Deliveries of industrial properties reached record levels during the first nine months of 2018, but demand from retailers, third-party logistics providers (3PLs), and manufacturers was so strong in both primary and secondary markets that vacancy rates held at historically low levels of 4.9 percent, and asking rents for distribution space increased almost 6 percent to an average of $6.15 per square foot.
About 212 million square feet of industrial space was delivered in the first three quarters of 2018, “the largest wave of space delivered in the first nine months of any year,” Cushman & Wakefield reported in its third-quarter ‘US Industrial MarketBeat’ report. Despite the huge supply of new industrial property, 203.9 million square feet of warehouse, distribution, and manufacturing space was absorbed, sustaining the industrial boom that is in its eighth year.
While the current growth cycle began in the coastal gateways such as Los Angeles-Long Beach and New York-New Jersey, as well as inland hubs such as Chicago, Dallas-Fort Worth, and Atlanta, secondary markets including Louisville, Indianapolis, Cincinnati, Charleston, and Nashville are growing faster percentage-wise than the primary markets. Jason Tolliver, head of industrial research, Americas, at Cushman & Wakefield, said organic growth from manufacturing and e-commerce, as well as some spillover in demand from the largest markets, are driving growth in the secondary markets. More than 30 secondary markets have absorbed at least 1 million square feet of industrial space in the first nine months of 2018.
Strong demand for all classifications of industrial space will continue in the coming months.“With 95 percent of the product fully occupied, vacancy rates will stay at the 5 percent level in the fourth quarter of 2018 and in 2019 as well,” Tolliver said. Although average asking rents increased 5.9 percent in the third quarter year over year, demand by users of distribution space is so robust that all property classifications are doing well. “They just need space, so Class B and Class C properties are in higher demand,” he said.
Goal: limit total supply chain costs
Although shippers, receivers, and 3PLs face higher warehousing costs, they are focusing on total supply chain costs, including transportation to and from the warehouses and the cost and availability of labor, in deciding which properties to lease, Tolliver said. Big-box facilities in excess of 1 million square feet are still in demand, but space is getting especially tight in the 100,000-250,000 square-foot market, and even as small as 50,000 square feet, especially in the urban core locations. Smaller properties geared toward the high-velocity needs of e-commerce fulfillment will continue to do well if they are zoned properly by the cities, he said.
Despite the continued strong demand, and the fact that new deliveries are barely keeping up with demand, rents are increasing at a steady but measured pace. “The market is not overheated,” Tolliver said. In fact, when measured on an inflation-adjusted basis, rents are at a lower level than during the previous two growth cycles, he said. Institutional developers looking for steady returns are in control of the market.
The big growth areas that are just beginning to take shape are e-groceries and e-pharmaceuticals. These new online sectors will spur development in the cold-chain industrial real estate market, Tolliver said, and they will create additional business opportunities for 3PLs with end-to-end solutions. “The 3PLs will do well because their value proposition is dealing with complexity,” he said.
With demand increasing, vacancy rates at historic lows, and asking rents steadily rising, developers of industrial properties are moving forward boldly in all parts of the country. Construction starts increased 22.4 percent in the third quarter, according to the MarketBeat report. The Midwest led the way with an increase of 34.5 percent in starts over the second quarter of 2018. Construction activity increased modestly in the South and Northeast, and fell slightly in the West.
Traditionally tight markets are getting tighter, including Los Angeles, with a vacancy rate of 1.4 percent; Orange County, 1.7 percent; the San Francisco Peninsula, 2.6 percent; Central New Jersey, 2.8 percent; and Silicon Valley, 2.8 percent. However, some secondary markets also have low vacancy rates, including Salt Lake City, 2.4 percent; Cincinnati, 2.9 percent; and Jacksonville, 3 percent.
Trump administration tariffs on imports from China, which are scheduled to increase from 10 percent this summer to 25 percent on Jan. 1, 2019, have so far not resulted in a drop in freight volumes, and if anything, moves by retailers and manufacturers to front-load shipments ahead of the tariffs have actually taken up more warehouse space than would have occurred without the tariffs, Tolliver said. However, if the 25 percent tariffs are implemented, the first quarter of 2019 could lessen demand for industrial space. “If that’s the case, Class C properties will get hurt,” he said. However, the growth of e-commerce is strong and is projected to increase by double digits over the next three years, “and that will sustain the market, especially in the high-end products,” he said.
Contact Bill Mongelluzzo at email@example.com and follow him on Twitter: @billmongelluzzo.