 Demand Is Becoming Pent-Up
The Twin Cities industrial market continues to gain momentum as it chips away at vacancies, boasts positive absorption, sees fewer user-buildings sales and reports dwindling concessions. The tide is turning from a tenant’s market to a landlord’s market. Demand is becoming pent-up, and quality space is becoming limited. As the number of options decrease, tenants must decide between newer, more costly space and lower-priced, less efficient spaces. This supply shortage will also prompt more build-to-suits and speculative development in select submarkets and eventually drive rental rates up for the first time in years.
Overall vacancy remained stable at 13.7%—essentially the lowest since 2001.
In 2005, the market boasted record-setting absorption of 3,767,091 sq. ft.—the highest since 1999. While absorption in the first half dropped to 531,956 sq. ft., another one million square feet is expected, which will further decrease vacancies.
The Northwest reported the most positive conditions with 11.3% vacancy and 256,925 sq. ft. of absorption. The Southwest saw 12.2% vacancy but only 34,150 sq. ft. of absorption. Despite just a handful of deals closing, many users are actively looking in this submarket. Three-quarters of a million square feet of potential activity remain in the Southwest. The Southeast reported 13.4% vacancy and 256,458 sq. ft. of absorption, followed by the Northeast, which struggled at 16.8% despite negative 15,577 sq. ft. of absorption.
Office showroom space boasted the lowest vacancy at 12%, followed closely by office warehouse at 12.4% and bulk warehouse at 16.6%. Office warehouse experienced the most absorption with 961,693 sq. ft. in the first half. Office warehouse space is particularly tight in the Southwest and Northwest, at 9.3% and 9.4%, respectively. Bulk continues to struggle in several submarkets, reporting negative 413,191 sq. ft. of absorption.
Despite strong demand, rental rates were flat at $4.46 for warehouse and $8.08 for office. However, concessions are diminishing across all submarkets. The cost of new construction is also impacting existing buildings’ rates. To be competitive with new construction, landlords of existing buildings may increase rates.
Pause in Market Due to Lack of Space
The market is experiencing a period of adjustment as tenants weigh limited options and adjust to higher pricing and fewer concessions. It was a tenant’s market for so long that many are experiencing “sticker shock.” Some companies are delaying relocation decisions until absolutely necessary. Some will pay the higher rates for newer space, and still others will retrofit existing buildings or split operations and take multiple locations. In the Southeast, tenants are starting to pay $5.12 (office) and $4.53 (warehouse) for new construction, which broke new rate territory. 2006 will continue to test the pricing model. Once tenants are willing pay the premium rates necessary for new construction, speculative development will follow close behind.
User-Sale Market Slows
The opportunity to purchase good, owner-occupied buildings is limited, and that’s pushing more companies to build or lease. Demand and activity are still strong, just not as active as in the past two years. Due to low interest rates, buying remains an attractive alternative, but many of the high-quality buildings have sold and prices continue to increase.
Redeveloping “Junk” Properties
As the market tightens, some users will take older, less functional space. As land and construction costs continue to skyrocket, renovation may become an attractive alternative. Raising an obsolete building’s roof to make it more functional is an option that’s occurring in other markets around the country.
Land Prices Peak
In outer-ring suburbs, land prices have peaked and will now begin to slowly stabilize. Traditionally, residential developers paid top-dollar for land. With the housing market slowing, residential developers’ appetite for land decreased and some are even letting land under contract go by not exercising options or following through with a sale. These factors will help stabilize land prices and provide more land inventory for commercial/industrial development.
The Outlook
The market will continue to tighten. Another one million square feet of absorption is expected by year end. With more pent-up demand, more deals will close. Concessions will continue to evaporate; rates eventually will increase. Tenants will continue to deal with decreased supply and increased rates and evaluate limited options. Users will begin feeling more urgency to sign deals. While some will pay higher rates for new space, others will retrofit existing buildings or split operations. We’ll see more build-to-suits and a half a dozen or more speculative buildings developed in the next six months. Land prices will slowly stabilize.
|