My mind wandered recently on a long drive, as it often does. I had the music going and, in typical Maine fashion, cell phone coverage was spotty.
It was nice to effortlessly jump from thoughts of the upcoming holiday season with my young kids, to my 20-year high school reunion and old friends, to the promise of another long playoff run by my beloved Patriots.
But as I passed commercial buildings and warehouses, my attention drifted to the bricks and mortar of the metro Portland industrial market.
Here is what I thought as I hummed along to the hits:
The Times They Are a-Changin’
Bob Dylan said it simply, and the statistics in our market suggest the same. The nearly eight-year run of a clear landlord’s market has finally shown indicators (albeit slight) that the pendulum is swinging the other way.
While the year-end numbers are not yet complete, I am predicting vacancy rates will increase 200 to 300 basis points from our historically low 2017 rate of 1.25 percent.
Let’s say, conservatively, our market increases to 3 percent overall vacancy. That is still what I would call a landlord’s market.
However, what concerns me is that our added industrial units are highly comparable spaces. Since early spring we have seen several 10,000- to 20,000-square-foot Class A and Class B industrial spaces come on the market and linger.
In years past, we’d often have prospects on the sideline ready to pounce. In 2018, these spaces sat (and are sitting) vacant for months at a time. The challenge stems from a lack of tenants.
In Maine, we simply have a limited number of industrial businesses to put into spaces that size. And when four or six facilities of the same quality and size come
online at roughly the same time, all of a sudden the larger tenants in the market carry leverage they haven’t had in years.
In the Air Tonight
Phil Collins sensed something was amiss. So did we in the industrial market, again in early spring.
The phones slowed down. Quality inventory that had previously turned over with such regularity was starting to sit. What was wrong? We began to hypothesize and then confirm through conversations with our tenant clients.
The macroeconomic pressures we’ve been tracking, primarily inflation and lack of labor force, finally became material reasons not to expand or relocate. Tenants began to tell us that they couldn’t hire enough people to support the workload that would come with additional square footage.
Additionally, the cost of virtually everything rose. From taxes to gas to electricity to raw materials to a loaf of bread, everything got more expensive in 2018. This indirectly squeezed real estate budgets.
This classic Wilson Phillips song (of course belted at the top of your lungs, admit it) raises a good question: Will the interest and activity we’ve seen in industrial construction hold on? I am not entirely sure.
The existing triple-net lease inventory we’ve added is renting for
approximately $6 per square foot. The cost of construction continues to skyrocket, there’s a lack of quality industrial land and we’re in a rising interest rate environment.
As a result, my unfortunate prediction is that, yes, the new construction window of opportunity will close in 2019.
For the Love of Money
President Trump’s favorite tune is best known for the simple yet powerful harmony, “Money, money, money, money…. Money!”
So how did we close any deals this year with all the challenges referenced above?
Sales prices continued to climb, as the market faces a dramatic lack of purchasing opportunities. Rising interest rates did not temper owner/user interest in acquiring industrial real estate. However, as sales prices climb (north of $80 per square foot for Class A space), our sales volume is down. This is simply due to a lack of sellers.
And leasing demand didn’t just drop off a cliff. We had steady interest in smaller units under 10,000 square feet. And there are a handful of very large end-users in the market currently that use 50,000 square feet and above.
Interestingly, the most consistent demand is coming from traditional industrial businesses.
Until recently, these companies have been begrudgingly on the sidelines, often losing out to start-up and well-funded industries like craft brewing and the marijuana cultivation trade.
Much like my long drive behind the wheel, the industrial market has been a nice ride. But there are clearly bumps in the road forthcoming.
For the first time in over eight years, the data suggests a softening market. Tenants finally have some leverage and can expect more incentives and better overall deals.
And landlords? Well, they will surely be singing a different tune. It should make for a rocking 2019.