Home / Archive / Market Bizarre
Thursday, May 17, 2012
Feature: August 2008
Market Bizarre
When will dwindling vacancy rates push rents up?
Story by Bill Romanelli
On paper, the Capital Region’s industrial market looks pretty good — until you flip the page. Brokers are seeing record absorption rates and a steady demand for industrial space, but construction is at an all-time low. So far, dwindling supply hasn’t spurred an increase in rents. Even the weakening U.S. dollar is giving Sacramento an advantage in attracting foreign investment to its industrial space.
At the end of March, Sacramento was one of the only industrial markets in the nation showing a decrease in vacancy rates for the first quarter of the year, according to a recent report by Grubb and Ellis. Cornish & Carey Commercial, Grubb & Ellis and Colliers International all showed vacancy rates somewhere between 10.4 and 12.9 percent.
“It’s always good news when vacancy rates go down,” says Kevin Jasper, vice president of Cornish & Carey Commercial in Sacramento. “For landlords, it means space is getting rarer, which can push up rents. For tenants, it means builders may see incentive for new projects, putting more space on the market and ultimately pushing rents down.”
A healthy and balanced market, Jasper says, is one in which vacancy rates are somewhere around 10 percent. Experts agree the price of land and costs associated with constructing new industrial facilities are putting a huge crimp in the construction pipeline. Fewer than 270,000 square feet of industrial space are currently under construction in the metropolitan area, according to Colliers International. That’s down from an average of nearly 2 million square feet in the construction pipeline at any given time. Of that 270,000 square feet, 210,000 is accounted for by JB Co.’s planned North Freeway Park project in Natomas and Crossroad Ventures Group’s planned industrial park in Elk Grove.
It should be a gold mine for landlords, but current economic conditions and what some brokers describe as a “bunker mentality” among landlords are creating an odd dynamic. The cost of space is staying relatively flat as the amount of available space continues to shrink, seeming to break the conventional laws of supply and demand. A close look at absorption rates, however, suggest landlords are no fools.
According to Colliers, net absorption rose above the 1 million-square-foot mark in the first quarter of 2008. To put that in perspective, the region’s quarterly average since 1999 has been fewer than 440,000 square feet.
Ordinarily, those kinds of numbers would have economists doing cartwheels, but the likely reality is they are a flash in the pan. Two big projects, Home Depot’s new 300,000-square-foot distribution warehouse in West Sacramento and OptiSolar Inc.’s new deal for a 675,000-square-foot manufacturing space at McClellan Park, together account for more than 90 percent of absorption in the first quarter. Factor these megadeals out of the mix, and West Sacramento actually had a net loss in absorption, and regionwide absorption for buildings smaller than 100,000 square feet was at its lowest level since 2001.
The low absorption numbers could be why rents are staying flat in an environment of limited supply. Recession or not, the good numbers on paper are a result of a handful of big deals that don’t show signs of being duplicated later in the year. If anything, other big projects may be eyeing the terrain in nearby San Joaquin County. Unlike Sacramento, outlying areas have the land available to accommodate needs for bulk distribution and warehouse space — 100,000 square feet or more — and officials aren’t being shy about it.
Mike Locke, president and CEO of the San Joaquin Partnership, says that on top of several thousand acres of available space, San Joaquin County has another 8,000 acres in the beginning stages of industrial development. He points to the proximity of major rail, marine and highway corridors, and competitive land and labor availability as assets attracting industrial developers.
Sacramento’s story is far from one of doom and gloom, however. Land availability notwithstanding, this region offers all the same benefits found to the south and more. The River City also has cutting edge universities fueling research and development, as well as the capacity to assist companies looking for manufacturing and distribution facilities.
Further, according to Bob Burris, deputy director of the Sacramento Area Commerce and Trade Organization, there isn’t a lot of demand for huge spaces.
“The average size need we’re seeing is for something a little smaller than the big warehouse or distribution center, and we’re finding that many of the deals we’re looking at can fit into existing space,” he says. “We’re talking to several companies that need the 5- to 30-acre space, and we’ve got lots of parcels in that range.”
The demand for this size space is being fueled in large part by the advent of the clean-tech industry. With Sacramento at the nexus of discussions about climate change, energy efficiency and reducing dependence on foreign oil, the region is poised to take advantage of the green revolution. Companies in this sector want the kind of geographic access to decision makers and policy leaders that only Sacramento can provide. That’s led to what Burris calls one of the biggest opportunities, in terms of economic development, the region has ever had.
“Nearly six out of every 10 companies we’re actively talking to right now are involved in clean tech, and what’s more, nearly two-thirds of all the companies we’re talking to are looking for industrial space,” Burris says. Much of the interest is coming from European companies, who say the wave of American clean-tech commerce is starting in Sacramento. They’re inclined even more by a weak dollar that’s making investment in U.S. real estate very attractive. Simply put, it’s cheaper to build, manufacture and export from California than it’s ever been before.
“The weak dollar creates lots of opportunity; if that’s what makes it possible for companies to start thinking about California, then we’re creating jobs and investment here that otherwise would have gone elsewhere,” he says.
Perhaps the biggest risk facing our region is the potential for a shortage of industrial space as the economy starts to revive and turn around, something that most economists are predicting to happen in late 2009 or 2010. Unlike the office market — where there is a glut of new space — there’s very little industrial product in the pipeline, and market lease rates are too low to justify rising building costs. Experts are predicting a vacancy rate around 8 percent by the end of 2010.
That’s likely to create an increase in rental rates on par with the increases in gas prices in the past six months: rapid and sustained. It’s bad news for tenants, but necessary to make building worthwhile again.
For the next two to three years, however, things should stay pretty flat, and that’s something many observers, including Jasper, can live with.
“A flat market is not cause for doom and gloom,” he says. “A flat and stable market is certainly more desirable to one that’s unpredictable and declining.”
