Industrial Short-Term Lease Frenzy Ebbs, But Sector Shines In The Early Third Quarter
The industrial market has so far been the darling of the coronavirus pandemic, displaying strength as most other asset types have taken a hit.
Demand for e-commerce services and goods have prompted those users to snap up more warehouse space around the country in order to cater to the growing number of people who are opting to order everyday items online. And though early in the pandemic it appeared lease terms might shorten, that trend evened out, and most industrial users are taking the same long-term bets they typically have.
“If there is a good real estate story, it is the industrial side of the business. Outside of another major shutdown of the country, I think it will continue to follow case here through the end of the year and into next year,” Seefried Industrial Properties Vice President of Leasing Doug Smith told Bisnow.
Smith is based in Atlanta, where the industrial leasing scene has seen a fast recovery from the disruptive early days of the pandemic.
At first, there was a flurry of short-term deals, which Smith dubbed a knee-jerk reaction. Companies were looking to quickly create excess warehouse space because they anticipated sales of certain products to fall.
However, as those companies re-examined their inventories and existing warehouse space, not all of those deals ended up getting done. Now, months into the pandemic, deal sizes have retained their typical length.
“Right now in Atlanta, most people are still doing five-year deals. That's the typical deal size — five-plus years,” Smith said.
A similar pattern emerged in Dallas-Fort Worth. Stream Realty Partners Vice President Sarah Ozanne told Bisnow that the firm initially saw an increase in requests for short-term leases as companies struggled to manage their inventory during the shelter-in-place orders.
Like in Atlanta, few of those prospects actually ended up signing deals, and those requirements have largely dissipated from the market.
“Average lease term for industrial continues to run between five and seven years, unchanged from pre-pandemic term length,” Ozanne said.
For the most part, day-to-day, bread-and-butter leasing activity has returned to the Atlanta market after a three-month hiatus during March, April and May.
“Really since the beginning of June, we've had a fairly consistent flow of demand for smaller deals throughout all the major submarkets here,” Smith said.
Those deals can range anywhere from 10K SF to 200K SF, and tenants tend to be regular industrial users. Smith noted that some of them have recently been light manufacturing users, which is a little unusual, given that Atlanta is more of a distribution-focused market.
“A lot of the deals it seems like we're seeing right now have more of a light manufacturing component to them. And I don't know if that's a result of onshoring certain responsibilities back to the U.S. or it's just a growth segment in our economy right now,” Smith said.
Leasing activity is robust in the Dallas-Fort Worth market, reflecting the rapid growth in demand for e-commerce and direct-to-consumer goods. Ozanne said the majority of leasing activity has been for bulk-sized properties of 250K SF or greater.
“We’ve seen that many of the major national distributors are experiencing large growth and taking down large blocks of space as a result,” Ozanne said.
The combination of the pandemic and the summer months has done little to hinder usual industrial leasing activity in Dallas-Fort Worth, she said.
“I’d say leasing activity is on par with previous summers — we always see a bit of a slowdown in July and August, especially in when we get to the details of getting a transaction fully executed, and that has been no different this year.”
The West Coast is seeing many large transactions completed in a very short time frame, said Cushman & Wakefield Executive Director Robin Dodson, who is based in Los Angeles. She said Los Angeles also saw an early pandemic spike in short-term leases, especially in vacant buildings, which are getting much more activity than occupied buildings due to the immediate needs of the end user.
“Lease renewals were trending towards shorter term at the start of the pandemic, though we are now seeing many companies staying in place with long-term renewals of five to 10 years,” Dodson said.
In Los Angeles County, leasing activity is only down by 1.2% from 2019, showing continued strength in the market.
“The majority of leasing activity is coming from many large national retailers, [third-party logistics], food-related companies, the automotive industry and, of course, e-commerce,” Dodson said.
“The average deal term is five to 10 years, and rates are holding steady and, in many cases, increasing over last year. There are few concessions given, mainly free rent to maintain current rental rates, while annual rent increases were starting to trend to 4% last year but remain at 3% for most transactions.”
Cushman & Wakefield Vice Chairman, Capital Markets Jeffrey Cole, who is also based in Los Angeles, said recent core stabilized asset pricing is basically unchanged from pre-pandemic pricing.
“While overall sales volume is down, cap rates are actually showing a slight drop from last year due primarily to mostly newer credit leased product being sold. Expect that to continue into the third quarter with a strong and growing weight of capital for West Coast industrial product,” Cole said.
In comparison, Houston’s industrial leasing performance over the past few weeks and months has lagged other major markets.
“The buzzword is activity, but there's not a terribly large amount of leases being signed on spec product. [However], there's good activity on build-to-suits,” Duke Realty Corp. Vice President, Leasing and Development David Hudson said. “I think the tenant range, say 100K SF to 300K SF, is really, really slow right now on your spec product leasing. So it could be quicker and more brisk there, for sure.”
Hudson attributed the slowness in spec leasing to the fact that people are still, for the most part, working from home. As a result, the decision process has slowed. When multiple approvals within a company are required to sign a lease, that can translate into major delays.
“It makes everything much harder. There's a little stickiness to the process right now, I think is what our issue is,” Hudson said.
Houston has a smaller e-commerce distribution footprint than other cities of a comparative size. The city is also dealing with the fallout of a severe energy downturn, which may also be dampening demand from some industrial users.
Though the pandemic has increased uncertainty for many businesses, that has not translated to shorter industrial lease lengths. Hudson said that because Houston still has plenty of high-quality industrial space coming online this year, tenants are taking advantage of market conditions.
“For deals that are in the 100K SF to 300K SF range, they've got a lot of options. And I think they're taking advantage of the conditions on the ground. They're getting very aggressive rental rates, free rent, big kinds of improvement packages. They're getting very, very good deals,” Hudson said.
That translates to leases that typically fall within the five- to 10-year range, particularly for tenants signing leases in new buildings. For build-to-suit leases, the average length is even longer, usually within the 10- to 15-year range, according to Hudson.
“You don't see anybody sign anything shorter than five recently, [it] just takes too much capital to put those folks in. You won't sign a three-year lease, you need at least a five,” Hudson said.
The only exception is renewals, where Hudson said he had seen some shorter-term deals that have ranged between one and three years. Larger corporate users typically fall on the longer end of that time frame, just because of the planning requirements.
The pandemic has prompted inquiries from some users that specialize in certain medical supplies or cleaning materials, such as hand sanitizer. Those inquiries have been large but short-term in nature, typically falling within the one- to two-year time frame, Hudson said.
For companies looking to take advantage of certain market demands, like hand sanitizer or cleaning supplies, it is likely that those companies will choose to utilize third-party logistics platforms, according to Smith.
“Most owners of industrial product are not willing to go and do shorter-term deals because I think that, you know, most of them are still very bullish on their positions, and they don't necessarily see a need to go lease a space at less than a normal-term deal,” Smith said.
“When you've got a national vacancy rate that's probably in the 4% range, owners can do that, because there's just not a lot of available space out there.”
There are some leasing trends that could take a little longer to appear. Ozanne said based on various forecasts, she expects to see increasing demand for warehouse space from medical, food, freezer/cooler and manufacturing companies. On the flip side, declines are anticipated from event-related uses, airline and travel, and luxury goods.
“So far, though, we haven’t seen enough activity to clearly confirm these forecasted trends have become reality,” Ozanne said.
Smith said that as Amazon continues to make aggressive real estate deals around the country, other online retailers will follow. That bodes well for industrial leasing activity in the future.
“I think a lot of these other retailers that are going to come out of this COVID issue, they're going to come out with a different game plan, probably more focused on the e-commerce than malls and stores. And I think that, again, that will be nothing but positive for the industrial sector,” Smith said.