Industrial Rents Reach New Heights in Northeast
The industrial real estate sector across the Northeast continues to exhibit strong rent growth due to a number of factors: increased tenant demand, decreased supply and the ever-growing presence of e-commerce companies.
In the five largest metro areas, rent growth over the 12-month period that ended June 4 averaged 6.2 percent, according to CoStar Group. The vacancy rates in those same markets were all at or below 6 percent as of June 4.
The Northern New Jersey industrial market led the way with rent growth climbing 8.2 percent over the 12-month period, followed by New York (+7 percent), Boston (+ 6.3 percent), Philadelphia (+ 5.3 percent), and Pittsburgh (+ 4.6 percent). In each case, the spike in rent was more than double the historical average.
“Supply is really struggling to keep pace with demand,” says Alex Previdi, managing director of Transwestern’s New Jersey office. “There’s an abundance of large tenants that are looking for industrial space and there’s just not a lot of options out there.”
On the demand side, the New York market led the way with a 12-month net absorption of 7.6 million square feet, followed by Philadelphia (6.6 million square feet), New Jersey (3.4 million) square feet, Boston (2 million square feet) and Pittsburgh (693,000 square feet).
In major metro areas, a confluence of factors has led to shrinking supply. For starters, much of the industrial inventory in the Northeast was built between 1970 and 1999 and is functionally obsolete for today’s market demands.
In the ’70s and ’80s, clear heights ranged from 20 to 24 feet. Today, desired clear heights are 36 feet and higher, enabled by construction techniques that allow racking to extend twice as far above the floor as it did 30 years ago. Additionally, as inventory and fulfillment systems improve, turnover volume for product production and shipments can be much higher, leading to increased trailer movements. This leads to not only the need for more docks, but also the need for more trailer parking spaces.
In addition, many former industrial buildings in major metros of the Northeast are being converted to residential, office and mixed-use developments, further reducing supply and driving land costs up. The growth of e-commerce has also played a role, as last-mile distribution centers close to city centers are increasingly in demand.
“A lot of the older buildings in places like Queens, New York are no longer fit for industrial use,” says Gabriel Silverstein, managing director SVN | Angelic Real Estate in New York City. “A lot of that product has been converted to retail and residential as neighborhoods gentrify. So you’re taking some of that supply away even as demand goes up.”
Of the industrial projects that are being built in New York, many are speculative developments, most of which are getting leased up before groundbreaking even takes place, Silverstein adds. “By the time you purchase the land, get the entitlement done and design a building, there’s already a deal in place,” he says.
The growth of e-commerce has altered the landscape of industrial markets in large metro areas of the Northeast as e-commerce tenants absorb large blocks of space close to population centers for distribution facilities and last-mile delivery. E-commerce is more warehouse-intensive than traditional retail, which has had an upward effect on rent in areas where there are large concentrations of people and space is at a premium.
In addition to being closer in to the population, e-commerce facilities also require more space for truck and trailer parking than other types of industrial facilities.
“There’s a push to get back closer to populations,” says Rich Gorodesky, senior vice president at Colliers International in Philadelphia. “Companies like Amazon and other web-based warehouse and distribution centers are now located throughout Philadelphia. The population is here and so is the labor.”
Vacancy is now so tight in some cities that landlords have all but eliminated rental concessions.In Philadelphia, it has become relatively common to offer one month of free rent annually to industrial tenants upon signing a lease. Gorodesky says that practice has now disappeared.
“Five years ago we were talking about free rent of around a month per year,” he says. “Today there’s no free rent and rents are higher.”
Return to city center
Each metro area is unique. In Boston, a number of “intelligent industrial” facilities, which require a highly trained workforce, are taking up large swaths of space close to the city. Logan International Airport is also located in close proximity to downtown Boston, which has created a point of tension among some industrial users that value airport proximity but have to pay higher rents to be located there.
“Intelligent industrial buildings are where highly trained workers build high-value products with precision equipment,”says Andrew Iglowski, managing partner of the Seyon Group in Boston.
“That is the nature of many of the industrial facilities that are popping up in the Boston area, and the construction costs are immense when compared to a traditional widget-manufacturing building. This is also one of the reasons we are unlikely to see a lot of speculative construction in this area. These buildings are going to be heavily customized.”
Although it’s becoming increasingly difficult to find and develop land in metro areas, the sharp rent growth has had the effect of making certain sites attractive for development that were not looked at as viable even a few years ago. For example, in Boston, the asking rent per square foot has increased from $8 in 2012 to more than $11 in 2018. Developers are now able to recover their remediation costs after cleanup and development of contaminated sites. The approval process for these buildings has also improved as well. Developers are also able to retrofit older buildings for the same reasons.
Renewed investment interest
One factor helping to lift the value of industrial real estate in the Northeast is a renewed interest frominstitutional investors who perceive the industrial property sector as a lower-risk investment opportunity compared with multifamily, office or retail investments.
“The demand by institutional investors to buy industrial product in New Jersey is staggering,” says Alex Previdi. “Part of it is the fact that rent growth has gone up and part of it is that in the last downturn, markets like New Jersey fared much better than some other markets. From a product-type perspective, many investors have come to understand that with industrial, while the peaks aren’t as high, the valleys certainly aren’t as low.”
Industry experts in the New Jersey industrial market say capitalization rates have compressed and fallen from around 6 to 7 percent a few years ago to around 4 to 5 percent in 2018 as a result of increased demand and New Jersey’s prime location for industrial product.
Because many developers in large metros in the northeast are having a harder time finding space for new warehouses in increasingly crowded and expensive cities, many are beginning to consider building vertically.
In New York, where the average asking rent per square foot has climbed from $9 in 2012 to nearly $14 today, many in the industry are expecting multi-story warehouses to become the norm as the rise in rents will eventually justify the high cost of vertical construction.
“I’m expecting that in the next five years, you’re going to see a 20-story warehouse,” says Silverstein, of SVN | Angelic Real Estate in New York City. “Amazon is going to be able to build a 20-story warehouse because it can vertically do all of this automated pick and pack. It’s going to be all done automatically. That can suddenly change the character of the supply chain in a major city like New York.”
— David Cohen