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Writer's pictureMark Childs, SIOR

IT’S FINALLY ARRIVED

A year and a half ago I foretold Clouds on the Horizon, expecting the Industrial Real Estate marketplace to cool off due to the recession we were in and the general economic climate of rising interest rates and global events. Then it was Powering Through the Mess, followed by Bogging Down in the Mess?. And for my last three, What Clouds?, Steady as She Goes, and The Momentum Continues. Six quarters of noting there should be a slowdown coming. Not too good a track record. LOL.


Well, it got here. Space being vacated at end of term, increasing sublease space, and new product coming online that is vacant, pushed the Q3 industrial net absorption (space being moved into minus space being vacated) to a negative 1.2M sf. With around 500k sf of positive net absorption in the first quarter and 1.0M sf of net absorption in the second quarter, that puts us at about 300k sf of positive net absorption for the year.


The data is finally showing what I have been seeing in the market for more than a year. The feeding frenzy coming out of Covid by Amazon and Amazon competitors (major retailers) has subsided, and with rental rates increasing 40-50% over the last few years, the locals are finding it hard to do biz. Unlike a couple years ago, there are now a couple or more alternatives in a size range and market, and, rather than a number of tenants competing for the space, there are a few tenants out there carefully surveying the market.


While we have a quarter’s worth of data communicating a slowdown, we still have a strong market. Vacancy has gone from 3% to 3.5%, still VERY healthy. And transactions continue to be completed. We track larger completed lease transactions in our semimonthly industrial meetings, and while the velocity has dropped from roughly 6 transactions a meeting to three, there is still underlying velocity out there.


One of the reasons for continued demand on the industrial side is the re-emergence of manufacturing as a demand source. The continued fallout from the supply chain issues, relations with China, and the need to source critical components locally, has created an increased demand for manufacturing space. Typically, a 10% of the market kind of number, manufacturing is starting to make up a higher percentage of the demand. Certainly, much of the reshoring is being handled by near shoring to Mexico (article follows), but there is still increased demand locally.


Industrial construction continues strong, doubling from 3.2M sf being built at the end of second quarter to 6.4M sf being built now. Many folks got into the ground in late summer, including a 1.2M sf speculative development in Longview and another 600k sf development in East Vancouver, located adjacent to an almost completed 600k sf development that is still available. Folks are banking that there are still retailers out there looking for large spaces to compete with Amazon.


Lease rates appear to be leveling off. Often sublease space hits the market with a motivated tenant that wants to get their product leased up, which can have a downward pressure on lease rates. Building sales continue to be far and few between. Industrial is still a popular product to hold onto, and at the Institutional level most Owners bought at a 5 Cap and don’t want to sell in this 7 Cap environment. Similarly, smaller user building sales are being challenged by the high interest rates. I’m in the middle of two transactions that are taking seller financing to complete.


Construction costs appear to have levelled out, although the Architects and Contractors are still quite busy. If anything, they are reporting that their backlogs are starting to shrink. Electrical components continue to be a challenge, with major components often more than a year out. This can create a challenge for a manufacturer who would like to move into a low powered warehouse, but has to wait a year to make productive use of the space.


Where are we headed? I have to admit I don’t know. The City of Portland appears to be earnestly working on the homeless problem, although funding comes out of the County, which is also trying harder to spend money faster. I actually just closed on an industrial building that will be used for County services like drug addiction and mental health. Fortunately, addressing the core problems rather than treating the symptom of where is someone sleeping tonight. Interest rates don’t appear to be coming down any time soon, and we’re headed into an election year, which tends to slow things down. And now we’ve got two active wars.


We were at 1.5M sf of absorption at the end of Q2, and I guessed we would double that to 3.0M sf by the end of the year. Boy was I wrong. I think the 1.2M sf drop was both a market weakness and aberration (randomness) in the data. My guess now would be that 4th quarter will be neutral, and that we’ll end the year around zero net absorption. A far cry from my estimate three months ago.

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