Tenants Have Shed Nearly 200 Million Square Feet of Warehouse, Factory and Flex Space Over the Past Five Quarters
The vacancy rate for U.S. industrial space eclipsed 10% and negative absorption topped 44 million square feet in the third quarter of this year as companies continued to shed warehouse, flex and manufacturing space in the face of continuing job losses.
But the most precipitous of the occupancy losses may be over, according to CoStar Group's Third Quarter 2009 Industrial Review. Looking ahead to next year, CoStar forecasts that, although the national industrial vacancy will rise as high at 11%, the amount of net vacant space on the market should begin to taper off over the next two quarters.
The vacancy rate jumped to 10.2% in the third quarter -- a 180-basis-point increase from the 8.4% reported during the same quarter last year and up from 9.8% at midyear 2009, according to the third-quarter industrial review delivered by Jay Spivey, CoStar's senior director of research and analytics, in an Oct. 20 webinar. The additional 44.1 million square feet of negative net absorption brings the year-to-date total to 147 million.
CoStar and economists at Property Portfolio and Research, Inc. (PPR), the global real estate analysis firm acquired by CoStar in July, project another two quarters of continued but moderating levels of negative absorption. By mid-2010, (barring a double-dip recession) the industrial market is expected to slowly resume leasing activity generating fairly robust quarterly positive absorption through 2013.
With new construction on industrial property largely in check, CoStar forecasts that the national vacancy rate should peak at around 11% next year, though rents are not expected to start climbing again until 2012-13. Net operating income (NOI) growth for industrial building owners, which flattened last year and had fallen nearly 6% as of midyear 2009, will continue to decline through 2011.
"The bad news is, we've got a little bit more to come in terms of rising vacancies. The good news is, we believe most of the negative absorption is behind us," Spivey said.
Between mid-2001 and mid-2002 following the collapse of e-commerce and other dot-com companies, which especially affected office buildings, the industrial market recorded 70 million square feet of negative absorption during four quarters, with no more than 30 million square feet given back in the worst quarter. The current downturn is clearly much worse by comparison, Spivey observed.
"This [recession], we've had five quarters of negative absorption totaling 194 million square feet, and we're probably not completely done yet," Spivey said.
Economy: Encouraging Signs, But What About the Jobs?
The general economy, now said to be in a state of torpid recovery, is also providing some encouraging signs. The nation's gross domestic product (GDP) fell a lower-than-expected 0.7 in the second quarter and may finally turn positive when third-quarter numbers are released this week. Imports and exports are have increased in recent months, though they're still down from their pre-recession highs by 33% and 26%, respectively.
The Federal Reserve's Industrial Production Index, a manufacturing indicator, gained slightly in August, and the Institute of Supply Management (ISM) purchasing managers index moved above 50 for the second consecutive month in September. Any reading above 50 indicates growth in manufacturing, while below 50 is contraction.
However, the pain for building owners is deep-seated. Owners of transactions negotiated at the height of the market in mid-2007 will see their properties' equity and value, which has been gradually eroding for two years, fall below the balances on their loans beginning early next year, with values continuing to trough through 2011, Spivey said.
And of course, the big negative and question mark remains unemployment. Though it may be ending or even over, the recession is now officially the worst in terms of job losses since World War II, and jobs are continuing to be shed. Labor market recovery will be slow and irregular across the country, Spivey said, with the ripple effect from job losses causing more negative absorption, higher vacancies, depressed rents and shrinking net operating income.
Development Still Idled
Quite simply, 2009 will likely be the slowest year of the modern era for new development. But that dubious record will be short-lived, as 2010 will probably be slower, according to CoStar projections.
Of the meager construction that's under way or in the pipeline, more than half is in four markets, Houston (3.3 million square feet) Philly (3.2 million SF) Dallas/Fort Worth (2 million SF) and Chicago (1.5 million SF), Spivey said. Developers have stopped development, especially on spec, and restricted their construction to previously committed projects or build-to-suit projects for specific buyers.
For example, take a look at the Inland Empire in inland Southern California to see how dramatically industrial development has fallen. Riverside and San Bernardino counties had 23.5 million square feet under construction in third-quarter 2007 and 10.8 million square feet a year ago in third-quarter 2008.
The Inland Empire's third-quarter 2009 total: a scant 400,000 square feet under construction. Likewise, Atlanta, which had 17 million square feet under development in 2005 and 5 million as recently as second quarter of last year, now has 24,000 SF.
Leasing Down, Vacancy Up
Even in the construction-constrained market, 44.1 million square feet of negative net absorption pushed up industrial vacancy rates to 10.2% in the quarter, well past the highest vacancy of the dot-com era of 9.6%. The upward spike in the vacancy curve is pretty steep and not likely to turn around in the next couple of quarters, Spivey said.
Overall gross leasing activity is down sharply year over year, 287 million square feet through Sept. 30 versus 367 million SF during the same period in 2008. That said, gross leasing hasn't fallen at nearly the volume of the beleaguered office market, where landlords have been slower to release empty space back onto the market.
Houston remains the sole major U.S. market to post positive industrial absorption at just under 1 million SF, according to CoStar data. The bottom 5 markets include Chicago (negative-13.6 million SF), the San Francisco Bay Area (-12.3) Los Angeles (-11.5) South Florida (-9.5 million) and Philadelphia (-7.8).
Among the 20 largest industrial markets, Long Island, NY, had the lowest vacancy rate in the country at 4.3%, followed by Los Angeles (4.9%), Orange County, CA (6.6%), Milwaukee (6.7%) Houston (6.9%). Markets with the highest average rates are Detroit (13.5%), previously fast-growing markets since as Atlanta and the Inland Empire (both 12.7%), Dallas-Fort Worth (12.1%), Boston (12%) and Chicago (11.8%). South Florida had the sharpest year-over-year increase in vacancies at 3.3%, followed by Dallas at 2.6%.
Investment Market: Waiting For the Thaw
Properties are remaining on the market for longer and the number of properties being taken off the market due to lack of buyers is rising, Spivey said. Only owner-users have been net buyers of industrial real estate in 2009, with private companies and REITs disposing of property and private equity and institutions staying mostly on the sidelines, neither buying nor selling.
Industrial cap rates leveled off in the third quarter and are showing signs of a slight decrease in the current quarter, but remain up 35% from their low of 6.2% in 2007 following several years of steady compression. However, they're hovering right around the long-term average of 8.5%
Per-square-foot prices rose 113%, an average of 6.4% per year, between 1995 and 2008.Since third-quarter 2007, like virtually all commercial real estate sectors, they've fallen 23%. Still, industrial prices remain above their historical average since 1995 and are faring better than office and retail prices, which are down more than 50%. The exception of flex industrial, where prices are down 57% from their highs and well below their historical average.
Overall industrial prices are down across the board in 2009 compared with the previous year, with the exception of Houston, which has seen an 11.8% increase. The biggest price declines are in Philadelphia, minus-36.2%, the Bay Area (-35.8%) Atlanta (-29.7%) Los Angeles (-23.1%) and Chicago (-22.6%).
The number of industrial sale transactions is down 64% and the dollar volumes are down 81%, according to CoStar. Smaller deals are suffering less than larger transactions: Sales of less than $5 million are down 60% while sales of over $20 million, hindered by lack of credit, are down 90%.
In individual markets, Chicago has seen $1.33 billion in industrial property change hands, followed by Los Angeles, $743 million, Northern New Jersey, $589 million, Atlanta ($515 million) and the Bay Area ($504 million).
By Randyl Drummer
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