Relatively more robust economic activity during the second quarter appeared to benefit the industrial sector as fundamentals improved at a modestly quicker pace. In contrast with the first quarter, when improvements fell in line with results from 2013, absorption, construction and rent growth figures all accelerated. Demand for warehouse and distribution space was particularly strong. Net absorption for the quarter totaled 21.5 million sq. ft., a 35 percent increase over the first quarter and the highest level observed since the fourth quarter of 2012.
Tight supply conditions in the market for class-A warehouse/distribution space continued to drive increased construction activity. The 13.1 million sq. ft. of space completed over the past three months is the highest quarterly total since the recovery began in the fourth quarter of 2010. Despite the uptick in completions, demand was robust enough to compress the national vacancy rate by 20 basis points to 11.3 percent. Vacancy has fallen 50 basis points over the past year and is now 290 basis points below its cyclical high of 14.2 percent reached in the third quarter of 2010. Although we expect demand to continue to strengthen, an accompanying increase in new construction will restrain any significant decline in vacancy. We believe that the substantial amount of space scheduled to come online in the second half of 2014 will arrest further vacancy declines until 2015.
Asking and effective rents rose 0.6 percent and 0.7 percent respectively, during the quarter. This was up from the 0.4 percent and 0.5 percent increases exhibited last quarter. While the improvement in rent growth was only marginal, it is noteworthy that growth in effective rents increased on a quarter-over-quarter basis for the first time since the second quarter of 2013. Additionally, year-over-year rent increases reached their post-recession peak in the latest quarter, with asking and effective rents both rising by 2.1 percent. After seven straight quarters of annual rent growth stuck in the 1.6 percent to 1.9 percent range, surpassing the 2.0 percent mark is certainly a heartening sign. Rising demand, coupled with surging construction of high quality space with above-market rents, will continue to push rent growth higher. Nonetheless, it is unlikely that national rent growth will reach the 3.0 percent mark before mid-2015.
Wholescale improvement
The recovery in the flex and R&D sub-sector continued during the second quarter as well, showing slight signs of improvement. Occupied stock increased by 2.7 million sq. ft., reaching its highest quarterly level since the end of 2012. Net absorption was up 14.6 percent over last quarter and roughly 75 percent up compared to the total from one year ago. Some of that increase was spurred by a surge in construction activity. The 975,000 sq. ft. of space completed during the quarter was the most since late 2012 and more than triple the amount from the previous three months. The national vacancy rate remains elevated at 13.2 percent, down 20 basis points during the quarter, but it has declined by 270 basis points since reaching a high of 15.9 percent during the third quarter of 2010. Gradual declines in vacancy remain the name of the game, but Reis still forecasts a 70 basis point tightening of vacancy for all of 2014, which would be an improvement over 2013.
The pace of rent growth also improved during the quarter, as asking and effective rents increased 0.4 percent and 0.6 percent respectively, compared to 0.3 percent and 0.4 percent in the previous period. Rent growth on an annual basis is proceeding apace; effective rents are up 1.5 percent over the last 12 months compared to 1.0 percent as of last quarter. Year-over-year rent growth is at its highest level since before the recession. Demand is slowly gaining momentum, yet the flex and R&D sub-sector remains a tenant’s market.
Activity on the East Coast
Absorption figures were noticeably stronger in the East Coast warehouse/distribution markets this quarter. Baltimore, Md., Richmond, Va., Raleigh-Durham, N.C., Palm Beach and Fort Lauderdale, Fla. and both Northern and Central New Jersey all ranked among the top 10 metros based on net absorption as a percent of inventory. Anticipation of greater warehouse and distribution center needs following the Panama Canal expansion is likely driving firms to soak up excess space in these coastal markets before conditions tighten.
The largest warehouse/distribution markets continue to outperform smaller markets. Among the top 10 metros ranked by annual effective rent growth were Houston, Texas, San Bernardino/Riverside, Calif., Chicago, Fort Worth, Texas, Atlanta, Philadelphia, Los Angeles and Dallas. The other two cities not mentioned above, Kansas City and Memphis, Tenn., are both well-situated logistics hubs. All 10 metros posted year-over-year rent growth between 3.0 percent and 4.6 percent.
The top performers for the quarter in the flex/R&D sub-sector were predominately west coast markets. San Francisco, Los Angeles, San Bernardino/Riverside, Calif., Seattle, Orange County, Calif., San Jose, Sacramento and Phoenix all exhibited quarterly effective rent growth of 0.7 percent to 0.8 percent, as did Atlanta and Dallas.
Near term outlook
The future for warehouse and distribution space owners remains promising. Annual effective rent growth reached a post-recession high in the second quarter and is likely to climb to nearly 3.0 percent by the end of 2014. Vacancy compression is expected to slow in the near term, but this is more a function of increased construction activity than any weakness in future demand—it is mostly a reflection of the extremely tight market for quality, high-end space in well-situated metro areas that is generating opportunities for developers.
Year-over-year effective rent growth in the flex/R&D market should approach 2.0 percent by the end of 2014. Vacancy will continue to fall, but only by another 30 basis points before the end of the year, as growing demand will also be met with expanding inventory.
