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Spec Construction on the Rise in the Industrial Sector, as Demand Remains Strong

Spec Construction on the Rise in the Industrial Sector, as Demand Remains Strong

In light of current high demand for industrial space and favorable cap rates, investors are in buy mode and developers are increasingly engaging in speculative construction, industry sources say.

The U.S. industrial sector experienced a banner year in 2015. Vacancy is currently at a low of 6.1 percent nationally and expected to decline further this year, according to real estate services firm Cushman Wakefield, which also pins the national weighted asking rent at $5.44 per sq. ft. Cushman, Colliers International and CBRE all forecast that industrial rents will continue climbing throughout 2016. Nationwide space availability is at a 15-year low with 9.2 percent, CBRE research says.

“We see industrial as one of the few markets in equilibrium, relatively consistent performance with 2015. Rents will continue to grow in 2016, offset by new supply coming on-line,” says Steven Marks, managing director and head of U.S. REIT research with ratings agency Fitch.

Speculative construction

At this point in the cycle there is not enough industrial space supply to satisfy demand, leading to increased speculative construction. Developers are banking on the fact that if you build it, they will come. Of 175.8 million sq. ft. in industrial space currently under construction, 62.5 percent has been speculative, Cushman Wakefield reports.

“We are seeing a greater volume and ratio of speculation in this cycle,” says John Morris, executive managing director and leader of Cushman & Wakefield’s logistics and industrial services group for the Americas.

There is a higher proportion of supply on the speculative side, agrees Eric Frankel, analyst with Newport Beach, Calif.-based research firm Green Street Advisors. “Spec became more predominant in [the] last two years” says David Egan, head of industrial research for the Americas region at CBRE, adding “We are at the best phase for construction since the cycle started in 2010. There has not yet been a quarter where construction has met demand.”

Buy vs. build

A major question facing investors in buy vs build decisions for industrial properties is figuring out the true replacement cost. Market indices currently favor building. “Right now REITs are much more inclined to build than to buy based on acquisition cap rates," Marks says.

Foreign investment in U.S industrial properties—for which 2015 was a watermark year—is also expected to continue. “More foreign investment has been coming in in that last the two years than we’ve ever seen before, period,” Egan says.

“There has been a lot of foreign demand for industrial properties because of favorable yield differentials and risk-return," says Brian Ward, CEO of asset management services firm Trimont Real Estate Advisors. For example, "E-commerce fulfillment center strategy is really high on Asian capital list.”

Foreign investors are viewing industrial properties as a better asset class than some of the alternatives. That perception should keep foreign capital flowing into the industrial sector this year.

“Capital flow from outside the Americas into the U.S. industrial investment market remains strong. Acquisitions of industrial real estate assets by overseas capital represented about 10 percent of total investment in 2014 and about 35 percent in 2015. With negative interest rates in some overseas markets, the strength of the industrial property market and the overall stability of the U.S. economy, relatively, it is no surprise to see the strong inflow,” says Morris.

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