Sector report shows top industrial “buy” markets clustered in California, with Los Angeles, San Jose, Oakland, San Francisco and San Diego outpacing the national market
IRVINE and SILICON VALLEY, CALIF. April 16, 2018 – Ten-X Commercial, the nation’s leading online and only end-to-end transaction platform for commercial real estate, today released its latest U.S. Industrial Market Outlook, including the top five “Buy” and “Sell” markets for industrial real estate assets. The report found that changes in technology, supply chains and consumer habits continue to drive leasing demand for industrial properties, propelling vacancies to their lowest levels on record.
The research also shows that 2017 was the sixth straight year during which rent growth accelerated, and the first year on record in which the industrial sector’s rent growth outpaced that of the other three major commercial real estate sectors. Industrial demand looks to remain healthy throughout this year, with more than 10 million square feet of projected net absorption, which would bring 2018 slightly below the levels of the past three years. By year-end, vacancies are projected to tighten an additional 30 bps to an even 7 percent.
The forecast indicates that Los Angeles, San Jose, Oakland, San Francisco and San Diego – all metropolitan areas in California– are the top markets in which investors should consider buying industrial assets. While Los Angeles benefits from perennially tight vacancies and strong rent growth, the West is more broadly at the epicenter of other demand drivers including cloud computing and legalized cannabis.
In contrast, Ten-X Commercial identified Dallas, San Antonio, Houston, Cleveland, Ohio and Baltimore as the five markets where investors should consider selling industrial properties. These markets struggled with either a heavy supply pipeline, flagging demand, or a lack of fundamental growth drivers and may face significant challenges in a projected cyclical downturn.
Nationally, Ten-X Commercial found that the ongoing consumer shift toward e-commerce continues to drive demand for distribution and warehouse space. As a result, absorption remains robust and vacancies continue to shrink, despite a growing supply pipeline. In 2017, the national vacancy rate declined to 7.3 percent, its lowest level since the initiation of coverage in 1999.
As part of its analysis, Ten-X Commercial created a recessionary model to forecast the potential effects of a general, cyclical downturn and analyzes how each sector would respond. During the modeled years, 2019-2020, Ten-X Commercial forecasts a negative impact on industrial absorption, though the decrease in demand is unlikely to be as severe as the previous downturn.
During the forecasted 2019-2020 recession, vacancies are expected rise to 9 percent, 300 bps below their prior peak. Once growth returns, vacancies are expected to recover quickly while rents should bounce back and hit new highs.
Despite an overall positive outlook, trade policy uncertainty is currently the single largest threat to the industrial sector. Any aggressive implementation of import tariffs on goods could hamstring industrial production and demand, while fueling inflation.
“Right now, industrial is the cream of the commercial real estate crop, and the trends that are driving the sector – including e-retail, cloud computing and legalized cannabis – show no signs of abating,” said Ten-X Chief Economist Peter Muoio. “These new growth drivers are joined by the more traditional ones of recovering industrial production, capacity utilization, capital goods orders and trade, which has fueled vacancies and the broader health of the industrial sector to previously unseen levels.”
The Industrial Sector’s Top Five “Buy” Markets:
Los Angeles’ local economy is growing modestly and the city’s population growth is decelerating but, insatiable demand for industrial properties is driving rents up and vacancies down. Vacancies are set to reach a cyclical low of 2.3 percent by year-end 2018, before edging up during the forecasted recessionary scenario. Annual rent growth is expected to continue in the 6 percent range this year. Together these trends will spur annual NOI growth of 3 percent through 2021.
San Jose is benefitting from a tightening industrial market and vigorous demand, as 6.5 percent rent growth has pushed rents to an all-time high. Rent growth is expected to continue in the mid 5 percent range in 2018, as vacancies fall south of 13 percent. San Jose’s labor market remains tight, with a 2.9 percent unemployment rate that is well below the national average. While the city’s information sector is enjoying double-digit annual gains, other employment sectors are seeing more modest growth. These negative factors are offset by the industrial sector’s healthy rent growth and low availability. Annual net NOI growth of 3.6 percent is expected through 2021.
Oakland’s diversified economy continues its slow but steady expansion, with payrolls now at an all-time peak and unemployment down to 3.2 percent. Meanwhile, demand for industrial space has pulled vacancies down nearly 500 bps from their recessionary high to the low 6 percent range — well below the U.S. average. Rent growth, which has averaged 8 percent annually for the past two years, will become more moderate in 2018 down to the 6 percent range, as the supply pipeline remains manageable. The modeled recession would cause demand to reverse in 2019-2020, pushing vacancies up and slowing rent growth. While NOIs are expected to flatten during recession model years, Ten-X projects annual NOI growth of 2.6 percent through 2021.
Weak demographics are constraining San Francisco’s economic expansion. However, the city’s industrial real estate has continued to thrive. Healthy demand for industrial space is driving vacancies down to a 15-year low and fueling rent growth in the 4 to 5 percent range — a rate that is expected to persist through 2018. Ten-X Commercial’s forecasted 2019-2020 recession will likely push vacancies to nearly 10 percent, however that figure should improve with an uptick in fundamentals in 2021. Rent growth is expected to maintain a 2 percent pace over the forecast period, driving NOI gains of 2.7 percent a year through 2021.
San Diego is an appealing market for industrial property investors thanks to its judicious supply pipeline and healthy demand, which have brought vacancies to a 20 year low. The city’s economic outlook is sound with employment in professional/business services and government at an all-time peak. Demand for industrial space has outstripped supply for much of this economic cycle, driving vacancies down to the low 5 percent range. Ten-X sees vacancies edging down even further through the end of the year. Year-over-year rent growth has neared the 5 percent mark in recent years and rents are projected to reach all-time highs this year. While NOI growth is expected to slow and then flatten during the forecasted 2019-2020 recession, it will resume its growth at the start of the next cycle generating average annual growth of 2.6 percent in the coming years.
The Industrial Sector’s Top Five “Sell” Markets:
While strong demographics continue to support Dallas’ local economy, an unrelenting supply pipeline will affect the sector. Vigorous demand is expected to absorb record levels of supply this year, continuing a trend that has brought vacancies to their lowest levels since 2000. However, a crash in absorption and continued completions will cause vacancies to rise some 400 bps during the forecasted recessionary scenario. Rents are projected to fall from 2019 to 2021, causing NOIs to contract sharply.
Low demand is projected to weaken San Antonio’s industrial market, canceling out the positive impact of impressive population and economic growth figures. Absorption has trailed completions over the past two years, pushing vacancies up to the low 8 percent range. Availability is forecasted to begin rising in 2018 before spiking to the high 11 percent range during the 2019-2020 modeled recession. Rents are forecast to drop 2.4 percent in aggregate during the forecasted downturn from 2019-2020. Rising vacancies and falling rents will impact NOIs, generating declines of 0.7 percent per year through 2021.
Much like in San Antonio, industrial demand will sour in Houston despite a local economy that is strong and gaining momentum. After dwelling in the 8 percent range for several years, Houston industrial vacancies fell to the mid 7 percent range in 2017, where they are likely to remain this year. However, they are expected to rise to the 10 percent range as demand collapses during the forecasted downturn. After reaching an all-time peak in 2018, we expect rents will drop more than 5 percent in the 2019-2020 forecasted downturn and fail to fully recover in 2021. As such, NOI is expected to drop 3.4 percent in aggregate in the coming years.
An uninspiring weak economy, a shrinking population, and fundamentals likely to remain weak for the foreseeable future suggest a difficult investment environment for Cleveland’s industrial segment in the coming years. Vacancies have been lingering in the 8 percent range for several years as demand has only pulled availability down 160 bps from the recessionary high. Rent growth has been similarly disappointing, hovering around the 1 percent mark year after year. Even as demand turns negative in 2019-2020, vacancies will rise less than 100 bps and rents are expected to see only minor declines, underscoring the rock-bottom nature of the market. NOIs are expected to rise modestly in 2018, then contract during the forecasted recession, before flattening through 2021.
Stalled rent growth and elevated vacancies are likely to constrain Baltimore’s industrial real estate in the coming years. The sector is also hampered by local economic conditions, including an unemployment rate above the national average and weak demographic growth. Industrial vacancies now stand in the mid 9 percent range, as recent supply deliveries keep strong demand in check. Vacancy rates are expected to climb into the mid 11 percent range during the 2019-2020 modeled recession. NOI will remain unchanged through 2020, due to the expected negative impact of the modeled downturn, followed by sub 1 percent growth at the beginning of the new cycle.
About Ten-X Commercial
Ten-X Commercial is the nation’s leading online, end-to-end transaction platform for commercial real estate. Since 2009, the company has sold more than $18 billion in commercial real estate. The company blends data-driven technology with industry expertise to accelerate close rates and streamline the entire transaction process. Ten-X Commercial and its parent company, Ten-X, are headquartered in Irvine and Silicon Valley, Calif., with offices in key markets nationwide. Investors in the company include Thomas H. Lee Partners, L.P., CapitalG (formerly Google Capital) and Stone Point Capital.