2020 will go down in history as a weird year at a minimum. As we roll through the first half of 2021, we continue to be impacted by what transpired, certainly in Oregon where we didn’t get back to anything near “normal” until about the middle of this year. The weird part is it feels very busy in the Industrial Real Estate world, but the numbers don’t tell that story. Our Net Absorption (space leased minus space vacated) was a negative 40K SF in the second quarter. For a quarterly figure that is not that big a deal. The problem is that for the last four quarters (mid-2020 to mid-2021), we are running at a negative 2M SF net absorption. It feels like a total disconnect.
So how does this happen? Well, real estate brokers make money on change, both in a growing market, and in a shrinking market (admittedly more difficult). What 2020 brought us was CHANGE. There were serious winners from the virus, and certainly losers. As brokers we spend our day helping companies grow, and it feels like the world is swell. But there are certainly companies that are struggling. We tend not to spend time with those companies. For instance, in the last year or so Safeway put a little less than 1M SF on the market and the old United Grocers was vacated putting more than 1M SF on the market. Both were probably impacted by the Amazon Effect, and both represent vacancies to be filled by Brokers at Capacity (which feels good). While not necessarily occurring in the last year, they both added to the negative net absorption.
I used to joke that there were many folks looking for 5K SF, fewer looking for 50K SF, and none looking for 500K SF. Well, again thanks in part to Amazon, that has changed. There are many national companies looking to expand their warehouse network to compete with fast delivery by Amazon. Consequently, there are many requirements greater than 100F SF, and the national companies are happy to pay our rising rental rates compared to doing business in LA, Atlanta, or elsewhere. We are still the cheapest location on the West Coast. However, our smaller local businesses are struggling. As rental rates rise and the squeeze of how business is changing hits them, many companies are just throwing in the towel.
As a result, what feels like a healthy economy has been going backwards at -2M SF for the last four quarters. Historically we have been seeing around 3M SF of positive absorption. We’re about 1M SF down in the first half of this year. I would expect us to finish in the black by the end of the year, hopefully in the plus 1.5M SF range.
Part of what is hurting the locals are the rental rate increases. While we’re not experiencing strong absorption, we’re still hovering at 5% vacancy (see following article for submarket vacancies). There are few choices below 100K SF and hardly any above 100K SF. This imbalance between supply and demand alone can drive prices up. Add to that skyrocketing construction costs and you have further pressure on rental rates. The Eastside, with rents generally in the $0.50’s, has now climbed into the $0.60’s, and the Westside has also bumped up a dime into the $0.70’s. Rumor has it that a recent 500K SF lease in NE Portland had a $0.68 shell rate. Rental rates are continuing to ebb northward.
Another impact on rental rates is construction costs. Last year a normal office surcharge was $0.95, with construction costs expected to be in the $100/SF range. As you’ve seen in the news, wood, steel, concrete, and other product costs have been skyrocketing. As a result, that TI is now usually north of $125/SF and landlords are now bumping their office surcharge to $1.10/SF and beyond.
Another factor influencing lease rates is the expectations surrounding inflation. I’m old enough to have been around in the crazy ‘80’s. We’ve been at around 2 – 3% since the early 90’s, so plugging in a 2-3% bump each year has been the norm. Now, we’re starting to see the Consumer Price Index (CPI) make a comeback. The last 2 transactions I processed with 10-year terms each ended up with a fixed increase for the first 5 years and CPI increases for the second 5 years. We’re actually hearing that in other markets, partly out of acute space shortages, landlords are just dropping in 4% or 5% fixed annual increases. Portland tends to be behind the larger markets, but we usually end up where they have been.
Industrial continues to be the darling of the investment world. Retail and office continue to struggle, leaving most money chasing Industrial. Cap Rates continue to get compressed. Historically only Institutional money buying large business parks got into the sub 5% Cap Rate range, but recent transactions by locals purchasing 100K SF buildings have been transacted in the 4.5% to 4.75% Cap Rate range.
Practically all my clients are scrambling to fill positions due to a shortage of labor. Short labor, companies are having trouble keeping up with demand, which of course brings shortages, which of course brings rising prices.
As national companies continue to expand their warehouse delivery capabilities, the Portland/Vancouver market continues to see strong demand for larger warehouse spaces. However, as we continue to see increased taxes applied at the City/ County/ Metro/ State/ National levels, there is a dampening effect. We’re hearing of families and companies departing. I just finished a transaction which will result in a 200K SF manufacturing company vacating Portland and moving to Clark County. Hopefully the pendulum will swing the other way to make this place more business friendly.
In the meantime, the National Industrial market remains strong. I expect it to be the same here. Hopefully the data will back up how the Industrial market feels, and we will finish 2021 with around 1.5M SF of positive net absorption, about half of what we’ve been seeing historically. Alternatively, we may be starting to slow.