Jones Lang LaSalle’s Mid-Year 2008 National Industrial Real Estate Market Report, which analyzes activity in industrial properties 50,000 square feet and larger, shows that while both warehouse and manufacturing sectors have been impacted by the slowing economy, the national industrial real estate market experienced overall positive net absorption in the first half of the year, exceeding most forecasts.
U.S. industrial markets absorbed approximately 5.6 million square feet in the first quarter of 2008 and 125,000 square feet in the second quarter, significantly lower than historical first-half performance. Jones Lang LaSalle views the slower growth as a consequence of uncertain economic conditions.
According to Craig Meyer, managing director and national brokerage leader of industrial services with Jones Lang LaSalle, “There is a myriad of economic issues causing this slowdown in activity—soft unemployment, increasing fuel/transportation costs, lower retail sales which have a rippling effect on warehousing needs, and our nation’s overall recessionary trend—contributing to the declining activity in the overall industrial real estate market.”
The national industrial vacancy rate ended the second quarter at 9.1%, up three-tenths of a percentage from the first quarter 8.80% rate. Markets that experience positive net absorption can also see vacancies increase due to the delivery of new developments.
“Most major industrial real estate markets nationwide felt the softening of conditions during the second quarter as companies avoided unnecessary moves and focused on cost control, flexibility, and short-term solutions,” said Meyer. “In the short term, this creates negotiating leverage for tenants still in growth mode, while over the longer term, a cautious stance helps the market maintain stability and avoid overbuilding.”
The Jones Lang LaSalle report showed that occupancy growth during second quarter was minimal when compared with 2006 and 2007 levels. While Chicago, Dallas, Houston, and Philadelphia posted occupancy gains between April and June, several major markets including Atlanta, Los Angeles/Inland Empire, and northern New Jersey, experienced negative net absorption.
Despite this downturn in absorption, however, Los Angeles/Inland Empire—the nation’s largest industrial market with a total industrial base well over 1.6 billion square feet—remained among the tightest markets in the country with a 6.1% vacancy. Overall, vacancy rates in Los Angeles County were just 3.8%.
Houston, one of the few markets to see continued healthy tenant activity in second quarter, also posted a tight 6.1% vacancy rate, as strength in the oil and gas industries and population growth drove demand for business and consumer goods that pass through warehouse/distribution facilities.
While Houston was badly hit by Hurricane Ike, the damage to industrial facilities was minimal compared to the destruction caused by hurricanes Katrina, Rita, and Wilma throughout the Gulf Coast in 2005. Ike’s primary impact on business functions following was a lack of electricity.
“The real impact from the storm will most likely be on oil production and distribution,” said Meyer.
Nationally, new industrial construction has dropped considerably compared to historical standards. Just 22 million square feet was delivered in second quarter, and there is only 35 million square feet in the development pipeline.
“We’re looking at the lowest construction pipeline in 15 years. In fact, we could be down by as much as 70% from 2007 totals,” Meyer added.
Rental rates have held steady, according to Jones Lang LaSalle, with the national overall average standing at $4.73 per square foot. Asking rates for warehouse and distribution space increased an average of just 0.3% from mid-year 2007.
Los Angeles topped the scale at $6.69 per square foot, followed by northern New Jersey at $5.68 and Houston with an average of $4.67 per square foot.
Outlook: Rising Vacancies/Dropping Rental Rates Expected to Round out 2008
“We are facing highly uncertain market conditions as we head into 2009. The credit crisis, bank failures, and bailout will definitely have a negative impact on the industrial real estate markets,” Meyer conceded. “We’re looking at the storm clouds on the horizon and just don’t know right now if it’ll be another Katrina or a summer shower. Fortunately, there have been signs of an economic slowdown for several months, so tenants and developers have had time to adjust their strategies, unlike past economic cycles that took many by surprise.”
He added that while the industrial real estate market fundamentals seem to be functioning fairly well, the prognosis is circumspect. “If we can continue to muddle along as we have been, we should be pretty well positioned by 2010.”
Overall, national industrial vacancy rates are expected to continue to climb through the remainder 2008 and reach 10% by year-end. Vacancies for the distribution sector, which currently stand at 13.1%, should rise to 14%.
While some markets may experience modest pricing growth, rental rates for the most part are expected to come under increasing pressure in response to recoiling demand. Rental rates could drop between five and seven percent by year-end, adding to the increasing pressure on landlords to retain and land tenants.
“The name of the game for the remainder of 2008 and into 2009 is ‘occupancy.’ Landlords must act quickly and decisively in this competitive market to stay in the game,” he added. “More than ever, tenants will be focused on shorter terms, flexibility, increased concessions and speed to market at the lowest possible occupancy costs.”
Construction will be minimal throughout the remainder of the year and into 2009.
“While building will continue, the challenging financing environment and the uncertain economic outlook will certainly curtail new starts across the board,” said Meyer.