El Paso’s industrial market is growing and maturing, as evidenced by a surge in investment demand from institutional capital sources over the last 18 to 24 months.
Whereas in past cycles, institutional capital found its way to El Paso by developing here, new players have been ready to buy existing portfolios, but we have seen very little new spec development. Stonelake Capital Partners, LINK Industrial Properties and Equity Industrial Partners/Raith Capital Partners are examples of new investors actively buying into the El Paso industrial market.
Christian Perez Giese, CBRE
Several factors have contributed to El Paso’s rise on the radars of institutional investors, but the heart of this trend is simple rent growth. The average asking rent for Class A and B industrial properties increased by a stunning 15.8 percent between 2018 and 2019. Rent growth in the East El Paso submarket increased by an even greater margin of 24.3 percent.
As those numbers suggest, demand for industrial space in El Paso, which is largely driven by manufacturing activity in the sister city of Ciudad Juarez, Mexico, is quite strong. Demand for space comes from a diverse set of industries, namely automotive, consumer goods and electronics. El Paso has also seen new industrial demand from construction materials, wholesale operations and manufacturing suppliers this cycle.
But supply-side constraints have played a part in the market’s phenomenal rent growth as well.
More Spec Product Needed
Most of the new construction in the past five years in El Paso has been from owner-occupiers, and we continue to see larger users buying land and developing their own industrial facilities. However, only in the last 18 months has the level of rent growth supported more speculative development.
Bill Caparis, CBRE
Prior to the end of 2019, developers had delivered just three speculative projects during this cycle. One of those projects, which was developed by local builder Russell Hanson and completed at the end of 2019, leased up in the first quarter of 2020.
Today, developers and investors alike are starting to realize that El Paso can support more spec product. In the greater El Paso area, which includes the submarket of Santa Teresa, New Mexico, there are five speculative projects in the works that will add about 1.5 million square feet to the local supply.
Construction of most of these projects is scheduled to begin within the first half of the year. Yet even if all of those projects were delivered today, the market would still be undersupplied. The aforementioned rent growth numbers and the market-wide vacancy rate of 4 percent confirm the market is significantly undersupplied.
The absorption numbers further support the notion that El Paso has significant runway for speculative industrial development. Last year in Juarez, net absorption was roughly 3.8 million square feet, about 40,000 square feet shy of the annual record. By the end of the first quarter of this year, El Paso will have posted net absorption of almost 450,000 square feet, which is half of the entire total for 2019.
That said, new speculative product needs to fit the needs of the market. The biggest key to meeting the needs of El Paso’s industrial user base lies in building depths. The spec projects that will come out of the ground in the coming months all have depths of 200 to 250 feet so that they can be demised efficiently.
The market is rife with users seeking spaces under 100,000 square feet. There tends to be some variance from year to year in terms of what most deals call for. But right now, there are several good options for users seeking 25,000 to 50,000 square feet, but virtually nothing for users seeking 100,000 or larger.
It’s worth pointing out that even with a 4 percent overall vacancy rate, that number would be below 2 percent if not for two older buildings of 861,000 and 458,000 square feet. There simply aren’t many requirements for spaces of that size.
And although El Paso may in several years’ time become a regional distribution hub for major e-commerce or retail distribution uses, those buildings lack the physical features that those users need. So, while El Paso desperately needs more spec product, it’s critical that such projects fit the unique requirements of this market to absorb some of the demand and provide those continued returns for investors.
Other Factors
With many institutional buyers chasing deals in major markets like Dallas, Chicago and California’s Inland Empire, some investors are recognizing El Paso as a market with less competition and, consequently, higher yields.
For investors willing to take the time to learn and understand the El Paso market, higher yields can indeed be had. We typically see spreads between yields on industrial assets in El Paso versus comparable deals in major markets run as high as 150 basis points.
El Paso has also been the beneficiary of some geopolitical factors. A renegotiated U.S. Mexico Canada Agreement (new NAFTA) has put to rest fears that industrial developers and users may have had about tariffs and supply chain disruptions between Mexico and the United States.
In addition, the trade dispute with China caused many American firms to move their manufacturing operations out of that country, not to mention issues surrounding the coronavirus.
With proximity to end users and a relatively low cost of doing business, Mexico was perfectly poised to receive that demand. As a result, manufacturing activity as a whole has increased in Juarez, which has in turn fueled demand for storage and distribution space in El Paso.
Regarding COVID-19 and its impact, we expect El Paso’s industrial and logistics market to fare well in the long run. While we will see a short-term slowdown in leasing, rents will hold steady and the overall sector will be a net beneficiary due to strong e-commerce growth and retailers diversifying their supply chains.
Overall, the landscape remains largely positive for industrial investors and landlords here in El Paso and across the border in Ciudad Juarez, and our tenants seeking space are happy to have access to new, well-positioned properties to choose from when seeking a new location.
— By Christian Perez Giese, senior vice president and director, CBRE; and Bill Caparis, senior vice president, SIOR, CBRE. This article first appeared in the April 2020 issue of Texas Real Estate Business magazine.