The industrial property market ascends to new heights
Rebecca Perlmutter Finkel is a senior vice president in CBRE’s Western United States industrial team with Darla Longo and Barbara Emmons. She joined this team in 2007 and since that time has been involved in $11.2 billion worth of real estate transactions totaling over 122 million square feet.
Gateway markets on the west coast have gone through tremendous transformation since the end of the Great Recession, recording increases in value, record low vacancy and high interest from investors across the world. Technology and e-commerce are driving the demand for industrial space across this region, and Perlmutter’s team has been helped shape the market over the last decade. Here is her perspective on the market and the year ahead.
We still view new development as measured relative to the last cycle with 14 percent fewer deliveries and almost 15 percent higher net absorption.
2017 has been a remarkable year for industrial real estate, and especially so in gateway markets like Northern California, what surprised you the most about the year that just ended?
Our team was most surprised to see continued cap rate compression for core industrial real estate in 2017. In 2015 and 2016 we saw cap rates compress to record levels in the 3.9 percent to 4 percent range, as illustrated by the sales of The Crossings and The JFC building in Fremont. The recent sale of I-210 Logistics in Rialto highlights this further compression with a 3.7 percent cap rate on a 10-year lease!
Which deals really exemplified the year for you, and why were they significant?
2017 was a significant year for our team given the number of land sales that we completed. In Northern California, we sold 342 acres in Stockton to CT Realty and Diamond Realty Investments. They are in the process of delivering 1.7 million square feet of industrial product during the first quarter of 2018.
In aggregate, we sold 569 acres in 2017 and are in escrow with an additional 1,200 acres across the west coast. Given the strong industrial fundamentals, land prices are reaching all-time highs across the west coast.
Our team really enjoys working all angles of the industrial market from land sales, forward commitments and leased investments to joint ventures and equity recapitalizations. We find that we are best able to help our clients by staying active across the industrial product cycle and stay busy with a diversified business plan.
Has development and construction kept up with demand? What have been some of the biggest challenges for the industry in 2017 as a result of the heightened demand?
With vacancy rates in the one percent range for infill markets like the East Bay and Los Angeles/Orange County, we continue to see untapped tenant demand. Strong user demand has pushed pricing in Los Angeles north of $60 per leasable square foot. As a result, we are seeing older product being torn down for new development or rehabbed to make it more functional, which often entails removing portions of the building to add additional loading. I am waiting for an example of a developer raising a roof to increase storage capacity!
We still view new development as measured relative to the last cycle with 14 percent fewer deliveries and almost 15 percent higher net absorption. This cycle supply has really been measured by a more institutional developer base and tighter lending standards.
Who have been some of the biggest consumers of industrial space in the last 12 to 18 months that really helped shape the industry?
The most active users in the market are related to e-commerce, food and beverage, consumer goods, furniture, logistics and automotive. Some of the top names for new leases in the Bay Area include Fedex, UPS, Amazon, Tesla, Berlin Packaging, Wayfair, Whirlpool, Pratt Industries, and CEVA Logistics.
What does a successful product look like today? Are developers and tenants creating something that is new, and in what ways is the product different?
New product is being designed today with lower coverage to accommodate both employee and trailer parking and heavy power to accommodate automation. In the Bay Area, we also have more advanced manufacturing uses that require more office.
We are also seeing a push towards 40’ clearance and beyond in some cases to increase warehouse efficiency. To date the vast majority of these buildings have been build-to-suits driven by users such as Medline, Lifetime Brands, Ashley Furniture and Amazon. Prologis also built a one-million-square-foot building on a speculative basis in Tracy that was later leased to Amazon.
Given the high cost of land and lack of alternatives in infill locations like the Bay Area, we are also seeing more groups explore the multi-story warehouse concept. Prologis has two multi-story projects underway in Seattle and San Francisco.
What do you think will be some overarching trends that will continue into 2018 and beyond?
We will continue to see users push for infill locations to provide same day delivery to consumers. As a result, older obsolete real estate will continue to be redeveloped and renovated.
What are some key indicators or numbers that you track that gives you a sense of the status of the market?
In addition to the primary metrics of vacancy, net absorption, asking rents and new deliveries, I also like to track the percent of the construction pipeline that has been pre-leased. I also find it helpful to segment the market by size and product type to determine micro trends by size range or sub-product to determine rent growth and vacancy. For example, given the higher construction costs for smaller bay product and more limited new supply, we are seeing the strongest rent growth in this segment of the market.
I also find it interesting to track the sources of capital that are targeting the industrial sector. Real estate funds continue to increase their allocations to industrial given the defensive nature of the sector, as well as the strong demand created by e-commerce. Over the last few years we have also seen a strong increase in demand from sovereign wealth funds. In fact, elevent of the last twenty-two portfolio sales were acquired by sovereign wealth funds. Foreign capital is also targeting smaller, one-off opportunities typically using U.S. based advisors.
What excites you about 2018 and conversely, what worries you?
I am really excited to continue to track how e-commerce drives the industrial sector. We have seen unprecedented user demand as sales continue to shift from retail stores to the online delivery model. We are at the beginning of this evolution with only 9 percent of all sales transacted online. Our research department forecasts that each additional $1 billion of e-commerce sales generates 1.5 million square feet of incremental warehouse demand. As a result, we expect 50-60 million square feet of new requirements this year nationally.
I am most worried about the environment. I moved to San Francisco 3 ½ years ago and really appreciate the eco-conscious nature of the culture here.
Is there one segment of the industrial market in the Bay Area and perhaps across the West Coast that will fare better/worse in the next 12 to 18 months?
Infill sites close to population bases will continue to outperform the market given the barriers to new development with few sites remaining as well as entitlement challenges across the region.
If there is one thing you would like our readers to keep their eyes on, what would that be?
We are tracking closely the impact of driverless trucks and cars on the logistics industry. It will be interesting to watch how it impacts site selection and building designs going forward.