After Paying Up To 50% More For Land, Houston's Industrial Developers Eye Higher Rents
The competition for well-situated land along transportation corridors has become so fierce in Houston that industrial developers are now paying anywhere from 30% to 50% more for land than just a few years ago, according to industry experts.
“In certain instances, we have seen land prices increase by upwards of 30% to 40% for industrial sites. Seven dollars to $9 per square foot is the new $5 to $7 from two to three years ago for the best industrial sites,” Stream Realty Partners Managing Director and partner Justin Robinson said.
Developers are in a strong position to pay up to nab sites. Industrial was incredibly hot in 2020 as consumers turned to online shopping on a scale never before seen in the U.S., driving intense demand for warehouse and distribution space. But experts say they will pass those increased costs down to tenants, which will lead to spiking rents after a few years of sluggish growth.
Rent growth in Houston has been muted compared with other cities, as landlords have been working through a glut of industrial capacity delivered over the past two years.
Houston delivered 30.3M SF of industrial space in 2020, more than any other U.S. market. That volume was more than double the amount of net absorption, which was 14.5M SF for the year. Vacancies hovered in the high single-digit range during that time and edged slightly upward in early 2021.
Industrial rents in Houston have also trickled upward: Citywide, triple-net annual asking rents went from $7.32 per SF in Q1 2020 to $7.68 per SF in Q2 2021, according to NAI Partners. Though some areas held steady, other popular submarkets like the northwest experienced increases.
The market appears poised for change.
Land prices have skyrocketed, the result of more competitors entering the industrial development space and creating more competition for quality sites. As a result, the barriers to development in the market are higher than Robinson has ever seen.
Industrial buildings are fetching record pricing as many U.S. markets are seeing cap rates in the mid to upper 3% range, leading to developers underwriting more aggressive exit pricing, according to Robinson. That, in turn, is leading them to pay more for the land in order to secure a development site.
Griffin Development Partners President David Hudson said that he thinks industrial developers are now paying upward of 50% more for some industrial sites. Like Robinson, he pointed to compressed cap rates and the widespread availability of capital as the reasons why land prices have increased so much.
“If the capital wasn't there, you wouldn't be doing it. You wouldn't be able to pay those kind of prices,” Hudson said.
The competition for land has become fierce enough that on occasion, industrial developers are approaching homebuilders to purchase 100-acre to 200-acre tracts, offering a price significantly higher than what the land was previously purchased for.
Land Advisors Organization broker Duane Heckmann said he is working on two deals where an industrial developer has offered to buy land from a homebuilder. Heckmann noted that such deals are the exception, rather than the norm, but they demonstrate how eager industrial developers are to acquire ideal sites.
“The industrial developers tell us rents have gone up, what industrial users are willing to pay, which means the developer can pay more for the land, and get the same margin,” Heckmann said.
That can also work in the other direction. As developers have to pay the steep increase in land prices to secure quality sites, Houston industrial rents will need to keep pace, Hudson said. Those increases are starting to appear in leases being negotiated and signed right now.
“You're going to see much higher rents than we've seen in the past 15 to 18 months,” Hudson said.
One reason that rents will be able to rise is the slowing construction pipeline. Deliveries totaled 3.1M SF in Q1 2021, 22% below the five-year quarterly average, according to JLL. Another 13.3M SF is under construction, mostly in the warehouse and distribution space.
Adding to that slowdown is the extremely long lead times for certain construction materials, such as steel, which is affecting delivery timelines. But Hudson said that the delivery slowdown will ultimately force more absorption and boost industrial rents in Houston.
"This lack of available supply, coupled with the most robust tenant demand I’ve seen in the last 15 years, will cause industrial rents to rise across the market,” Robinson said.
Industrial users are still eager to sign leases. JLL said leasing activity in Q1 was 6.7M SF, well above the five-year quarterly average of 5.8M SF. That trend has continued into Q2 with several large industrial leases signed, including The Webstaurant Store’s 644K SF lease in Cedar Port Industrial Park and Custom Goods’ 353K SF lease in Bay Area Business Park.
Hudson said that even for older, existing product, brokers are seeing a big rental increase on renewals because users don’t have a more cost-competitive place to go.
Overall, the outlook is that Houston will soon be a very supply-constrained market for new industrial product in almost every submarket, but especially the northwest, west and southeast submarkets, according to Robinson.
He said that almost every vacant Class-A industrial building in the city is either trading letters of intent or negotiating leases to fill the buildings. Those deals haven’t shown up in vacancy or absorption statistics yet, but they should appear before the end of 2021.
“We predict a recovery back to mid-single-digit vacancy by the end of the year. We also believe 2021 will set a record in terms of positive net absorption across our market,” Robinson said.
Hudson also believes that the majority of Houston’s supply glut will be absorbed by the end of the year, which will bring the vacancy rate down and make the market even more attractive for future investments.
“I can see us getting to the 20M SF absorption this year. I know that sounds crazy, but I think we [will] get to post a huge number,” Hudson said.