A Pause in Progress
The Portland Industrial Real Estate market place took a pause in the 1st Quarter of 2018. Industrial Net Absorption (space moved into minus space vacated) came in at about zero for the quarter. And this after 4th Quarter 2017 came in at only 200k sf of net absorption. Even with the weak finish in ’17, last year finished at around 3M sf of absorption, about the same as the previous 2 years. Interestingly, while we have been in a statistical lag, it doesn’t feel like we have been in a work load lag. We have as many Industrial Real Estate brokers at Capacity as any office in the City (probably including both Portland and Vancouver), and the general consensus is continued strong activity. Similarly, the national real estate conference I recently attended (Capacity belongs to the Global CORFAC network) indicated the same strong activity across the US. However, the numbers don’t lie.
Potentially we are uniquely feeling the Amazon effect in the greater Portland area. Amazon currently has under construction 2.2M sf in Troutdale, 1M sf in Rivergate (North Portland), and 1M sf in Salem. As has been previously mentioned, in recent years our absorption has been driven by large, national Third Party Logistics (3PL’s) firms. It could easily be that these national firms are waiting to see how Amazon construction modifies the greater Portland distribution landscape. Furthermore, from my experience moving a client into the Cincinnati airport area (actually northern Kentucky) last year, there are companies that will create space demand by locating near an Amazon DC after they are up and running.
While I am on Amazon, I would add that yes, Amazon is putting retail on its ear. Grocery store chains have all but stopped their new store expansion plans and I am in the middle of a transaction for a beer distributor that decided to sell out, in part because of the fear of what will happen when someone can get a 6 pack of beer on their front door step within two hours of clicking some buttons on their computer. Furthermore, I’ve talked to retail brokers that say now when their retail client wants to find a location, they aren’t satisfied with a neighborhood. They have to be on a specific corner, or they are afraid they won’t generate enough business to justify the bricks and mortar investment.
Another possible reason for a drop off in absorption is the move to own. Our statistics basically track leased space, mostly business park type product. As companies move into purchased buildings (owner occupied not being in the data base), they create a net negative absorption. It makes the data look weaker, but the cause is created from a strong economy. We continue to see land sales moving briskly, with users purchasing land to construct their own building and vacate their leased spaces. Additionally, while the inventory is very tight, companies are purchasing what buildings are available and modifying them for their use. With the cost of new construction going through the roof, companies are able to pay a considerable amount for a worn-out building and still have room in the budget to make significant improvements.
Overall Vacancy continues at 3.6%. This rate is bracketed by Tualatin at 1.5% and East Columbia Corridor (East of the Airport) at 9.9%, where the effect of all the new construction is starting to be felt. In between is the Clackamas area, increasing to 5.5% thanks to the relocation of the Safeway distribution operations to the Gresham Albertsons DC. This move has put more than 750k sf of challenging product on the market, which helped to drive down the 1st Q absorption numbers. The balance of the submarket info can be found here.
Lease rates continue to hold in the $0.50+ range on the east side, while a lack of vacancy in the west side is driving rates towards the $0.60 level. With the increased cost of construction, including hard costs, soft costs, and Systems Development Charges (SDC’s), it once again is a challenge to build speculative smaller buildings (<100k sf) because the proforma lease rates don’t provide a sufficient return. A recent new industrial building construction cost estimate had the SDC’s at $25/sf. That’s roughly $0.25/sf/month of rent for just the government fees.
Cap Rates continue to get compressed as institutional money continues to flow into the markets. With the national shift from retail to warehouse for product delivery to the consumer, Industrial is the darling of investors. As a result, Cap Rates in the Inland Empire and Puget Sound areas are pushing well below 5%, meaning local institutional Cap Rates in the Portland area are now routinely in the low 5’s. Consequently, properties in the $1M - $5M range that many local investors are pursuing have had their Cap Rates driven down 100 to 150 basis points from their previous 7 – 8% Cap Rate levels.
Product under construction statistics have gotten complicated. While there is around 3M sf under construction in the Portland/Vancouver area, 1.8M sf is for Amazon, and the 800k under construction in Troutdale (really 2.2M total sf on three floors). This leaves a little over 1M sf of general speculative construction, which will not be enough if we continue growing at the historical 3M sf per year, absent the Amazon effect. This should help to keep rents rising, which while bad in general, at least helps to support expensive new construction.
What will ’18 bring? I still believe net absorption will be in the 2.5M sf range as I said at the end of ’17. Business will continue strong and there will not be a trade war. The WSJ noted last week that China is trying to figure out how to give US Automakers more freedom to operate in their country, without requiring that they have a local Chinese partner. Hardly the action of a country that has declared a trade war on the US. Recent news has Boyd’s and Esco being purchased and shut down. It’s hard to run a World Class company when you can only hire the World Class employees that live within a 15 minute bicycle commute from your operation. However, we are a creative bunch, and seem to keep the company startup pipeline full. I see continued strength through 2020.