Construction Continues At Slower Pace
The Inland Empire market remains the most sought-after warehouse/distribution market in the United States with the lowest vacancy rate and highest rental rate of comparable markets with major distribution hubs. Developers remain interested in new speculative construction activity. In the past 12 months, a total of 23.4 million square feet of new supply was added to the base. During this time, the vacancy rate remained low as nearly all new supply was absorbed by large tenants seeking modern distribution centers. There were 5,072,100 square feet of construction completions this quarter, while 19,643,100 square feet of industrial space remains under construction. Development is heavily concentrated on buildings over 500,000 square feet, which account for 49% of all space currently under construction. Capitalization rates decreased over the quarter to average 4.8% in the first quarter of 2018. Investment-grade product traded with capitalization rates as low as 4%. Average investment sale prices increased to $119 PSF.
Vacancy rose 10 basis points to 4.4% on vacant construction completions. Rates continue to remain near record lows. Vacancy remains tightest in the West Inland Empire at 3% compared to 6.4% in the East Inland Empire. Industrial demand remained strong with 3,473,600 square feet of positive net absorption, the 34th consecutive quarter of growing industrial demand. Average asking rates increased $0.01 PSF NNN over the quarter to end at $0.59. Asking rents, as well as effective rents, continued to rise. Much of the newer industrial space currently on the market does not have a marketed asking lease rate, making rental rate comparisons challenging. E-commerce tenants continue to drive demand. Landlords for these larger companies are seeing increased need for tenant improvements as well as longer free rent periods to make the necessary improvements. In exchange, they are getting longer lease terms at higher rates to compensate.
- Construction completions totaled 5,072,100 square feet this quarter, which is lower than the 8.7 million square feet delivered last quarter.
- New construction is expected to average about 5 million square feet (SF) a quarter for the rest of the year.
- Net absorption totaled 3,473,600 square feet for the quarter, due in large part to occupied construction completions. Around 30% of new construction is pre-leased or pre-sold.
- The vacancy rate rose slightly for the second quarter in a row to 4.4%. New construction may increase the vacancy rates in future quarters.
- Average monthly asking rents increased $0.01 per square foot (PSF) triple net (NNN) over the quarter and have increased $0.05 over the past 12 months to end at $0.59.
Demand remains strong and average time on market remains low as tenants quickly absorb industrial space, anticipating future rental rate increases. This quarter saw a larger number of user sales as tenants seek to fully control their real estate assets. Demand remains strong for larger e-commerce companies. Online retail has grown from 3.5% of all retail sales in 2007 to 8.5% of all retail sales currently. The pace of this growth has not slowed and will continue for the foreseeable future as consumer preferences continue to evolve. As internet retail continues to grow, so too will the need for industrial space.
New supply is likely to raise vacancy rates in future quarters, albeit at a slow pace due to increased industrial demand. Absorption is likely to remain positive for future quarters as fully leased buildings are constructed. Growing tenants have few options in Southern California, and the Inland Empire will attract tenants from infill markets who cannot find space to meet their needs. Rents are at an all-time high. This is due to rising market conditions for new buildings with state-of-the-art features, which is reflected in the rental rate. These newer buildings allow tenants to be more efficient by lowering operating costs and increasing the velocity at which goods can be sorted and shipped. This is especially true for e-commerce-related tenants that require specialized build-outs. Construction activity is slowly dwindling as major projects finish and there are fewer projects to replace them. Large, fully leased assets in a prime location command a significant premium in the Inland Empire, which is considered a core market for institutional industrial investors.