Demand Floods Mid-Atlantic Industrial Market
By Taylor Williams
Demand for industrial space continues to surge throughout New Jersey and eastern Pennsylvania, prompting developers to undertake more projects on a speculative basis and avail themselves to the classic mantra of “If you build it, they will come.”
E-commerce users, spanning every industry from building materials to electronics to food, continue to spearhead the demand side of the equation. According to the U.S. Census Bureau, in 2020, a year in which a global health crisis spurred furious increases in online shopping, e-commerce sales accounted for 14.4 percent of all retail sales, up from 7.3 percent in 2015. That figure is expected to grow to nearly 20 percent by 2024.
Lenders are eager to finance speculative industrial projects, and developers are scouring the Mid-Atlantic for viable sites as spec projects increasingly account for bigger portions of their portfolios.
“Pre-COVID, and even dating back several years, you might see 20 percent of the Mid-Atlantic industrial projects being done as build-to-suits,” says Rob Borny, senior vice president of capital deployment and head of the East Region for Nevada-based Dermody Properties. “It’s now moving toward being significantly less [build-to-suit activity] due to robust tenant demand, as well as the shorter lead times that users have to occupy space and become operational.”
New Market Dynamics
For the last several years, the pricing and availability of land has represented the largest barrier to entry and growth in the Mid-Atlantic industrial market.
“It’s tough to find sites of 100 acres or more that are located near major highways, have all the utilities and infrastructure hooked up and are zoned for industrial,” says Peter Polt, executive vice president at J.G. Petrucci Co., a developer based in Lehigh Valley.
“So, we’re starting to see more requirements for Delaware and northern Maryland, as well as more creativity in the form of conversions of old office buildings, retail centers and malls to meet demand for industrial space.”
But in a time of accelerated online shopping, demand for e-commerce facilities that can service large population bases is prevailing over a limited supply of more affordable sites. This trend has helped ensure low vacancy rates and strong rent growth.
According to CBRE, the I-78/81 corridor in eastern Pennsylvania closed the first quarter with an industrial vacancy rate of 6.3 percent, down roughly 30 basis points year-over-year. In 2020, of the approximately 14.5 million square feet of new product delivered in this region, about 13 million square feet was absorbed.
This declining vacancy rate and healthy absorption over the last 12 to 15 months have translated to growth in the average asking rent, which now stands at $5.18 per square foot. CBRE also notes that as of the first quarter, more than half of all industrial product in the region’s development pipeline had been pre-leased.
Northern and Central New Jersey experienced one of their strongest quarters ever to start the year, according to CBRE. Combined, those markets recorded 8.8 million square feet of leasing activity in the first quarter of 2021, the highest mark since the third quarter of 2006.
In addition, the Garden State’s industrial vacancy rate clocked in at 5.5 percent to close the first quarter, down 70 basis points from the first quarter of 2020, according to CBRE. The average asking rent for Class A space is $11.58 per square foot, a 4.6 percent increase from the previous quarter and an 11.8 percent increase year-over-year.
The strength of the demand is matched only by its diversity. Polt notes that the breadth of industries and products that are represented in the Mid-Atlantic industrial market runs the gamut of consumer goods.
“We’ve seen a surge in demand from fashion clothing users that need one-day travel proximity to New York City and Miami, so we’ve seen a lot of requirements for the I-95 corridor with direct connectivity to those markets,” says Polt.
“Food-based companies are also very active, as are Chinese e-commerce groups that provide a range of consumer goods — furniture, fitness, clothing,” he continues. “Peloton is about to do a 900,000-square-foot deal, and Nike is also about to finalize a deal in the Lehigh Valley.”
Sources say that spec industrial deals in Northern and Central New Jersey as well as in the Lehigh Valley are generally trending farther away from New York City. Developers can find better opportunities to build by targeting areas that are further south and west from the Big Apple, but these secondary and tertiary markets are now seeing land values appreciate too.
Higher prices paid for land by developers translates to higher rents for tenants. In addition, being located farther away from the base of end users drives up tenants’ transportation expenses, which are generally the costliest components in the supply chain. But again, demand for the services that these predominantly e-commerce users provide trumps all. In addition, these secondary regions offer strong labor pools, an equally critical factor in tenants’ site selection process.
The fact that demand is powerful enough to overcome supply constraints to keep deal velocity at a high pace means that both tenants and developers are being forced to revise their criteria for what constitutes an infill site.
But developers say e-commerce users in New Jersey and eastern Pennsylvania are willing to locate farther away from urban population hubs — thus incurring heavier supply chain costs — in exchange for being in spaces that fit their requirements and allow them to ship more product to more customers.
“We’re seeing users throw out broader nets in terms of site selection because they’ve been priced out or can’t find product,” says Art Makris, senior vice president for the Northeast region at Duke Realty. “If their search requirement was originally to be within a 30-mile radius of New York City, those same users are now looking at being within 90 or 100 miles. We’re seeing them in the Lehigh Valley, Southern and Central New Jersey, and they’re landing wherever the available buildings are.”
“Developers are finding sites that, in the past, were not considered infill from a tenant perspective but that are now becoming more desirable and driving land values higher,” adds Jon Pozerycki, vice president of acquisitions who oversees the New Jersey market for Chicago-based Bridge Industrial. “But there’s such demand for e-commerce and last-mile services that tenants are willing to take secondary locations to be housed in modern Class A facilities with high clear heights and ample trailer and car parking.”
Bridge Industrial recently announced plans for the second phase of its Bridge Point 78 project in Phillipsburg, a city in New Jersey located along the I-78 corridor by the Pennsylvania border.
Phase II of the industrial development will consist of a 1.4 million-square-foot building and a 262,500-square-foot building that can accommodate users with a wide range of space requirements. In addition, the buildings check all the boxes for e-commerce users: cross-dock configurations, 36- to 40-foot clear heights and ample parking for cars and trailers.
Not only are both developers and tenants settling for sites and buildings that are located farther away from major population centers, but they are also compressing the timelines under which they come together to negotiate deals.
“The pressures that users face to provide e-commerce platforms, to onshore their manufacturing and to stockpile inventory for emergency situations ensure that they’re leasing turnkey space as quickly as possible,” says Makris. “This is why we’re seeing such an uptick in the percentage of deals that are pre-leased by the time construction is done.”
The pandemic played a major role in accelerating the timelines for sales growth and real estate expansion for e-commerce space users, says Borny of Dermody Properties. He cites his firm’s recently announced, 1.1 million-square-foot project in Woolwich Township, located in southern New Jersey, as an example of the market’s newfound leasing velocity.
“During 2020, e-commerce users that had four- or five-year growth plans saw those plans compressed into a single year,” he says. “People knew we were entitling the site of our Woolwich project, but once we made a formal announcement, demand hit a new level.”
“In a traditional market, tenants usually start taking space seriously once they start seeing site work and possible walls going up,” he continues. “Now you can see leasing activity and interest start to occur as soon as a project is announced.”
Dermody’s LogistiCenter at Woolwich project will consist of three buildings of various sizes: 262,500 square feet, 552,585 square feet and 336,700 square feet. The buildings will be developed on a 154-acre site in Gloucester County. Construction is set to begin later this year.
Emergence of ‘Spec-to-Suit’
Inquiries from prospective tenants regarding industrial facilities built on a speculative basis tend to peak when vertical construction starts, typically when the walls have been tilted and tenants can really begin to see the buildings coming out of the ground, says Pozerycki of Bridge Development. It’s also at this point that timelines for negotiating leases and taking occupancy of facilities become more clearly defined.
As these conversations get underway, developers and tenants get a feel for each other’s requirements on a more specific level. As the dialogue continues, the discussion regarding the delivery of the product begins to shift from speculative to build-to-suit.
“We call it spec-to-suit,” says Pozerycki. “We deliver the shell of the building, prospective users who we’ve been in contact with us specify what they need for tenant improvement allowances and we build it out. Given how much demand is out there and how fast the market moves, we’ve found that this approach captures the best of both worlds.”
Makris of Duke Realty observes that the distinction between speculative and build-to-suit projects in the Mid-Atlantic is beginning to blur, especially relative to other markets like those in the Midwest (Duke Realty is based in Indianapolis). The two project types are becoming less distinguishable partly because of the entitlement process in New Jersey.
“Tenants are under time pressure to occupy the buildings. So, rather than start with an unentitled site and customize the entitlements to their liking, they are making certain concessions to lease sites that are completed with the entitlement process,” he explains.
“Once the site is through the entitlement, we are unable to make major site plan changes. So, tenants are living within the boundaries established by the developer to shave time off the construction process.”
Makris adds that this type of quasi-speculative development is most prevalent in infill submarkets, meaning those that enjoy close proximity to New York City.
Investment Holds Strong
As an unprecedented level of demand hits the market, enabling developers to push rents higher, investors across all commercial real estate property types and locations are taking notice.
Both institutional and private investor capital sources are targeting the space in greater numbers as some look to divest of asset classes that have proven vulnerable to the COVID-19 pandemic, such as retail, office and hospitality.
In the first quarter of this year, institutional investors accounted for 62 percent of the buyer pool for industrial sales in Pennsylvania’s I-78/81 corridor, with private capital comprising the other 38 percent, according to CBRE and Real Capital Analytics.
Notably, deals involving foreign capital sources were essentially nonexistent in the first quarter, as investors abroad elected to wait for the massive rollout of the COVID-19 vaccine to bring about a return to a pre-pandemic lifestyle.
“New Jersey has been ground zero for out-of-state developers looking to plant their flag in the Northeast because they see how robust the investment demand is for Class A properties that are leased to high-credit tenants,” says Borny.
“We think this trend will continue, as many institutional investors are still underweighted on industrial, particularly in core markets, so prices should rise in the coming years as these groups allocate more money to the space.”
In addition to e-commerce, big box retail and third-party logistics (3PL) users that drive demand and draw capital into Mid-Atlantic industrial markets, a new variable has recently entered the equation: the legalization of marijuana in the state of New York.
This legislative milestone will most assuredly spur more demand for industrial space, but at this point it’s too early to tell just how significant the impact will be on industrial vacancy and rent growth, say sources.
In terms of investment, however, there may be some hesitation, especially on the institutional capital side, to acquire properties occupied by marijuana growers. The reluctance to invest in these pot-producing facilities largely stems from the fact that the federal government still considers marijuana to be an illegal substance and does not regulate the manufacture or sale of the drug.
“As for marijuana legalization in New York and its impact on demand, we’ve had some conversations with brokers who are specifically focused on those deals,” says Pozerycki. “But the biggest challenge is that institutional investors in these deals have an issue with it not being federally approved or regulated.”
— This article originally appeared in the March/April issue of Northeast Real Estate Business magazine.