Go Big or Go Home
By: Mark Childs, SIOR
The Industrial Market in the Portland Metro area continues strong. Net absorption for the 4th Quarter was a very strong 2.3M SF, bringing the absorption for the year to 3.4M SF, a strong year for absorption in the Portland Metro area. As a result, vacancy has dropped to 3.4%, not dropping further only because approximately 5M SF of new construction was brought online in ’21, also a record (ignoring some previous year Amazon anomalies).
Speaking of new construction, a look at the blog following this article is the Capacity Commercial Group Quarterly Report, which shows what is happening in the construction pipeline. We are showing around 5M SF under construction and close to 6M SF planned beyond that. It was just a few years ago that building a speculative 200k SF building was rare. If you had enough land, you built a few buildings larger or smaller than 100k SF each. Now most sites are simply covered by one building, with some sites having two or three buildings only because the site configuration won’t allow one large building. The average building size currently under construction is close to 250k SF, and while the data is still a little sketchy, the average size for the buildings planned will probably be a little larger. Go big or go home.
Why the shift? Basically, the Amazon effect. As I’ve shared here before the basic concept is that the largest 100 retailers have to compete with home delivery, so they are expanding their one or two national warehouses to the six to eight range, with at least one landing in the Pacific Northwest. And when they land, it is usually in the 100k to 500k SF range. One would expect them to land in the Seattle area, being the larger market, but that has happened so much that they are basically out of land. New, large developments have been pushed down to the Centralia/Chehalis area, and while this locale has the land, they don’t have any employees to staff them. Plus, the Kent Valley has become very expensive. A 20k SF lease in the Portland area that would be in the $0.70 shell and $0.25 NNN range is a $1.10 shell and $1.00 NNN range in the Kent Valley.
This means lease rates are going up. Smaller, local folks are getting very little new product, making relocating quite difficult. With a shortage of space and cost of construction continuing to rise (albeit not at the rates it did in the end of ’21), shell rates are rising. Product on the west side is now routinely in the $0.70’s with occasional $0.80’s, while east side is now firmly in the $0.60’s, with occasional $0.70’s. We’re starting to run into what happened coming out of the great recession: Companies with 5 to 7 year leases are looking to renew and getting sticker shock from what has happened since they signed their last lease.
With new construction costs continuing to escalate, the price that industrial buildings are trading at just moves northward. A 20k SF industrial building on the east side (Troutdale) was recently put on the market at $185/SF, and sold at $205/SF. Additionally, institutional capital continues to flow into the industrial sector, driving cap rates down into the low 4% range. Institutional money is betting on future rental rate increases.
New development takes land, and we are running out in our core. Even Canby is close to sold out. As a result, development is occurring on the perimeter pushing out to Woodburn and Salem to the South and Camas, Ridgefield, and even Kelso to the North. A move to a more remote location then brings its own set of challenges, such as getting tractor/trailer traffic through what are already strained commuter connecting roads.
It will easily be a couple of years to get caught up with the major shift to e-commerce that was accelerated by Covid in ’20. And the shift is happening. I suspect you’ve noticed how quickly you are getting product from vendors other than Amazon (you are using other vendors aren’t you?). I just ordered some gauges for one of my old cars from Summit Racing and they were at my door in 3-4 days. Similar responses from Home Depot and others. The retailers are catching up, and will continue to expand their warehouse networks into the foreseeable future.
With the marketplace going so strong, the Economists are finally having to acknowledge what we’ve known for more than a year. Rising prices aren’t a temporary issue. I’m old enough to know we are in an inflationary period, and now the Feds are realizing it and starting to take some action. Raising interest rates will slow things down, certainly on the housing side of things. For industrial expansion, I don’t think so. I’ve never been through a period of rising interest rates while the retail world is trying to expand their warehouse footprint. I think the retailers will trump the Fed. I believe industrial will continue to do fine into the foreseeable future. I expect absorption in ’22 to be more than our historic 3M SF per year, but not as high as ’21. With new construction, I see little change in the vacancy rate. For now, the best course of action is to go big or go home.