Cassidy Turley looks at upside potential in DC's industrial sector.
Washington, D.C.’s suburban industrial markets in Maryland and Northern Virginia have seen limited new development due to supply constraints for well-located and developable land. Currently, suburban Maryland’s industrial activity is centered around the redevelopment of inefficient but well-located properties to meet the needs of today’s warehouse users that require features such as ceilings with at least 24-foot clear heights, 120-foot truck loading courts, trailer-drop areas and flexible configurations with 50-foot on center column spacing. With its strong fundamentals, the industrial property investment sales market continues to be a focus for institutional investors and REITs. Despite overall economic sluggishness, both markets have strong upside potential.
Exemplifying suburban Maryland’s redevelopment trends, Chesapeake Realty Group, Oakmont Industrial and Carlyle Group are renovating a 368,000-square-foot former special-purpose facility into a new, modern general-
purpose distribution center along the eastern Capital Beltway network. A similar deal involves the renovation and Nash Finch’s subsequent 500,000-square-foot lease of a former Giant Food ’60s-era distribution center. This single transaction led to the vacancy rate falling to below 9 percent in the Landover submarket.
Limited new development is occurring along the main transportation arteries feeding into D.C.’s CBD. Demand drivers include regional distributors and service companies catering to the needs of consumers and the federal government. The overall market has remained generally healthy, and new development has been fueled by a meaningful recovery in leasing demand that gained momentum in mid-2012. Existing tenants’ expansions have fueled net absorption and increased leasing activity, resulting in a significant reduction in available inventory and vacancy rates in most submarkets.
Owners are moving forward cautiously, with greater scrutiny of potential tenants. That leads to decreased tenant improvement (TI) allowances, but it also gives owners the opportunity to offer more attractive deals by trading rental rate for TI.
The overall economic slowdown curbed the expansion needs for many businesses — with some companies downsizing or rightsizing — and the market reacted with a halt to new development. Ultimately, this strengthens the market. New development in the pipeline will take up to two years to deliver due to the lengthy processes for entitlement and capital acquisition. Submarkets recently liberated by the expansion of road networks that have available, developable land are the most likely targets for new development and redevelopment. Demand will continue to be driven by the ever-increasing population in the region and suburban Maryland’s access to Washington, D.C.
The Route 5 corridor east of D.C. will improve dramatically due to recent road improvements, creating the opportunity for a high-volume access route to the Capital Beltway and residential population with little congestion. Population growth has continued for the past five years, and there is a reasonable amount of developable industrial land to meet increased demand in the area.
In Northern Virginia, high barriers to entry created by limited industrial land and a thriving local service economy, government contracting and government leasing make entry into the market very challenging. Existing owners have weathered the recession relatively well and typically have elected not to sell quality properties because it is virtually impossible to replace or duplicate comparable assets within the market. Principal Financial’s recent sale of a 165,000-square-foot, cross-dock building for $109 per square foot demonstrates the demand for institutional-grade properties, especially given the lack of new development in the past three years.
Within Northern Virginia’s more than 77 million-square-foot industrial market, each submarket contains a good mix of service-center industrial and flex properties with access to major transportation corridors. Few good sites remain for development, but those few sites are seeing strong demand. For example, ProLogis recently delivered approximately 150,000 square feet of new spec space in the Route 28 North submarket, practically the only submarket with new construction, and it had 45 percent of the space committed shortly after completion. The lack of land inventory leaves few developers the ability to deliver new product, which effectively places a governor on supply and stabilizes rental rates.
Absorption of warehouse space by data center operators is a significant trend in Northern Virginia. Two-thirds of the country’s internet traffic flows through Loudoun County, which is home to the Route 28 North submarket. Recently delivered buildings by Seefried Properties and a 140,000-square-foot building owned by First Industrial have been leased to data centers. Data centers have kept the market healthy, leasing existing buildings for the long term and effectively placing pricing pressure on the few, well-located development sites. Other submarkets such as the I-95 corridor and inside the Capital Beltway (I-495) have no land for new development. It is anticipated that the industrial base will actually shrink due to redevelopment of warehouse space into mixed-use, high-density residential and retail properties.
Industrial rental rates have basically equalized between buildings in older, less functional submarkets and the new product in the Dulles area. These rates range from $7.50 to $8.50 NNN for warehouse space with 10 to 15 percent office finish. Including flex space, vacancy rates stand at moderately over 11 percent. Functional obsolescence will continue to force migration out of older submarkets in a general flight to efficiency and quality, and rates have contracted as much as 25 percent in some of these obsolete areas. The I-95 corridor exemplifies this trend with vacancy levels at all-time highs of 10 percent, primarily due to tenants’ flight to the Dulles Corridor’s new development. This trend has stabilized, but only the most functional buildings will lease first. Long term, though, as the market continues to recover and the base shrinks, occupancy levels are likely once again to be above average.
— Edward “Bert” Harrell, managing director, and Michael Royce, SIOR, senior vice president, at Cassidy Turley