The Neverending Story
It is always a challenge to come up with the quarterly title, especially when we are at record levels for duration of recoveries. We have had growth in the US economy for about a decade now, which can make it tough to come up with a different way to say things are good. As I have been digesting information over the last couple of weeks getting ready to write this quarterly, the title above came to mind. We seem to be in this fantasy, never ending growth environment, which I, of course, will expand on below.
I couldn’t use the title phrase without Googling it, and I got a 1984 movie about a kid reading a novel about Fantasia, a fantasy land threated by the “The Nothing,”, a darkness that destroys everything (my firstborn arrived in 1985, so no wonder I didn’t see this one). How ironic that in our Fantasy current economic growth cycle, it is “The Nothing” that is helping growth, and “The Regulation” of Everything that slows it.
Why do I believe it is The Neverending Story? You know I try not to get “Economist” on you, but I’m going to have to spend a little time on economic trends. For once I believe this applies more to our Industrial product category than to the other food groups. Starting large and working small I think Industrial has and will do well in Portland because China has started to feel the effect of a real Middle Class, which always increases the costs for the low cost producer; we’re about a year in to what should be a 2 – 3 year tax cut stimulus; we’ve got a Congress that won’t be able to do anything for a while; and the trend to pick and click shopping continues to increase. Finally, since 2015, for the first time ever more money was spent at restaurants than grocery stores (feeding restaurants takes more warehouses). All these forces help drive Industrial real estate. Apartments appear to be peaking (certainly in large part thanks to Portland’s rule making), retail continues soft, office is still chugging along, and institutional appears to be waning.
With the growth in some product categories easing, we are starting to see a softening in the rise of construction costs. While hard to pin down, it seems like construction costs have increased about 50% in the last couple of years or so. These costs include labor, materials, and government fees. For the last couple of years all I ever heard was horror story after horror story (no Fantasy here) about ever increasing contractor construction prices. Recently I’m hearing snippets about how wood prices are dropping, big institutional contractors are worrying about their pipeline, and small contractor folks are actually taking a little time off between jobs. This trend will help support the continued growth of industrial due to reasonable construction/tenant improvement pricing.
Now to the numbers. Hopefully we will not see this significant an impact of the Amazon Effect for a long time to come. Gross numbers are 4.8M sf absorb and 4.3M sf constructed/delivered in 2018. Back out the 1.8M Amazon Effect and we finished the year with roughly 3.0M sf of net absorption (total absorbed minus vacated), finishing the fourth quarter with over 1.1M sf absorbed. With more absorbed than delivered, Portland/Vancouver vacancy for warehouse type product has dropped to 3.1%. You can find the submarket vacancies here, however, some highlights would include Rivergate is below 2%, East of the Airport has dropped from over 9% to less than 7% in spite continued new deliveries, and even with almost 1/2M sf of new deliveries in Clark County, vacancy has dropped from almost 5% to less than 3.5%.
The increase in lease rates has seemed to moderate. Notice I didn’t say the rate of increase is less. When you use the word less, people think The Neverending Story is over, which becomes a self-fulfilling prophesy. For 40k sf leases of current product, shell rates are in the low $0.50’s on the East side and low $0.60’s on the West side. These numbers will continue to increase at a slower rate ending the year at the middle of each price bracket. We’ve seen a growth in east/west spread from around 10% to 20% over the last couple of years as the effect of little buildable land on the West side has had its impact. Soon that will be the Neverending Story everywhere.
Speaking of land, I just did a search for 5 acres of land in the Columbia Corridor (Willamette to Sandy Rivers) and got one result. We’re out. This METRO 20 year supply thing is so far beyond reality (Fantasy?) that I don’t think folks even bother worrying about it anymore. As a result, folks are moving outward to find land and the news will start to come from places like Canby, Woodburn, North Plains, and Ridgefield. If Oregon doesn’t loosen the reins on the dragon between Portland and Salem, the only choice left is going to be from Vancouver to Longview.
Trying to purchase a building is very expensive.
Traffic still sucks, although adding a freeway lane I-5 southbound between Hwy 217 and I-205 has cut afternoon rush hour traffic gridlock considerably. It’s amazing what a 33% increase in capacity can do. And I don’t think it cost $1B, which is the smallest price unit available for light rail.
There is still lots of money flowing into the Industrial Institutional game. Cap rates continue to get compressed into the low 5% range. It appears interest rates are going to stabilize at levels still considerably below historic average. SBA rates spiked up into the 5.5% range in the 4th Quarter, but have already dropped back down into the 5.0% range due to Fed signals that the quarterly increases appear to be over.
I estimated 2.5M sf of net absorption this year, a slight reduction from the 3.0M sf we’ve seen over recent years. I was wrong. We hit what has become our routine 3.0M sf once again. It would be easy to say 3.0M sf for 2019, but I’m going to go with my 2.5M sf again. We shall see.
Is the story Neverending? Most certainly not. Even industrial will see an end to this Fantasy run. That being said, I think we are good to the end of 2020, even though the current State of Oregon representatives like the idea of additional taxes. If we see a business-friendly President in 2021, I think our run could continue for another 4 years. We just need to remember that wealth is an open, not a closed system.