- 2005 was a breakout year for industrial, absorbing a record-breaking 3,767,091 sq. ft.
- Market could absorb another 3 million square feet in 2006, pushing the vacancy to 10% or lower—the lowest since 1999
- User sales market is drying up, pushing more companies to build or lease
Breakout Year for Industrial
The industrial market absorbed 3,767,091 sq. ft. in 2005—more than three times the absorption in 2004. This strong activity helped push down vacancies to 13% at year-end 2005 from a historical high of 15.5% in 2004.
The Northwest’s vacancy was the healthiest at 10.7%; the submarket absorbed 590,076 sq. ft. in the second half. The Southeast boasted the biggest drop in vacancy, decreasing to 15.2% from 18.8% at mid-year and absorbing 560,291 sq. ft. The Southwest’s vacancy was 11.6% with 30,515 sq. ft. absorbed after coming off 876,954 sq. ft. in the first half. In the Northeast, absorption fell to 36,692 sq. ft. from 473,680 sq. ft. at mid-year; the vacancy was 14.9%.
Bulk warehouse experienced the most absorption with 1,914,194 sq ft., pushing down the vacancy to15.9%. The biggest bulk deal was Citi-Cargo & Storage Co. Inc. leasing 312,000 sq. ft. at Apollo Distribution Center in Eagan. Office/showroom ended the year with an 11.3% vacancy rate and office/warehouse was at 11.8%.
2006 Should Be Another Strong Year
Another 3 million square feet could be absorbed in 2006, which could push down the vacancy to 10% or lower—the lowest since 1999. Several factors are behind the market’s recovery. One is the number of user buildings for sale is diminishing across the submarkets. With fewer options, more companies will lease or build. Interest rates are expected to rise from the record lows of 2004 and first-half 2005, which also will slow sales. In addition, there’s steady job growth. Minnesota’s employers added 34,000 jobs from November 2004 to November 2005 (seasonally adjusted), according to the Department of Employment and Economic Development. The manufacturing industry added 4,500 jobs in the same time period. Minnesota’s unemployment rate is below 4%.
Supply Constraint Conditions
If the market continues experiencing strong activity in 2006, it could face supply constraint conditions. There has been a lack of office/showroom space, but with several new projects underway or recently completed, we expect the office/showroom vacancy to rise in the Northeast. The Southeast will probably be consistent in the 10% vacancy range across all product types. In the Southwest, vacancies in office/showroom and warehouse could approach 5-6%.
A Landlord’s Market
Landlords will benefit from these tighter market conditions. Concessions are dwindling, and renewal rates are firming up as tenant options become more limited. Landlords will press for longer lease terms. Tenants may feel sticker shock, and they will have to make quicker decisions. Higher rental rates might spur activity as tenants go to the market to prove to themselves whether they’re getting an attractive deal.
More Speculative Development
The Northwest saw the most development at year-end with two projects totaling 724,000 sq. ft. Several more could begin in 2006. In the Southeast, two projects were delivered with one or two that could start in 2006. One speculative project will open in early 2006 in the Southwest, and at least one speculative office/showroom building could get underway next year. In the Northeast, three speculative buildings were delivered in 2005 and no further speculative development is expected in 2006.
While more speculative development is planned, challenges exist. Land, construction and energy costs are at all-time highs, and a shortage of land exists in some submarkets. Developers will move forward cautiously. It won’t be “Should we develop?” but “Can we make the numbers work?” Quoted rates are flat at $7.99 for office and $4.39 for warehouse. A sizeable gap exists between market rates today and where they need to be to justify new construction, so there might be a rough period until tenants “buy into” new development. This might lengthen the time frame before development really takes off. The question is will users pay higher rates for a new building or “settle” by retrofitting an existing property or splitting up operations and moving into multiple locations? The perceived value of new construction space, and the associated higher costs, will be tested in 2006.
Also, despite impressive statistics, some question if there’s as much depth of activity in this recovery as there was in the mid-1990s. Developers may wait for the market to show them further signs of improvement, which may result in the market tightening further before developers decide that the new prices necessary for new development can be achieved.
Outlook
Another 3 million square feet could be absorbed in 2006; vacancy could hit 10%. The number of for-sale user buildings will continue to dwindle, and higher interest rates will deter user/buyers. The speculative market will increase, although cautiously due to high land and construction costs and limited land supply. Developers may need to build their confidence in 2006 and wait until 2007 to pull the trigger. Tenants renewing leases will pay more because of limited options. Landlords will press rate terms. The market may see real rental rate improvement in 2006.
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