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Worst May be Over for Warehouse Market

The nation’s industrial market has been jolted by rising vacancy rates and declining net absorption, but economist Leonard Sahling of Denver-based ProLogis Research Group believes the worst is over, and that net absorption will turn positive by the fourth quarter. Even so, developers aren’t likely to build new warehouses anytime soon.

The overall vacancy rate for bulk distribution space rose from a cyclical low point of 6.8% in the first quarter of 2007 to a high of 10% by the second quarter of 2009, says Sahling, who is first vice president of the research group. The change in vacancy rates over the period amounted to an increase of 320 basis points.

The rise in vacancy reflects the state of the economy, Sahling says. “Here we have the worst recession in the past 60 years, and it’s showing up in our numbers.” Net absorption for the top 31 markets ProLogis tracks was a healthy 141 million sq. ft. in 2007, and dropped to 34 million sq. ft. in 2008. By early 2009, net absorption had gone negative. In the first half of 2009 the change in net absorption is dramatic, amounting to negative 56 million sq. ft.

Over the same period, a similar seismic shift took place with construction starts. In 2007, ProLogis recorded 161 million sq. ft. in new construction starts. In 2008, the number dropped to 92 million sq. ft. But this year, starts suffered a dizzying fall. Through June, they total 5 million sq. ft. “That’s just a pittance,” says Sahling. “We don’t think that pace is going to pick up in the third quarter.” More likely, it will be 2010 before construction resumes, he says.

Asking rents dropped 3.9% in the second quarter, the fifth quarterly decline in a row, according to a midyear report ProLogis issued in late September. At the end of June, asking rents were 9.3% below the cyclical peak in the first quarter of 2008.

Sublease space rises

One measure of the stress in the bulk distribution market is the rising amount of sublease space. In central Los Angeles, for instance, the amount of warehouse space available for sublease in the second quarter this year rose to 3.6 million sq. ft., an increase of 35.2% from the first quarter. In Chicago, available sublease space increased by 38.5% over the same period, to 6.9 million sq. ft., according to ProLogis, a global provider of distribution facilities.

Over the past several decades, although net absorption in the bulk distribution market has dropped during certain quarters, the annual result has been positive, says Sahling. “We see net absorption decline, but it doesn’t usually turn negative. This year may prove to be the exception.” But even if net absorption does turn negative for 2009, at worst it will amount to a 1% decline in total occupied space from 2008, he predicts.

Problems in the warehouse market are not as severe as they could have been, given the deep shifts in the economy since the recession started, the economist notes. The nation’s real gross domestic product (GDP) declined nearly 4% from a cyclical high in the second quarter of 2008 to the second quarter of 2009. During the same period, the demand for distribution space declined by just 1%, he says. “It’s highly disproportionate.”

To an extent, the industry has learned to buffer itself from cyclical swings. During periods of lower demand for space, such as recession, many firms either sublease their warehouse facilities or operate them with skeleton crews and fewer work hours to economize on expenses. But they keep the spaces so that when the market improves their network is already in place. That allows them to quickly gear up to handle more goods traveling to retailers and end users.

In the meantime, as the market waits for recovery, net absorption could be negative again in the third quarter, says Sahling. “But it will be less negative in the third quarter than in the second quarter. My further guess is that by the fourth quarter net absorption will have turned positive. So if we’re not at the bottom of the bulk distribution market, we’re very close.”

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