The first half of the nine-year bull market in U.S. logistics warehousing was marked by a dearth of “speculative development,” in which buildings go up based on faith in market demand and not on commitments from specific customers.
Spec activity froze up during the Great Recession, and didn’t pick up even after the smoke initially cleared. This would spawn the start of a powerful rise in asking rents, a trend that accelerated after 2012 once it became clear e-commerce demand was not cyclical.
The latter half of the bull story, by contrast, has been punctuated by a surge in development, which doesn’t appear close to cresting. Still, asking rents continue to climb, approaching $6 a square foot across the nation, and higher than that in the sizzling markets of the East and West Coasts, Atlanta and central Pennsylvania. In fact, the need for space to meet e-fulfillment needs is so strong that demand may blow by even the large volume of supply entering the market.
For now, rent hikes have taken a breather, due in part to geopolitical and macroeconomic concerns that have dampened animal spirits, but mostly to another wave of supply. In the first quarter, 10 million square feet was added to the pipeline of projects under construction, according to data from JLL Inc. (NYSE: JLL), a real estate and logistics services company. That brought the total market under construction to 258.8 million square feet, a 4 percent increase from the fourth quarter of 2018 alone, and during a period of inclement weather in parts of the country.
More telling was the dominance of spec properties in the pipeline, a sure sign of developer confidence that their buildings will find takers once they are finished and available for occupancy.
“Spec development accounted for about 73 percent of all new deliveries last quarter,” JLL said. “Pre-leasing transactions, a practice in which both sides agree ahead of time to a specific rent that would take effect when the space is occupied, rose 43.1 percent over the fourth quarter. Pre-leasing transactions for spec development rose more than 25 percent.”
A recently issued report by the econometric unit of real estate services firm CBRE Inc., found that demand continues to outpace the multi-year surge in development, thus allaying any fears about overbuilding. Since 2015, about the time spec development began kicking in, warehouse demand has outpaced new warehouse completions by 169 million square feet, while rents have increased by 19.2 percent, according to CBRE data.
Overall estimates of the market by CBRE and JLL closely align. CBRE estimated that more than 255 million square feet is under construction. Of that, 70.2 percent is on spec, it said.
Spec building isn’t going away. In half of the top 10 markets for spec development, vacancy rates are around the national average of 4.4 percent while net asking rent growth is clocking in at 7.8 percent annually, according to CBRE data. Those trends are what developers like to see. The remaining five markets have vacancies well above the national average and are seeing rent growth of 4.6 percent, which is comparable to the national median increase of 4.7 percent. Demand in those markets remains strong, and big-box developments built on spec will lease quickly after completion.
“Developers remain bullish on the top U.S. industrial markets,” said Mehtab Randhawa, vice president and director of U.S. industrial research at JLL.
While the national market overall may see a leveling off in growth rates, competition for space will remain keen in the top markets operating at a sub-3 percent vacancy rate, keeping pressure on rents through the balance of 2019.
“Overall, the sentiment around pricing is that of a sticker shock, and some tenants are struggling with annual double-digit rent growth,” Randhawa said. “To control their space, many tenants are exploring and encouraging early renewal options.”
“Spec construction is healthy construction,” said Gregg Healy, senior vice president of supply chain & logistics consulting at real estate services firm Colliers International, in an e-mail. “Occupancies continue to outpace vacancies, reflecting an environment where strong demand is pushing ahead of the increased supply.”