The Last Solid Year?
The year 2017 finished with another solid performance. Net Absorption was weaker in the Fourth Quarter, with only 200k sf absorbed, resulting in an annual absorption of around 2 ¾’s M sf. This is down slightly from the roughly 3M sf absorbed each of the last two years, but still healthy. I had estimated a cooling to below 2 ½ million sf, so the year was a little stronger than I expected. Our year over year National GDP growth of around 2% continues to fuel our industrial absorption in the Greater Portland/Vancouver marketplace.
We have been on a healthy, steady-as-she-goes course for quite a while now. I heard recently that we are in our 106th month of economic recovery, which is the third longest ever, possibly chasing the 120 month record I believe was set with the help of the Vietnam War in the 1960’s. As I’ve mentioned before, Economic Recoveries do not die from old age. They usually get jarred into an untimely death, which doesn’t appear to be happening anytime soon. Most people believe a reduction in taxes will result in an economic stimulus. I happen to believe the same thing. The short term effect here isn’t whether the economics work or not, but that if people believe the economy will be stimulated, it will be. Most business cycles are simply a product of self-fulfilling prophesies.
With around 2M sf of new construction in ’17, Industrial Warehouse vacancy (ignoring flex space) has crept to just over 3.5%. New product that has been brought on over the last couple of years has allowed local customers to relocate, creating some miscellaneous vacancies across the size and geographic range. As a result, fewer property tours are starting with the problem of “there just isn’t any of that size in that neighborhood”. Most areas are below 5% vacant, while the area east of PDX (referred to as East Columbia Corridor) is still hovering at 8% as a result of all the new construction out in that area. You can learn more about the submarkets by clicking on the following link: Industrial Absorption and Vacancy.
With the recent string of healthy annual results, I’m led to ask is this the last “solid” year? Amazon is about to change the face of our simple little data system. Somewhere in ’18 Amazon will be opening about 1M sf in Rivergate and another 800k sf in Troutdale, although the Troutdale facility will have almost 2.2M sf on three levels. Not counting the 1M sf in Salem. How does one adjust for this aberration and come up with how are things going compared to how things were? 2018 will probably look pretty good after adjustments for 2-3M of Amazon space. But then what of 2019? How might Amazon upset the Portland Industrial Real Estate marketplace? We could be looking back at 2017 as the “last solid year”.
Yes, we are still out of roads and land.
Rental rates continue to hover in the $0.50 shell rate. There has been only a slight rise in the rental rates over the past year. I believe the market is processing these higher rates, with some companies going out of business, and/or electing to not expand as they possibly thought they would. The problem with today’s expensive construction costs is that we are going to run out of the smaller spaces again as it now takes rental rates in the $0.60 shell range to justify constructing a single speculative building smaller than 100,000 sf.
Finding a building to purchase is all but impossible. Buildings costing $75/sf two years previous (50k sf distribution building for instance) are now commanding prices around $125/sf. Even with these rapidly appreciating prices, they are still priced below the faster accelerating replacement costs.
Leased investment cap rates continue to get compressed. Small properties purchased by local investors are still priced in the 6 – 8% cap rate range, but high quality institutional cap rates continue to get pushed downward. Transactions in the 5% range are now common, with communications of sub 4% cap rates occurring in the Seattle and California markets. One of the drivers are the Life Insurance companies, which try to keep their portfolios allocated across different investment groups. The problem is when their stock portfolio value increases by 20%, they HAVE to invest another 20% in real estate. As a result, purchases are being made that only make sense if there is considerable rent appreciation in the future. We shall see.
As mentioned above, 2017 could be the last solid year. The data is going to change in 2018. Amazon will absorb a lot of space. They are obviously changing the face of retail across America. As we continue forward, the question is how much will they change the face of industrial? Folks still need to make and store product before it is sent to the customer. Amazon is simply a different pipeline for getting it to the customer.
The economy is still chugging along. I expect it to continue through ’20. As I have said before, think what you want, but business loves a business-friendly president. I expect net absorption (Amazon adjusted out) to be in the 2.5M range in ’18 with vacancies holding steady due to continued new construction.