Industrial real estate market making progress but challenges remain, says Jones Lang LaSalle report

Even though the economy is still far from recovered, the industrial real estate market appears to be taking some positive steps, according to a report issued by global real estate firm Jones Lang LaSalle (JLL).

According to JLL, the national average vacancy rate for the North American Industrial real estate sector fell from 10.6 percent in the first quarter to 10.4 percent in the second quarter. Despite the slight decline in vacancy, the fragile economy still looms large due to declining consumer confidence, the drying up of economic stimulus funding, and the potential threat of a double-dip recession, the report noted.

“We have seen a positive absorption in the vacancy rate in the second quarter, but we are very concerned going forward,” said Craig Meyer, SIOR, Managing Director and leader of JLL’s Logistics and Industrial Services Group, in an interview. “Any kind of sustained, demand-driven component in the industrial real estate market is going to be driven by jobs. We are just not seeing any of that. It is going to be a long, slow recovery.”

Looking at base indicators like the Institute of Supply Management’s Manufacturing index, Consumer Confidence data, and industrial real estate vacancy and absorption rates, there does not appear to be what Meyer labeled as a strong indication of a positive upswing on the horizon.

The report points out that a need to restock inventories that were running at 50-year lows this year resulted in large occupiers—or companies—strategically capturing high quality logistics space at cyclically low rates. And with slow levels of leasing activity and sparse speculative construction, industrial real estate options—especially in the Class A large block sector—are limited in some markets.

And the swift correction in inventories during the second half of 2009 and first quarter of 2010 has left inventory levels lean and ready for expansion, provided sales rebound in the coming months, said JLL. Should this occur, it could lead to increased industrial and logistics real estate leasing activity.

The report also pointed out that the initial recovery in the economy was largely driven by improvements in the manufacturing sector and cyclical adjustment in inventories. But with the recovery now becoming more broad-based, the recent slowdown of inventory building—or cooling—could have more of an impact on the industrial property sector than the office sector, said JLL.

“We are also concerned about seasonality with the holiday season coming up,” said Meyer. “The indications we are getting are that we may not see as much preparation for that as we hoped. A lot of retailers are saying they are restocked and if consumer confidence is going down, they are not going to build up inventories. They are going to be more cautious. And for larger, big box companies, they will see declining values in rents, but the availability of product for them to lease is diminishing.”

As a result of this, Class A, big box distribution space is becoming more difficult to find in this economy, said Meyer. But the build-to-suit market could come back eventually for major retailers, as evidenced by a new 1 million square foot distribution center space deal by Amazon.com in Harrisburg, Pennsylvania and a 1.4 million foot location in Phoenix.

But for a mid-sized industrial building in the 100,000-to-150,000 square-foot range Class B-sized building, Meyer said there are an infinite number of these on the market at the moment. The JLL report said that while opportunities exist in every market for deals to be closed at aggressive terms, there is little or no speculative construction occurring at the moment, which is leading to a separation between large-block and medium or smaller warehouse, distribution, and manufacturing requirements.

Looking ahead, Meyer said there will still be downward pressure on pricing, a double-digit vacancy rate, and no increases in lease rates, which, he noted, are actually weakening a little bit and tend to lag a recovery.

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