLD) and AMB Property Corp. (NYSE: AMB).The U.S. just recorded its fourth straight quarter of positive absorption, posting 27 million square feet in the first quarter, compared to a negative 15 million square feet in first-quarter 2010.Absorption levels have reached roughly 2003 levels when the country was emerging from the previous recession.In fact, the current early stage recovery in industrial real estate is actually more robust than at the same point in the last recovery, with nearly 80 million square feet absorbed over last four quarters — about four times the amount filled during the early 2000s recovery period. Vacancies have once again edged below 10%.”Overall, the steady recovery in industrial real estate continues,” said Walter Rakowich, co-chief executive officer of Denver-based ProLogis, during the company’s recent first-quarter 2011 earnings call with investors. “And while issues such as sovereign debt concerns, rising energy costs, military actions and the devastating earthquake in Japan contributed to some deferrals of customer leasing and development decisions, we remain encouraged by the continued firming of market fundamentals that we’re seeing.”

The improved supply and demand metrics are starting to impact quoted warehouse rents. While still falling year over year, the rate of decline slowed further in the first quarter.

Rakovich said Denver-based ProLogis is beginning to see rents begin to rise in some markets, albeit by a modest amount. Rent declines should be in the single digits in 2011 and could even turn positive next year.

That said, leasing is only “good, not great,” with a few markets plagued by weakness stemming from the double-dip housing downturn, such as Los Angeles and Northern New Jersey, still experiencing some negative absorption. Gains in absorption of big-box warehouse space in national distribution markets are being offset to some extent by losses in smaller buildings in distribution markets with closer ties to bearish local economies.

The improving but not exceptional first-quarter leasing report was reflected in the first-quarter results of ProLogis and AMB, which are expected to close the largest industrial REIT merger in history by the beginning of next month.

Global leasing volume in Denver-based ProLogis’s direct-owned portfolio was down roughly 15% compared with first-quarter 2010, and the company ended the quarter with occupancy at 90.7%, down from 92% at the end of the fourth quarter.

However, AMB teams leased a record 8.9 million square feet worldwide — the highest level for the first quarter and the second-highest level for any quarter in the company’s 27-year history, said Hamid Moghadam, co-founder, chairman, CEO and president. The company ended the quarter at 92.8% occupancy, a 90 basis-point drop from year-end 2010 and materially better than the 100 to 150-bps decline the San Francisco company had forecast.

CoStar reported that most U.S. markets saw positive net absorption in the first quarter, led by Chicago at 5.9 million square feet, Indianapolis with 3.2 million sf and inland Southern California’s Inland Empire at 2.9 million sf. Those markets were followed closely by Detroit and Philadelphia, each 2.8 million square feet; Atlanta (2.6 million sf) and Dallas-Fort Worth (2.4 million sf).

Along with improving corporate profits and consumer spending, another reason for the improved absorption and vacancy numbers over the last year is the complete shutdown in development. With new supply at the lowest levels on record, absorption is having an immediate positive impact on fundamentals. New building deliveries as a percentage of total building stock, which averages 2.5% annually long term, stands at near zero, CoStar said.

And 2011 won’t see any more new supply hitting the market than 2010. Quarterly construction starts are also at all-time lows, with just 3 million square feet in the first quarter, compared with quarterly numbers ranging from 40 million to 64 million square feet through most of the last decade, according to CoStar data. ProLogis and AMB, the two largest developers of warehouse and distribution space, have few new projects slated for the U.S., and no spec projects.

Most of the few projects moving forward are smaller buildings — virtually no big boxes — and most are built to suits or pre-leased. The average size of industrial buildings under construction currently is 63,000 square feet.

That could begin to change a year or so down the road. It is noted that several large markets have only two or three blocks of space of 200,000 to 300,000 square feet or above in certain submarkets.

“When those are gone a year from now, we’ll need to have some new supply or [companies] will move to other submarkets,. “With interest rates low and corporate profits high, my bet’s on new supply.”

For now, however, not a single significant construction project broke ground in the most recent quarter in more than half of U.S. markets. Those that led the nation in construction, including Raleigh/Durham, NC, and the Inland Empire, did it on the basis of one large fully leased build-to-suit project.

The Inland Empire, which showed one building of less than 600,000 square feet in progress, regularly saw annual construction starts of 20 million square feet a year during the market peak.

ProLogis’s Rakowich said while he expected to see more speculative starts this year, construction has “not picked up meaningfully.”

“Maybe we will [see an increase] in the second half of the year. But starts have actually been quite slow in the U.S. over the course of the last couple of quarters. I don’t think we’re going to see much speculative development here for the next 12 months.”

The number of U.S. submarkets with declining vacancies has reached all-time highs in recent quarters due to low supply, but that number declined a bit in the first quarter.

The Inland Empire by far saw the sharpest year-over-year increase in occupancy rates at 2.4%, with Cincinnati, Philadelphia and Indianapolis a distant second at around 1%.  Following the normal pattern of recovery, quoted rents are still falling year over year, but the rate of decline is slowing, Spivey noted.

CoStar forecasts another couple of years of low supply followed by a slow ramping up of development. Demand should remain robust through 2015, though lacking as much positive absorption as the early 2000s cycle. Vacancy rates should go down to just over 6% — about the level at height of the warehouse boom market in 2000. (credit, r,drummer-co-star)

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