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Industrial Hubs See Drivers of Demand Stabilizing

As the market starts a slow comeback, it's being driven by improved fundamentals.

The U.S. industrial market is expecting a slow, sustained recovery for the rest of 2010. Although manufacturing and retail sales have improved, a more robust jobs recovery globally is needed before extended growth can occur in the industrial sector.

The first quarter of 2010 represented the 10th consecutive quarter of rising vacancy rates in the U.S. industrial sector. Indeed, the vacancy rate has risen from 7.9% in the fourth quarter of 2007 to 10.9% in the first quarter of 2010, reports brokerage firm Grubb & Ellis.

Net absorption, a measure of demand, measured negative 160 million sq. ft. in 2009. That unhealthy figure was driven in part by new supply as completions totaled 61 million sq. ft. By the end of 2009, the construction pipeline had less than 20 million sq. ft. under way with starts almost nonexistent.

The average asking rent dropped 6.2% in 2009 for warehouse and distribution space, 2.8% for general industrial space and 8.5% for flex space. The average effective rate for all types of industrial space decreased by 12% as landlords made concessions to tenants, including free rent and tenant improvement allowances.

Following a bruising stretch, however, vacancy, absorption and rental rates are showing signs of stabilizing as the drivers of demand for industrial space — manufacturing activity, freight shipments, global trade and retail sales — have been improving for several months.

Measuring recovery

The industrial market has the ability to rebound faster than other property types. Its short build-out lengths of six to nine months for warehouses and its rebounding fundamentals place the industrial market either first or second among the major property types in terms of how quickly it will recover in 2010, according to Grubb & Ellis.

“There is an increasing confidence in the industrial sector as sales and investment activity has picked up,” says David Birdwell, executive vice president and chief operations officer of IDI. “This confidence in the market at large is creating reserved but positive momentum that is expected to continue through the rest of the year.”

IDI's Birdwell sees industrial markets rebounding before retail and office due to a return in public consumption, which increases warehouse and distribution activity. He also cites the relatively short construction cycle for industrial facilities. Lastly, there aren't as many distressed industrial assets as distressed retail and office properties.

“Rental rates are steady, though concessions are still high,” Birdwell says. “There is increasing absorption of quality buildings in core markets, which in turn will help rental rates stabilize even more in the future.”

Relatively low rents coupled with recently completed transactions — new leases in Class-A logistics properties — have helped turn a corner in major hub markets such as the Inland Empire in Southern California, Dallas, Houston and Harrisburg/Philadelphia. Industrial tenants seek to lock in suppressed rental rates before pricing resistance sets in. However, demand is proving to be geographically uneven as areas like Atlanta, Northern California and Seattle are still experiencing a stall in activity.

In markets where the recovery has already started, such as the Inland Empire, an increase in leasing activity has meant that rental rates are at or near a bottom. However, significant concessions are expected to remain in place for at least the near term in stagnant markets with vacancy rates far above equilibrium.

It will take time for industrial tenant demand to fully emerge from this downturn as caution prevails for the remainder of 2010. However, industrial owners are still spurring activity with decreased rents and tenant concessions. Their hope is to secure more long-term tenants, and spur on the recovery.

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