Archives for October 2022

When a city grows, where does it go?

With rock bottom vacancies in the industrial real estate market and increasing demand in all real estate markets, finding affordable space is becoming more difficult around Albuquerque.

Persistent supply chain issues and a labor shortage have contributed to rising costs, reducing new construction – and thus, supply – across retail, industrial and office real estate.

“The market is really all over the place,” said Steve Lyons, retail broker at SVN/Walt Arnold.

Industrial

The industrial commercial real estate market has been particularly squeezed, with historically low vacancy rates around the city, as well as across the nation. Albuquerque has almost identical industrial vacancy rates to the national average, but slightly less available space than similarly sized markets.

Industrial broker Bill Robertson, senior vice president and principal at Colliers International, said he’s never seen levels this low.

“Not in my lifetime,” Robertson said. “And I’ve been working in this for 40 years.”

Amid high demand, low supply and nationwide inflation, prices are up; a recent CBRE report found that in Q3 of this year, the median leasing price increased by 38%.

Robertson said many people looking for warehouses are desperate enough for space that they’ll “make do” with what they have. And if Albuquerque doesn’t have that supply, they’ll look elsewhere.

Jim Smith, first vice president of CBRE, said there’s been little new industrial construction in Albuquerque for the past decade. But that’s starting to change.

According to the October CBRE report, there’s 528,636 square feet of industrial property under construction, with a 15,715-square-foot speculative project under construction in Rio Rancho. However, Smith noted that much of this new construction won’t be usable for a while. Supply chain issues have extended construction times, delaying the incoming wave of new properties.

“It’s got everybody pulling their hair out,” Smith said.

Office

Albuquerque has slightly more wiggle room in office real estate, with more properties available to rent than in Tucson and Colorado Springs. But the number of office spaces available to rent has remained stagnant in the city for many years.

“There has been very little new supply in Albuquerque for the last 20 years,” said Walt Arnold, managing director of SVN/Walt Arnold Commercial Brokerage Inc. “I mean, we have not built any considerable office space for quite a while.”

A July Colliers report said that there was no new office space under construction in the city.

Arnold said that rising costs have pinched new construction for new office spaces, with more developers choosing to adapt existing properties to office use rather than build new.

But even building rehabilitation and general maintenance have raised in price as well.

“Everything: the taxes, the insurance, the janitorial, the landscaping, the heating, ventilation, air conditioning, all those costs that it takes to run an office building are increasing,” Arnold said. “But the cost to do that is not rising as much as the rents are rising.”

Arnold said office rents in Albuquerque have remained flat or risen only slightly, despite the increasing costs for landlords. Competition from other markets has kept rents relatively affordable in the city.

Arnold sees more change on the horizon as employers evaluate how they want to use space in a post-pandemic era.

“To have people in the office is what a lot of the leaders of companies feel is the right thing to do,” Arnold said. “And a lot of employees feel that they can work from anywhere. So I think those two dynamics will continue to kind of battle each other for the next several years … As leases start to expire, I think a lot of people will say, how much space will we need? Do we need what we have? Or can we deal with less space?”

Retail

Like office space, the retail real estate market has a higher vacancy than the industrial market.

But, a nationwide boom in new small businesses has sparked increased demand for small retail spaces, said SVN/Walt Arnold broker Lyons.

According to data from the U.S. Census Bureau Business Formation Statistics, New Mexico saw an almost 10% increase in the number of Employer Identification Number business applications between August of this and last year.

“It’s not quite as tight of a market as industrial, but it’s still very healthy, very strong,” said Ben Perich, vice president of Colliers International in New Mexico. “It is still a landlord’s market, more so than a tenant’s market.”

That demand isn’t even across the market; the best spaces – Class A and new construction – are filling up quickly, Lyons said. Class A office spaces are generally in prime locations, in good condition, and have more amenities than other office spaces – and charge higher rent.

But, for less desirable properties, there’s a “persistent vacancy,” Perich said.

Lyons echoed that sentiment.

“I’ve got some properties that are slow to lease, and then I have some properties that are 100% leased,” Lyons said.

The types of properties that renters look for are changing as well, Lyons said. He’s seen more interest in smaller properties that house just one business instead of large, multi-tenant strip malls.

“You have to turn around and charge them top-of-the-market rents to justify the construction costs (for multi-tenant properties),” Lyons said.

Similarly, he said that rehabbing old buildings for new uses is more popular in the retail market because it saves some of the cost of new construction.

Between labor shortages and supply chain issues, Perich said he’s seeing problems in increasing supply in certain areas of the city.

“We’ve got some negative headwinds that are going to keep a lid on, you know, the ability to quickly add more supply,” Perich said.

The city grows

CBRE’s Smith said that many developers and corporations are moving into “tertiary” markets like Albuquerque – with Amazon’s Albuquerque move last year as an example.

“Amazon had expansion in this market a year ago,” Smith said. “They didn’t need expansion in LA, or Dallas or Seattle, because they’d already built warehouses in those markets. … They look at places like Albuquerque and say, ‘Well, we don’t have a facility there, so let’s invest in that market.’”

Between June 2021 and 2022, Bernalillo County collected $51 million more in gross receipts tax – an increase of about 22%.

“I’m so excited about our Albuquerque-area economy because it’s expanding very nicely,” Lyons said. “After years of being sluggish, it’s not flat. And I think that’s great for our city.”

Arnold concurred.

“I’m bullish on Albuquerque,” Arnold said. “I still think Albuquerque has got a lot of growth ahead of it. I think the forecast for us is good.”

Although Robertson said that his warehouses have been flying off the shelf, eventually, he said that the market might even out.

“This is cyclical, and it does change,” Robertson said. “There’s a rosy end to the story at some point.”

The emergence of the coronavirus in early 2020 caused a drastic slowdown in supply chains across the globe. Labor shortages, fluctuating consumer demand, disruptions in shipping lanes, COVID-19 restrictions as well as general economic uncertainty caused major disturbances in the flow of goods. The war in Ukraine further compounded these issues by cutting off the supply of critical raw materials and ratcheting up energy costs. These disruptions have caused several challenges and opportunities for commercial real estate as the industry focuses on restoring the reliability of the global supply chain. Here are three of the most significant impacts:

Rising demand for warehouse space

During the pandemic, many companies struggled to restock in-demand products driven by a steep increase in online orders amid global lockdowns. Once lockdown restrictions loosened, this led to an “inventory bullwhip effect” as companies over-purchased merchandise to avoid future inventory shortages. Sustained supply-chain bottlenecks led retailers to continue over-purchasing—shifting from “just-in-time” inventory management to a “just-in-case” model in an effort to keep more inventory onsite. As a result, the demand for warehouse space skyrocketed.

The impact of this rising demand is significant. On one hand, warehouse sellers can get a significant premium for their property if they pursue a sale-leaseback of their real estate. However, companies looking to acquire or rent warehouse space might have a difficult time as vacancies are at record lows—for U.S. industrial properties it’s just 4.1%. Supply chain disruptions causing delays in construction materials also increase the build time for new warehouses, meaning many companies are left waiting several years for the space they need to accommodate today’s surging retail inventories.

From an investor perspective, rising demand often translates to low cap rates for well-located warehouses despite inflationary pressures and rising interest rates. However, the shortage in available space also enhances the criticality of these properties to tenants, making them less likely to vacate at the end of the lease term.

Re-shoring supply chains

Supply chain disruptions highlighted the risk of off-shore operations for many manufacturers. As a result, many manufacturers are making the decision to re-shore their production facilities to protect against such disruptions in the future. In fact, in 2021, a record 1,800 companies re-shored their production operations in the U.S.

Companies looking to re-shore production are choosing locations with a high availability of land for development, a large pool of skilled labor and well-developed transportation infrastructure including railways and ports. This has led to an increase in development in the Midwest and South due to both regions’ access to rail infrastructure and seaports respectively.

While re-shoring has contributed to the rising demand for warehouse space, it has also opened up new opportunities for investors as companies look to rent existing warehouses in tertiary markets that may not have historically been attractive, but have access to transportation infrastructure and land available for development.

Increased interest in last-mile logistics space

With limited warehouse space available, companies are having to get creative with their distribution strategies. One such method is through last-mile warehouses, which facilitate the movement of goods in the supply chain to the final destination. These warehouses are typically located close to the consumer and therefore decrease supply-chain costs while minimizing delivery time. As a result, warehouses situated near major highways and bridges that lead into metropolitan hubs are becoming highly in-demand for companies looking to make their distribution network more nimble. This presents an opportunity for investors who own these types of facilities to capitalize on demand and secure high-quality tenants on long-term leases.

Source: “Three Ways Supply Chain Disruptions are Impacting the Commercial Real Estate Market“

Housing starts dropped in September below the historical average of 1.5 million homes as both single-family home construction and multifamily apartment building slowed down. Nevertheless, the number of housing units under construction rose to 1.7 million units for the first time ever. While construction delays and supply constraints have lengthened the under-construction time, the record high number of units under construction is also attributable to the rise of the apartment buildings. Data shows that there are more multifamily than single-family units under construction. Specifically, in September, 893,000 units in buildings with five units or more compared to 800,000 single-family units were under construction. Meanwhile, it’s worth noting that the number of single-family units under construction has decreased for the last four straight months. On the other hand, the number of multifamily units under construction has increased for nearly the last couple of years. Thus, the completion of these units could help with rent increases.

In addition, even more apartment buildings have begun construction. Although multifamily housing starts eased in September, the U.S. is building about 50% more than the pre-pandemic historical average. Nevertheless, our country continues to underbuild single-family homes. Yet the number of single-family housing starts is 13% below the pre-pandemic historical average. Thus, multifamily construction has made impressive gains during the last couple of years. While people are buying homes faster than they can be built, builders are turning to structures that can accommodate more people under one roof.

In the meantime, high construction costs are reported to be one of the biggest hurdles for builders. However, building multifamily homes may help offset some of these costs. In microeconomics, this is primarily due to economies of scale. For instance, most subcontractors may offer a discount when they do one big project instead of two small ones. Moreover, the cost of the lot may also be relatively smaller. Buying a larger lot to build a multifamily home may be less expensive than buying two lots. Additionally, by building ten units on a one-quarter of an acre lot as opposed to one unit, you could economize on the land cost.

Data shows that multifamily construction is on the rise at the local level, especially in larger metro areas where single-family home construction is slowing. For instance, in Atlanta, GA metro area, the number of permits issued for five or more units has tripled during January and August of 2022 compared to the same period a year ago. In contrast, single-family permits dropped by 15 percentage points. Respectively, permits issued for multifamily units in the Baltimore, MD metro area have also tripled, while single-family permits decreased by 40% during January and August 2022 compared to a year ago.

Hover over the map below to see how many multifamily versus single-family permits were issued during January and August 2022 and the same period in 2021

As U.S., like the rest of the world, continues to grapple with stubborn inflation (at 8.2 percent in September), there are worries that consumer spending is going to falter and impact industrial owners’ ability to raise rents. Industry insiders, however, say such fears are over-stated.

At the moment, industrial real estate fundamentals remain strong and rental rates continue to rise, especially in key coastal markets, according to San Francisco-based Al Pontius, senior vice president, national director for office, industrial and healthcare, at real estate services firm Marcus & Millichap.

Pontius does cite nuances in the marketplace that might point to slowing demand for warehouse space. Such indicators include the depth of prospective tenants and change in landlords’ approach to lease up of new build-to-suit properties. For instance, in January and February of 2022, rental rates were rising so fast that landlords held off on making final deals with tenants until the date of occupancy. “Now landlords are locking in rates right away.”

Industrial tenants also are slower than they were before to make decisions, Pontius adds. As a result, absorption in secondary markets and absorption of older industrial product has slowed down.

In the third quarter, the national industrial vacancy rate rose by 10 basis points, to 4.0 percent from an all-time low of 3.9 percent, according to research from real estate services firm Savills. That change was distributed unevenly, however, with vacancy in Houston and the Pennsylvania I-81/78 Corridor falling by more than 350 basis points and vacancy in Detroit going up by 30 basis points. Year-over-year national rent growth reached 12.5 percent, which is considered a modest increase compared to rent growth of 40 percent in some markets in recent times. Industrial leasing activity fell below 200 million sq. ft. for the first time in eight quarters, Savills researchers report.

Leasing activity has decelerated over the past several quarters, in part due to constricted supply, agrees Matthew Dolly, leader of national industrial research with real estate services firm Transwestern. As a result, U.S. overall net absorption is at its lowest level in two years, and the national vacancy rate has ticked up slightly in the third quarter, to 3.9 percent, according to Transwestern research. Meanwhile, some warehouse owners are intensifying property marketing efforts, which could be another indication of a slowdown in demand, as Dolly notes that this has seldom occurred for the better part of the past 10 years.

New deliveries are expected to move average vacancies further up, despite continued strong demand. According to Dolly, more than 130 million sq. ft. of industrial real estate product was delivered nationally during the third quarter, which is consistent with the previous several quarters. And additional 970 million sq. ft. is currently under construction—a record high. Slightly more than one-third of that product is pre-leased, according to Dolly. That corresponds with Savills’ estimates, which put the share of under-construction space pre-leased nationally at 36 percent, though the figure also varies greatly by market. In Baltimore, more than half of under-construction space is pre-leased. In Houston, that figure is 17 percent.

But, overall, demand is strong enough that it’s still a landlord’s market, Dolly notes, especially in key locations. In Dallas, for example, demand for new industrial construction has rebounded in the third quarter to tie with the previously all-time high set in 2021, adds Andrew Matheny, Dallas-based research manger with Transwestern. That is pushing up forecasts for the industrial vacancy rate in Dallas-Fort Worth over the next 12 to 18 months to 8.5 to 9.0 percent (that rate today is 6.2 percent, according to Savills research). But while new projects could experience longer lease-up periods than they have over the past few years, the long-term outlook remains positive, says Matheny.

In fact, several of the most populated metropolitan areas in the U.S. are still underserved when it comes to the amount of industrial space they need, particularly those experiencing substantial population growth, says Dolly. The vacancy rates in the Inland Empire and in Los Angeles markets are currently under 2.0 percent, according to Savills. In Northern New Jersey, South Florida and the Pennsylvania P 81/78 Corridor they are under 4.0 percent.

In addition, rising demand for manufacturing space could tighten industrial vacancy, Dolly notes. Over the past few months, the number of manufacturing companies leasing space in the U.S. has increased, a good indicator of how much on-shoring is taking place. Plus, transportation and retail companies also continue to actively look for industrial space. “Large tenants continue to dominate leasing activity, but smaller tenants may get an opportunity if some of the larger users are able to unload some of their inventories during the holiday season,” Dolly says.

Meanwhile, Matheny notes that current trends may make the industrial property sector more resilient to economic downturns. He points to the continued growth in e-commerce shopping, which remains 25 percent above pre-pandemic levels, and the fact that prevalence of remote work has geographically shifted centers of consumer demand, creating the need for last-mile industrial facilities in suburban and periphery locations.

“Higher market share and geographic dispersion may increase inefficiencies and costs that discourage consolidation, partially insulating industrial vacancy in a downturn,” Matheny notes.

Source: “Demand for Industrial Space Is Slowing Down. But It’s Still a Landlord’s Market.“