Big Ups and Downs
We’ve enjoyed strong net absorption of industrial space over the last few years, averaging around 3,000,000 SF in each of the last three years. Most of this absorption has come from Third Party Logistics Companies (3PL’s) taking down large chunks of space. However, eventually big space occupiers move on. That happened in the first quarter of 2019, resulting in 200,000 SF of net negative absorption (space moved into minus space moved out of). Two of the largest contributors to the negative net absorption happened to be operating companies, with Solopower shutting down operations in 225,000 SF and Ashley Furniture consolidating 170,000 SF of warehouse space into other locations in their national distribution network.
This negative absorption would have little impact on our more than 200,000,000 SF database vacancy rate that was in the low 3% range, however, adding almost 1,500,000 SF of new construction to the database in the first quarter caused vacancy to spike to 4.1%. We generally have been delivering around 2,500,000 SF of new construction each year and expect about the same for 2019. The reason construction deliveries spike in the first quarter of each year is because of the ‘West of the Cascades’ rain. Most construction projects commence during the summer months when the ground is dirt, not mud. Add a seven month construction process for concrete tilt (metal takes a month off) buildings and you tend to have more product getting finished up right after the new year.
We still have about 1,900,000 SF under construction in the greater Portland/Vancouver area, with the largest being a 500,000 SF facility for Portland Bottling as they plan to greatly increase their production in Canby. With cheaper power and the ability to pull water directly out of their onsite well, the $1,000,000 savings per year made the move pretty easy. That, and the fact that large, close in sites are now about non-existent, the moves to places like Woodburn and Ridgefield are becoming more common.
There is already 2,700,000 SF of new construction planned for 2020. In the past, I couldn’t have shared that number with any certainty this early in ‘19, but the design permitting process has increased considerably as of late. It used to be you needed to have figured out the site you were going to build on by the holidays to meet the start of construction season (see above). Now, it is more like early summer. Sites are tougher, requiring more entitlement efforts, civil/structural/architect design expertise, and then of course permitting, all just seem to take longer.
2,700,000 SF in 2020 also communicates no drop off in optimism, not that developers aren’t inherently an optimistic gang. That optimism is magnified by the fact that our neighborhood is an attractive place to build. The complexities of working here tends to keep folks out, so we don’t over-build. Unlike most regions, our industrial vacancy never reached 10% during the depths of the great recession. Our absorption remains strong, people buying from warehouses continues to increase, and there is still lots of institutional money on the sidelines wanting to get a better return than what you can get from a bank. In summary, 2020 continues to look rosy.
Cost of construction continues to increase. In a recent conversation with a large local developer, they indicated they were ready to build another 50,000 SF building this year, same as the one they’d built the year before. Their construction cost came in 15% higher. I’m sure most of you are experiencing the same thing from your electrical and related contractors.
We quote our rates on a shell plus office surcharge basis. As it turns out, the office surcharge is coincidentally a rate per month similar to the cost of construction. For instance, coming out of the recession, the cost to construct new office in an empty warehouse came in around $75/SF, and the office surcharge was $0.75. While that is a 12% return, it is also more than an 8 year payback. For a five year term lease, the next tenant could easily want something different. That being said, we’ve been seeing construction costs balloon to $100/SF and office surcharges going to $0.95. Now I’m hearing that the cost to put new office in an empty warehouse is approaching $120/sf. The office surcharge will continue to increase.
Speaking of cost increases, and I’ve mentioned it before, lease rates have been in the $0.50/SF range east side, $0.60/SF west side. We are seeing those numbers rise due to the higher costs (and continued low vacancies). Those lease rates are going to have to shift to the $0.60 east side, $0.70 west range. We are already seeing examples of this shift with some lease comps. It is going to become the norm.
Traffic is still not good, so industry must adjust. Portland Bottling’s Canby Plant will begin operations at 3 AM, completing their day by 3 PM. Not only will this get their trucks on the roads before they clog up, but their Traffic Impact Fees (TIF’s) for new construction was considerably less, as most the TIF’s are computed with a rush hour premium. We know that we can get folks to work weird shifts with a premium wage. We continue to pay more for our products because business just can’t get around town anymore.
Across the board my clients continue to complain about the availability of workers, which is compounded by the Millennial effect. One of my clients is focusing on finding older workers for their production facility because of their work ethic. And, I just saw a McDonald’s ad claiming they are hiring older workers. It was positioned as a socially responsible ad, but you can’t be socially responsible if you aren’t in business, and older folks can keep you in business.
General consensus is healthy through 2020. Last quarter, I forecasted 2,500,000 SF of net absorption this year and I’m sticking to it. Amazingly, with labor and materials costing more, inflation doesn’t seem to be rearing its head. These are interesting times.