Commercial Investment Real Estate November/December 2018 | Page 18

INVESTMENT
A N A LYSIS
Industrial in Crisis
Despite low vacancies and higher rents, industrial construction
fails to meet demand.
n industrial housing crisis is affecting the U.S com-
mercial real estate markets and will have a major
impact on the ability for our economy to grow.
Across the nation, industrial vacancy rates have
dropped to their lowest point in decades, at approximately 4.7
percent at the end of the second quarter of 2018. Contrast that
against a 10.3 percent vacancy rate for office and a 6.4 percent
rate for multifamily, according to CoStar. Even more alarming
is the lack of entry-level, light industrial incubator product type
in the 1,500-square foot to 3,000-sf unit size range. Most vacant
industrial space is found in large blocks of high-cube warehouse
product produced over the last few years to support demand for
companies like Amazon, rather than smaller, multitenant build-
ings. In 2017, CoStar reported that 87 percent of construction
starts across the nation were for logistics buildings.
The news is worse for California, as the booming economy has
driven industrial vacancy rates down to 3.3 percent from their
five-year average of 4.4 percent, according to Kennedy Wilson and
CoStar Analytics. Even more interesting is the speed of the market.
The time frame to lease industrial product in California dropped
more than 50 percent; it now takes three and a half months to lease,
compared to the seven-to-eight-month historical average. This has
driven rents up from a $0.59 average to $0.82 psf per month today.
With few incubator projects pending, little relief is expected.
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These factors typically would indicate accelerated construc-
tion, but 12-month construction starts in California during 2017
are only slightly above the five-year average of 35 million sf at
$38 million. Very little of the construction was on light indus-
trial, incubator projects, further skewing the available space to
much larger blocks with at least 100,000 sf. Drilling down to the
regional level puts the issue into sharp focus. For instance, Contra
Costa County in Northern California has enjoyed a strong indus-
trial market that historically ran at about a 7.1 percent vacancy
rate. The hot economy has driven vacancy down to 3.1 percent
for the first quarter of 2018. But when small industrial spaces
of 2,500 sf or less are isolated, it’s an incredibly tight market, at
1.7 percent vacant. That means 20 spaces across the county are
left to support a historical deal velocity of 23 deals per month
in this size range. Additionally, the average age of an industrial
building in the area is 45 years old, so small startups have to vie
for expensive, old space.
While low vacancy and rent growth should have lenders eager
to invest in industrial development projects, they are taking a cau-
tious approach to the market. Here’s why. Loan-to-value ratio for
construction projects remains nearly at 65 percent. Actual rents
now are the focus rather than pro forma optimistic projections,
as lenders are keenly aware of the potential impact of rising con-
struction costs on the bottom line.
COMMERCIAL INVESTMENT REAL ESTATE
by Eric Rehn, CCIM