Warehouse Market Sees Gains As Absorption Increases, Vacancies Improve

"Add another commercial property type that is now on the path to recovery. The U.S. warehouse market joined the office market in clear recovery mode after logging another quarter of positive absorption and improving conditions as the national industrial vacancy rate edged down slightly for a second consecutive quarter.

Similar to its office market counterpart, the industrial real estate market is also seeing the pace of recovery vary quite a bit from market to market, according to CoStar Group's Third Quarter 2010 Industrial Real Estate Review & Outlook.

Recovery is slower to take root in the sales market and probably won't be as robust as some would like to see. But with so little new warehouse supply on the horizon, any growth in demand could quickly cause the rate of recovery to accelerate, CoStar Senior Director of Research and Analytics Jay Spivey said in a webinar presentation this week with Hans Nordby, Director of Advisory Services.

"We could be surprised at the level of recovery, given the low levels of supply we've seen," Spivey said.

Seven of the previous eight quarters prior to second-quarter 2010 posted negative absorption. The market has bounced back since earlier this year, absorbing 10 million in the second quarter and 8 million square feet in the third quarter. While far from broad-based, "it's official - we're in recovery," Spivey said.

Leasing activity remains steady. The amount of gross square footage leased quarterly has been a "picture of stability" through the downturn, even spiking to a decade high of 620 million square feet in 2009, one of the worst years for the economy on record. The Inland Empire, (positive 5.6 million square feet), Philadelphia (+5.1 million), Houston (4.6 million) and Phoenix (3.2 million) topped the list for net space absorbed, with Chicago and Cincinnati tied for fifth at 2 million.

While four of the top six markets reporting positive absorption are large distribution hubs, not all the major distribution regions are doing well. Some of the largest, Atlanta, the San Francisco Bay Area and Los Angeles, all posted negative absorption exceeding 5 million square feet in the quarter. New York, Dallas, Chicago and New Jersey also gave back significant space. Seven of the eight markets with the highest negative absorption have been hit hard by the housing and manufacturing busts.

The good news for the market, Spivey said, is that very few warehouse construction starts are on the books for the next couple of years. New supply will hit another all-time low in 2010 -- so low that any significant growth in demand as the economy improves could cause a fairly dramatic decline in vacancy rates, quickly accelerating recovery in the warehouse sector.

A look at the percentage of submarkets with declining vacancies in the third quarter shows how fast industrial occupancy is poised to rise as a result of constrained supply. Submarkets vacancies are a leading indicator for the national warehouse market because they generally start to decline much sooner than the national rate.

Almost 55% of the nation's industrial submarkets saw falling vacancy rates in the third quarter. During the last recession in the early 2000s, it took about 11 quarters to reach that level of submarket recovery, largely due to the huge amount of new space that hit the market early in the decade. With limited supply, declines in submarket vacancy have been much steeper in the current cycle.

Quoted rents have declined steadily for two years in the current downturn, about 11%, a larger drop than the last recession. With quarterly occupancies rising in about half the nation's industrial markets, rent declines appear to be bottoming.

CoStar forecasts relatively mild absorption in the industrial sector through 2014, much lighter than the huge spikes in both absorption and supply that marked the last recovery. "Overall, we're going to see improving fundamentals, declining vacancies and rising rental rates," Spivey said."