16/04: Warehouse Vacancy Up Sharply as Industrial Demand Plummets
Category: King Industrial Realty
Posted by: Wilson
Demand for warehouse and distribution, manufacturing and flex space plunged in the first quarter -- and economic data analyzed by King Industrial Realty suggests that the descent will continue for some time. In the first three months, the amount of negative net absorption of U.S. industrial real estate spiked to its highest level since the dot-com bubble burst in 2000, and the national vacancy rate is poised to move into double digits for the first time since the mid-1990s, two recessions ago.
The U.S. industrial vacancy rate hopped from 8.9% at the end of 2008 to 9.35% in the first three months of 2009. Tenants, meanwhile, gave back a whopping 48 million square feet of industrial space in the first three months -- the largest negative absorption posted in one quarter since 2000, according to King Industrial's Point of Veiw First Quarter 2009.
And this is expected to be just the beginning. Industrial production, consumer spending and imports/exports are all down sharply. Employers have shed 5.1 million jobs since the end of 2007, including 2.1 million in first-quarter 2009 alone -- far higher job losses than the previous recession. CoStar Group's analysis projects that as a result, 100 million square feet of industrial space will be returned to the market, pushing the national vacancy rate to 11.2% by the end of next year.
That said, the situation could be much worse for industrial property professionals -- they could be office landlords or brokers.
"The vacancy rate is higher than we saw during the dot-com era, but given the size of the industrial market, it's not an alarming vacancy rate," said Jay Spivey, senior director of research and analytics for Bethesda, MD-based CoStar, who delivered the industrial report and outlook to clients in a webinar presentation this week. CoStar tracks almost 22 billion square feet of industrial space making up about half of the nation's commercial real estate.
"Steep job losses and the significant decline in home prices have significantly reduced demand for goods, and as a result, goods movement," said Alan Pontius, senior vice president and managing director with Marcus & Millichap Real Estate Investment Services. "While there were markets in the dot-com bust that recorded very weak fundamentals, including San Francisco, Austin and Boston, the current downturn is far more widespread throughout the nation."
The weakness in trade flows, which directly affects supply chains, has been especially severe, said Peter P. Kozel, senior managing director and chief of research with FirstService Williams.
"The combined total of imports plus exports declined by 8.41% from the fourth-quarter of 2007 through fourth-quarter 2008, and the largest decline in the 2001-2002 period was 7.69%," Kozel tells CoStar Advisor. "The drivers for the industrial sector are profoundly weaker now than they were [seven or eight years ago]."
The market is not without a couple of bright spots, however -- and one of them is the sensible supply of new inventory, which remains in check relative to the great industrial building booms of the 1980s and ‘90s. Although pre-leasing of new projects is weaker, developers delivered only 34 million square feet of space in the first quarter -- a mere 0.1% of total industrial inventory, Spivey noted.
"Things have throttled down dramatically. We’ve gone from 55 million to 38 million square feet under construction; that is completely unprecedented," Spivey said. Even after the dot-com debacle and subsequent recession, there was never less than 88 million square feet under construction in any given quarter, he said.
When will construction pick up? Not any time soon -- the amount of available space on the market, much of it at reasonable rates, will first have to be absorbed before most tenants will consider paying a premium for new space, Douglas P. Frye, CEO and chairman of Colliers International, told Advisor.
Sales: Activity Way Down, Prices to Follow
Like other investments hurt by lack of access to capital, industrial sales volume is down about 83% over the last 18 months, Spivey said. Properties are now sitting on the seller's block for an average of 370 days, compared with 288 days in mid-2007, during the last gasp of the previous market boom.
Spivey believes activity probably can't and won't fall much further. Michael J. Ferrara, an investment sales specialist with Sutton & Edwards Inc. in Lake Success, NY, saw a change in investor behavior beginning at the end of last year.
"Back in November and December, most of the investors I spoke to were just sitting on the sidelines and telling me to follow up with them in three to six months," Ferrara said. "Now, these same investors are telling me to send them the information and seem to be getting their feet back in the water."
Cap rates, compressed during the mid-2000s price runup to a decade-low 5.8% a year ago, have since risen 130 basis point to about 7.1%. CoStar projects that cap rates could rise a total of 400-500 basis points over the next couple of years.
One bright spot for the industrial sales market so far is that average per-square-foot prices have eroded only about 17% from their first-quarter 2007 high -- relatively stable compared with the 50% drops seen in the office market, Spivey said. "We’re still well above the historical average in terms of prices."
The down side of that: prices still have a ways to fall, as much as 60% over the next two to three years. "If we can get to a bottom in terms of prices, we’ll start to see activity come back -- but not until we get to that bottom," Spivey said.
The bottom has so far eluded risk-adverse buyers and sellers in the last few months. Debt capital is more difficult to come by, particularly on larger deals, as lenders have heightened scrutiny on the quality of both the property and the borrower, and raised debt-service coverage requirements, Marcus & Millichap's Pontius said. Some buyers are looking for distress fire sales that have yet to materialize. Many owners, meanwhile, are electing to try and ride out the downturn rather than sell at depressing prices. Eventually, however, "buyers will win this chicken fight," Sutton & Edwards Inc.'s Ferrara predicts.
"When you have that huge gap where the seller won’t go above a 7% cap and a buyer won’t go below an 8% cap, the result is a freeze in executed transactions," Ferrara said. "However, eventually the sellers are going to have to raise the cap rate once they realize they have no choice but to sell or have the bank take over."
"We believe this is just beginning. Rents are eroding well below pro forma numbers and vacancy rates are going up. Without job growth, we will not see a bottom. And even if the market is getting close to a price bottom, it is not clear that the market will recover from that bottom anytime soon."
Absorption Goes Negative
Gross leasing activity dropped significantly and across all geographic markets to 82 million square feet in the first quarter -- about half the volume of the same period a year ago, according to King Data. Negative net absorption skyrocketed.
"So far, the three quarters of negative absorption we’ve seen recently is cumulatively more than we saw during the whole dot-com [collapse] back in 2000," Spivey said.
As dismal as those figures are, they're better than the numbers coming out of the office sector, which hasn’t yet given back space proportionally to the massive job losses sweeping the nation's financial industry. Those job losses suggest that the office sector should be posting 100 million square feet of negative absorption at present rather than the minus-20 million square feet reported last quarter, Spivey said.
The rising number of property listings by owners on CoStar also reflects the softening demand. If the current pace holds, almost 1 million new listings will be added this year across all property types, including nearly 48,000 industrial listings in the first three months alone totaling 640 million square feet -- the vast majority made up of relet and sublet space shed by tenants. The top five owners of industrial property alone -- ProLogis, First Industrial Realty Trust, AMB Property Corp. and RREEF America LLC and Duke Realty -- are listing a total of about 120 million square feet.
Colliers' Frye said anecdotally that receptionists in the company's Phoenix, San Diego, Los Angeles and Seattle offices report a higher level of inbound phone traffic recently, while industrial agents are reporting an uptick in prospective tenants looking at properties, taking presentations and making offers.
The industrial vacancy rate has jumped from about 8% to 9.35% in just a year. But as ominous as that number is, the amount of total space available and actively being marketed on CoStar -- some of it vacant, some of it occupied but soon to be empty -- is rising even faster, now standing at 18%. The amount of sublet space being marketed is much greater than the amount that’s actually vacant, suggesting that tenants will exit even more space in coming quarters, Spivey said. Properties are sitting on the rental market an average of 400 days before they’re leased, compared to 345 days a year ago.
Among the nation's 20 largest industrial markets, the Inland Empire region of Southern California saw its year-over-year vacancy rate jump 400 basis points to 12.3% in the first quarter as developers delivered another 3.3 million square feet. Long Island, NY, edged out Los Angeles as the market with the tightest vacancy rate at 4.2%.
The U.S. industrial vacancy rate hopped from 8.9% at the end of 2008 to 9.35% in the first three months of 2009. Tenants, meanwhile, gave back a whopping 48 million square feet of industrial space in the first three months -- the largest negative absorption posted in one quarter since 2000, according to King Industrial's Point of Veiw First Quarter 2009.
And this is expected to be just the beginning. Industrial production, consumer spending and imports/exports are all down sharply. Employers have shed 5.1 million jobs since the end of 2007, including 2.1 million in first-quarter 2009 alone -- far higher job losses than the previous recession. CoStar Group's analysis projects that as a result, 100 million square feet of industrial space will be returned to the market, pushing the national vacancy rate to 11.2% by the end of next year.
That said, the situation could be much worse for industrial property professionals -- they could be office landlords or brokers.
"The vacancy rate is higher than we saw during the dot-com era, but given the size of the industrial market, it's not an alarming vacancy rate," said Jay Spivey, senior director of research and analytics for Bethesda, MD-based CoStar, who delivered the industrial report and outlook to clients in a webinar presentation this week. CoStar tracks almost 22 billion square feet of industrial space making up about half of the nation's commercial real estate.
"Steep job losses and the significant decline in home prices have significantly reduced demand for goods, and as a result, goods movement," said Alan Pontius, senior vice president and managing director with Marcus & Millichap Real Estate Investment Services. "While there were markets in the dot-com bust that recorded very weak fundamentals, including San Francisco, Austin and Boston, the current downturn is far more widespread throughout the nation."
The weakness in trade flows, which directly affects supply chains, has been especially severe, said Peter P. Kozel, senior managing director and chief of research with FirstService Williams.
"The combined total of imports plus exports declined by 8.41% from the fourth-quarter of 2007 through fourth-quarter 2008, and the largest decline in the 2001-2002 period was 7.69%," Kozel tells CoStar Advisor. "The drivers for the industrial sector are profoundly weaker now than they were [seven or eight years ago]."
The market is not without a couple of bright spots, however -- and one of them is the sensible supply of new inventory, which remains in check relative to the great industrial building booms of the 1980s and ‘90s. Although pre-leasing of new projects is weaker, developers delivered only 34 million square feet of space in the first quarter -- a mere 0.1% of total industrial inventory, Spivey noted.
"Things have throttled down dramatically. We’ve gone from 55 million to 38 million square feet under construction; that is completely unprecedented," Spivey said. Even after the dot-com debacle and subsequent recession, there was never less than 88 million square feet under construction in any given quarter, he said.
When will construction pick up? Not any time soon -- the amount of available space on the market, much of it at reasonable rates, will first have to be absorbed before most tenants will consider paying a premium for new space, Douglas P. Frye, CEO and chairman of Colliers International, told Advisor.
Sales: Activity Way Down, Prices to Follow
Like other investments hurt by lack of access to capital, industrial sales volume is down about 83% over the last 18 months, Spivey said. Properties are now sitting on the seller's block for an average of 370 days, compared with 288 days in mid-2007, during the last gasp of the previous market boom.
Spivey believes activity probably can't and won't fall much further. Michael J. Ferrara, an investment sales specialist with Sutton & Edwards Inc. in Lake Success, NY, saw a change in investor behavior beginning at the end of last year.
"Back in November and December, most of the investors I spoke to were just sitting on the sidelines and telling me to follow up with them in three to six months," Ferrara said. "Now, these same investors are telling me to send them the information and seem to be getting their feet back in the water."
Cap rates, compressed during the mid-2000s price runup to a decade-low 5.8% a year ago, have since risen 130 basis point to about 7.1%. CoStar projects that cap rates could rise a total of 400-500 basis points over the next couple of years.
One bright spot for the industrial sales market so far is that average per-square-foot prices have eroded only about 17% from their first-quarter 2007 high -- relatively stable compared with the 50% drops seen in the office market, Spivey said. "We’re still well above the historical average in terms of prices."
The down side of that: prices still have a ways to fall, as much as 60% over the next two to three years. "If we can get to a bottom in terms of prices, we’ll start to see activity come back -- but not until we get to that bottom," Spivey said.
The bottom has so far eluded risk-adverse buyers and sellers in the last few months. Debt capital is more difficult to come by, particularly on larger deals, as lenders have heightened scrutiny on the quality of both the property and the borrower, and raised debt-service coverage requirements, Marcus & Millichap's Pontius said. Some buyers are looking for distress fire sales that have yet to materialize. Many owners, meanwhile, are electing to try and ride out the downturn rather than sell at depressing prices. Eventually, however, "buyers will win this chicken fight," Sutton & Edwards Inc.'s Ferrara predicts.
"When you have that huge gap where the seller won’t go above a 7% cap and a buyer won’t go below an 8% cap, the result is a freeze in executed transactions," Ferrara said. "However, eventually the sellers are going to have to raise the cap rate once they realize they have no choice but to sell or have the bank take over."
"We believe this is just beginning. Rents are eroding well below pro forma numbers and vacancy rates are going up. Without job growth, we will not see a bottom. And even if the market is getting close to a price bottom, it is not clear that the market will recover from that bottom anytime soon."
Absorption Goes Negative
Gross leasing activity dropped significantly and across all geographic markets to 82 million square feet in the first quarter -- about half the volume of the same period a year ago, according to King Data. Negative net absorption skyrocketed.
"So far, the three quarters of negative absorption we’ve seen recently is cumulatively more than we saw during the whole dot-com [collapse] back in 2000," Spivey said.
As dismal as those figures are, they're better than the numbers coming out of the office sector, which hasn’t yet given back space proportionally to the massive job losses sweeping the nation's financial industry. Those job losses suggest that the office sector should be posting 100 million square feet of negative absorption at present rather than the minus-20 million square feet reported last quarter, Spivey said.
The rising number of property listings by owners on CoStar also reflects the softening demand. If the current pace holds, almost 1 million new listings will be added this year across all property types, including nearly 48,000 industrial listings in the first three months alone totaling 640 million square feet -- the vast majority made up of relet and sublet space shed by tenants. The top five owners of industrial property alone -- ProLogis, First Industrial Realty Trust, AMB Property Corp. and RREEF America LLC and Duke Realty -- are listing a total of about 120 million square feet.
Colliers' Frye said anecdotally that receptionists in the company's Phoenix, San Diego, Los Angeles and Seattle offices report a higher level of inbound phone traffic recently, while industrial agents are reporting an uptick in prospective tenants looking at properties, taking presentations and making offers.
The industrial vacancy rate has jumped from about 8% to 9.35% in just a year. But as ominous as that number is, the amount of total space available and actively being marketed on CoStar -- some of it vacant, some of it occupied but soon to be empty -- is rising even faster, now standing at 18%. The amount of sublet space being marketed is much greater than the amount that’s actually vacant, suggesting that tenants will exit even more space in coming quarters, Spivey said. Properties are sitting on the rental market an average of 400 days before they’re leased, compared to 345 days a year ago.
Among the nation's 20 largest industrial markets, the Inland Empire region of Southern California saw its year-over-year vacancy rate jump 400 basis points to 12.3% in the first quarter as developers delivered another 3.3 million square feet. Long Island, NY, edged out Los Angeles as the market with the tightest vacancy rate at 4.2%.