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  • Writer's pictureMark Childs, SIOR

Clouds on the Horizon?

By: Mark Childs, SIOR, Capacity Commercial Group

The Portland Industrial Market (warehouse only) continues to chug along at a healthy rate. We had almost 700K SF of net absorption, which works out to almost 3M SF of absorption annually, roughly our normal rate. Vacancy remained a very tight 3.4%, meaning we brought new product to market at about the same pace as we were absorbing it. You can learn more about the Portland Industrial Market in Capacity Commercial Group's Q1 2022 Industrial Market Report here.

However, as we come out of one virus gray cloud we are entering into more gray clouds. The virus actually helped industrial real estate over the last couple of years. As shared previously, it rapidly increased the rate at which people transitioned from bricks to clicks, creating considerable demand for more warehouse space.

The current clouds could easily have a more detrimental effect on warehouse demand. The war in Ukraine seems to put a pall on things. We are seeing some companies take a pause, especially global companies HQ’d in small countries like Taiwan. They want to see if the world protects small countries attacked by big ones (like China).

Next, inflation is finally being acknowledged. You can only dump so much Federal money into the economy, experience supply chain shortages, and give people massive raises for so long, and it eventually will catch up with you. Folks in the industrial sector have seen these price increases for more than a year. Finally, the Economists had to admit it. While inflation can seriously impact savings and net worth, I believe it only has a minimal slowing effect on consumer activity.

Probably more relevant to the Portland industrial market is the rising interest rates. History says this will eventually slow demand for housing, housing construction will slow, and we run the risk of a recession later this year. I seem to be hearing folks talk about a one quarter drop in GDP (not a recession) or a two-quarter drop (recession) towards the end of this year. Obviously, the Fed has a lot to do with this, but forecasting stuff like this is well above my pay grade. I’ve included a current article from our national commercial real estate data base provider that digs deeper into the retail/consumer interactions here.

Assuming either of the above recession scenarios happen, I believe the Portland Industrial Market will continue to chug along at a healthy rate into the foreseeable future. There still is considerable pent-up demand for warehouse by what I refer to as the Top 100 Retailers trying to compete with Amazon. Numerous national companies are out there looking for space in the 100K to 500K SF range, which I expect to continue through this year and next.

We now have close to 6M SF under construction, in theory close to two years of our usual absorption. However, we have enough demand, and the vacancy rate is so low that this new construction should be absorbed as it comes on-line. The problem with the new construction is the product being constructed. As I described in last quarter's article here, almost all the new product coming on-line are buildings larger than 200K SF. Institutional money does not want to play with small product and lots of tenants, especially when there is so much big tenant demand. As a result, the smaller local tenants are in a jam. There is basically little to no product in the 20-40K SF range across the market, meaning that many local companies that would like to grow are stuck in their current space.

Speaking of inflation, guess what not having any available space does to lease rates? I put a tenant into a nice flexy space about a year ago with a $0.65 shell rate. An old third generation warehouse space nearby just leased for $0.78. I’m starting to run into the same problem we experienced in the mid-teens. Renewing or relocating a tenant in 2016 who had signed a five year deal in 2011 (still coming out of the great recession) usually had a 30-40% rate bump waiting for them. The same thing is happening now. I’m doing one renewal where the lease rate will be bumped 10% for each of the next 5 years, and will probably still be under market at the end of the next 5 years.

There continues to be considerable demand for building purchases, but there is nothing available. At the institutional level, industrial money continues to flow freely, plus now all the office, retail, and hospitality institutional money is chasing industrial. Cap rates continue to get compressed, with rumors of sub 4% cap rate deals being done. Numbers usually only occurring in the LA Inland Empire area. The same goes for small user buildings. Local 1031 money is actively chasing industrial. One would hope with rising interest rates there will be a cooling of demand for small buildings, but there is just too much cash out there chasing product. And even with the low returns, everyone knows that lease rates are, and will continue to rise, with the expectation of making the eventual returns attractive.

There are clouds on the horizon, including a probable recession. I’ve been through them before and have to admit I didn’t see the Great Recession when it hit. Maybe we get one of those again? Someone recently wrote we are heading into another round of anti-economics. Too much spending at the Fed level could result in worse inflation for a longer time. And who can guess on wars? However, I’m an optimist. I believe the above issues should be settled without a significant impact on the Portland Industrial Marketplace. I see another 3M SF net absorption this year and continued strength in the market. It’s just going to be tough for the local tenants when it’s time to renew.

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