By Harlan Reichle, Reichle Klein Group
As the Toledo, Ohio, area’s retail market proved to be stable and solid in the second half of 2020 and the industrial market continued a remarkable stretch of high performance since the Great Recession, 2020 was a tough year for the office market. However, all three property types have yet to register any negative COVID impact in our latest survey results.
Toledo’s retail market proved to be quite stable and solid during the second half of 2020. Given the fraught last year along with the headlines and travails of retail stores, gyms and restaurants, the general public might find this result surprising, but it was clear to our retail leasing brokers since mid-summer 2020 that transaction activity was snapping back fairly quickly after the initial shock of the spring 2020 lockdowns.
Our year-end 2020 market survey found overall market vacancy down from both the end of 2019 and mid-year 2020. The decline in anchor vacancy more than offset a small increase among inline spaces as the market absorbed 39,183 square feet of space in the last six months of the year. It is a nearly exact repeat of the market’s performance in the first half of 2020. We see three contributing factors to this outcome.
First, and perhaps most surprising, is the enduring confidence among retail players. Owners, as well as retail users, continue to focus on the other side of the pandemic and the rebound that must surely come. Among the space users most active in securing new locations during the past year were restaurants.
Other examples of significant moves are Loves Furniture & Mattresses and Big Lots, both of which absorbed large vacancies in the Toledo market. There is also the case of Sleep Outfitters, which entered the market in a big way by taking over the leases of Pure Sleep stores that had closed only a month or so prior with the sudden collapse of the Pure Sleep business — preventing a big increase in vacancy in the market.
The second factor, so far, is that there are very few actual vacancies recorded as a result from COVID-
related distress. Perhaps they are simply delaying the inevitable, or a combination of eviction moratoriums, landlord and lender accommodations and government-financial assistance will be just enough to prevent more widespread business failures among retail space users. At year-end 2020, however, things were holding together.
It is also worth noting that, so far and also contrary to the expectations of some, there have been few, if any, publicly reported loan defaults among retail landlords.
The third factor contributing to the Toledo retail market’s relative balance between supply and demand is a trend that well predates the pandemic. The ongoing rightsizing of the supply of retail space is happening through demolition, adaptive reuse and consumption by non-traditional retailers.
New space continues to be built, but at nowhere near the amounts needed to replace the space regularly being taken out of the inventory. Consequently, the inventory is steadily shrinking. Much of what is being built is small-scale, build-to-suit infill development with spaces better fit to the nature of current demand.
2020 was a very tough year for Toledo’s office market as the results of our year-end market survey show. For reasons discussed later, the changes in vacancy rate captured in the survey do not convey the scale and nature of the problems as well as the net absorption numbers.
The market registered negative net absorption of 192,384 square feet in the second half of 2020 after scoring 138,391 square feet of negative net absorption in the first six months of the year. It is by far the worst yearly performance in this key metric in the past 10 years.
More concerning is the fact that, as bad as the numbers looked at year-end 2020, the real story is even worse for the following reasons. First, none of the market erosion recorded in our survey has anything to do with the COVID pandemic. Any negative impact resulting from changes in the use of office space due to COVID is yet to formally register in the survey results.
Second, if Lucas County had not purchased the former Medical Mutual building on West Sylvania Avenue in West Toledo, which took the building and its vacancy out of the survey data set, the vacancy rate would be 18.6 percent.
Additionally, as we noted in our mid-year 2020 report, we know of yet more spaces that will be coming vacant and offered on the market in the coming months, all of which are due to non-COVID-related space contractions.
Finally, we are now learning of COVID-related vacancy looming as sublease offerings are being readied to be taken to market. Some of these are quite large blocks of space. The typical scenario entails an operation shifted to remote work during the spring 2020 lockdowns and then a decision being made along the way that the space would not ever be reoccupied.
Many companies continue to keep their workforces working remotely. But, with vaccines being administered at an accelerating rate, there is the sense that perhaps the end of the pandemic is in sight. More companies are announcing the planned reopening date of their offices over the next several months.
Optimistically, one can hope that some of these decisions to never reoccupy offices and to put them on the market for sublease will be reversed. Further, one can hope that more such spaces will not eventually be brought to the market.
So far in this cycle, the Toledo suburban submarkets have incurred most of the negative hits while the central business district (CBD) has been spared. The bad news for the suburban submarkets is not over, but based on transactions and coming events of which we are aware, in the coming year the CBD is going to suffer as well.
Absent some dramatic and unforeseen increase in demand for office space in the region, landlords in the Toledo-area office market are facing a very challenging near-to-mid-term future. On the other hand, if you are a tenant, particularly a large one, opportunities abound.
At mid-year 2020, our opinion was that it was too early to tell if the COVID-19 pandemic was having a negative impact on the industrial segment. By now, it is safe to say, based both on the results of our year-end survey and the activity we are seeing in the market, the industrial market has simply continued the remarkable stretch of high performance it has been on since emerging from the Great Recession.
In the second half of 2020, vacancy fell 3.8 percent and the average asking rental rate increased from mid-year and from those rates posted in December of 2019.
Beyond the core measures of market vitality, the strength of the Toledo industrial market can be seen in the level of activity with users searching for space or sites to locate facilities.
It can be seen in the confidence of local developers who are putting up spec buildings. We also see it in the number of large-scale professional developers from outside the region, such as Scannell Properties and InSite, who are actively searching for developable parcels.
These players join Duke Realty, which recently built an Amazon fulfillment center in suburban Rossford, Ohio, and NorthPoint Development, which recently launched a logistics park in conjunction with CSX/BNSF at its intermodal facility in North Baltimore, Ohio. NorthPoint is nearing delivery on a facility being built for UPS in the new park. Many of these developers have not previously been active in the Toledo market, and most have prospective tenants in hand.
The deal flow is coming from a very wide variety of user types (i.e. warehouse/distribution, manufacturing, automotive and non-automotive), companies that currently have operations in the region and those completely new to the region. The only cloud remaining is the very tight supply of available buildings/space, which is an impediment to transactional activity that would otherwise certainly be occurring at greater volume and velocity.
Cost of new construction is a big factor in the current market, and it is driving up rents and the values of existing buildings. There is a big gap between the cost of new construction and the historical trading range of existing buildings.
At $6 to $7 per square foot, the rental rate required to support the cost of new construction is also materially higher than the rates for which existing buildings have been leasing. With strong demand and tight supply, the outcome is inevitable. For many users, these rising costs are a real hurdle.
Even after the delivery of large projects, such as First Solar’s new plant and Amazon’s distribution building, during the past 12 to 18 months, the level of new construction remains elevated.
Looking back in time as far back as the 1950s, it is hard to pinpoint a period when new facilities were being built at the current rate and scale. It seems destined to continue. As an example, with little fanfare, InSite has secured a site in suburban Swanton, Ohio’s Land-Air Industrial Park and is marketing a 1 million-square-foot building it intends to begin in late 2021. More are coming.
We may be watching Toledo’s industrial market in the process of being remade. The result will be a market with an inventory of buildings that are newer, larger and better able to compete regionally and nationally. The market’s ability to retain and attract employers will be significantly enhanced.
Arrival of outside-the-market developers is also an important signal about the positive new way the capital markets are beginning to perceive Toledo and Northwest Ohio. Not having access to the kind of capital necessary to finance a 1 million-square-foot spec building had been one of the elements which held the region back. That class of capital likes company and attracts company. And so the flywheel moves.
Harlan Reichle is president and CEO of Reichle Klein Group. This article originally appeared in the May 2021 issue of Heartland Real Estate Business magazine.