As we close out the first half of 2023 (time flies), the Portland/Vancouver market saw almost 1M sf of net absorption in the second quarter. An increase from the roughly 1/2M sf in the first quarter, a rate still below the 5Msf absorbed in the record setting 2022. However, the Industrial Market continues at a healthy annual rate of 3M sf of net absorption, which has been our average rate over the last few years.
With new construction coming on-line, the vacancy rate continues to hold at a very low 2.9%. It can be very difficult to find space in some submarkets with less than 2% vacant. There is always 1-2% of product that is functionally obsolete (poor clear height, truck maneuvering, etc.), often resulting in no real alternatives for a company looking for a quality space in a specific size range. A breakdown of vacancies by geographic area is included in the second article, Capacity Industrial Market Update.
I feel like a broken record, but the momentum continues. High interest rates, the once again cycle of crushing the housing industry to make an adjustment in the overall economy, the downward spiral of downtown office real estate, and other generally bleak outlooks in the national economy, yet the Portland/Vancouver industrial market continues with strong absorption.
That being said, as I’ve shared over a number of quarters now, the storm clouds are out there. Sublease space continues to be a higher percentage of the available space than normal. Regional companies are vacating our market and supporting their operations from other locations, and local companies are throwing in the towel if they happen to be in one of the market segments that the Feds are trying to bust. Additionally, we are hearing that the 3PL folks (a large part of our industrial market) are having some tough times with decreasing volumes. This is In part due to the general economy, but also in part due to the global shipping economy. With completion of the enlarged Suez Canal, and the continual chokehold of the LA/Long Beach Longshoremen, cargo volume in the eastern ports continues to rise, while volume in all of the west coast ports has declined over recent years. Add to that the fact that companies are friendly/near/re shoring their supply chain sources, and the result is even less business for Portland, which has always benefited from trade with China due to our geographic location. Even with all this, our net absorption continues strong.
Rental rates continue to increase. A recent analysis of Portland/Vancouver industrial rental rates showed that rates have increased 6-8% every year for the last 5 years. If you just use 6% as the average, and you’ve been paying 3% bumps, you get hit with a more than 15% increase just to get back to market. For many companies that number ends up being worse.
Under Construction is up, but there is a general dread that this number might start to fall. As the Portland area Developers of industrial product look to the Equity and Debt markets, interest rates rising above 7% have a chilling effect. Add to that the general consensus concerning the storm clouds mentioned above, and many Developers have already tucked their tails in. They say vacancy rates rising above 10% is the threshold of going from a Landlord’s market to a Tenant’s market, and it will be extremely difficult to get there if the supply of new product is curtailed.
Purchasing industrial continues to be a challenge. Few folks want to put their product on the market as industrial is the product of choice. Some industrial buildings are on the market in the +/-$200/sf, but purchasing is difficult. Users are going to the bank to find interest rates higher than they have been in a long time (but not historically high) and investors are tying to figure out how to make the numbers work, with $10 annual rents per square foot penciling to a 5% return, while debt is 7%. At the Institutional level, transactions have ground to a halt. Product that was built to sell at a 5Cap now sits idle while folks are shopping for a 7 Cap. Again, at a $10 annual rate ($0.83 shell ignoring office) that product sells for $200/sf, but at a 7 Cap, it sells at less than $150/sf. Everyone is sitting on the sidelines waiting to see who blinks first.
Construction costs are generally softening, but lead times continue to be a problem. Electrical gear lead time is out more than a year, and roof and dock equipment continue to have long lead times. Industrial office construction in empty shells has risen into the $175/sf range, resulting in office surcharge rates rising to the $1.30 - $1.40 range. Speaking of costs, the City of Vancouver is working on a moratorium on warehousing, which has morphed into DEI and Environmental objectives. If enacted, it will drive the cost of new construction up significantly and greatly curtail speculative construction within their boundaries.
While I continue to discuss the ominous clouds on the horizon, I believe the momentum will continue for the Portland/Vancouver marketplace through the end of this year, and see us racking up 3M sf of absorption. The City and County appear to be trying to battle the homelessness and I can see an upsurge in overall activity as I come into the office in downtown Portland every day. My Associates are still being accosted, but the rate appears to be falling. Maybe there is hope for this place after all.