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High Demand Expected To Continue In Bay Area Industrial, But Challenges On Horizon

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From Silicon Valley to the East Bay, Tri-Valley and Central Valley, the Bay Area’s industrial markets are reporting historically low vacancy, high demand, strong rent growth and a healthy pipeline of new development.

As the market continues to mature, long-term challenges could start to have a significant impact on the future of industrial. In the short term, developers continue to push forward with projects in a market with many large tenants seeking high-quality space.

High Demand Expected To Continue In Bay Area Industrial, But Challenges On Horizon
Bisnow West Coast Regional Director Nick Bates, Coblentz Patch Duffy & Bass partner David Gold, Dermody Properties partner George Condon, srmErnst Development founder Joe Ernst, Paceline Investors principal Mark English, Cushman & Wakfield Executive Managing Director John McManus and HFF Senior Managing Director Scott Pertel

“The market is really good,” Cushman & Wakefield Executive Managing Director John McManus said during Bisnow’s Bay Area Industrial and Logistics Summit Thursday. “There is no question about that.”

In addition to the market conditions of the Bay Area’s industrial segment, panelists discussed what tenants want out of their industrial spaces and the Port of Oakland’s development pipeline.

Cushman & Wakefield reported 4.8% vacancy in the East Bay-Pleasanton market and 4.2% in the East Bay-Oakland segment during the third quarter. The Central Valley vacancy rate also decreased slightly to 3.5% last quarter compared to 3.7% a year ago.

“The vacancy rate where it is today is a dream. It’s hard to imagine,” Dermody Properties partner George Condon said. “We used to be in an environment where if vacancy rate dipped below 10%, we thought, ‘Wow, this is a landlord’s dream.’ These are good times for sure.”

Although vacancy is very low across Northern California’s industrial markets, the third quarter marked the sixth quarter of negative net absorption in the East Bay, largely driven by tenants moving into Class-A space and leaving Class-C space vacant.

Even though Class-A spaces cost more, tenants are willing to pay the rent to make sure they have buildings that work for them. Buildings need to be efficient and meet the needs of modern tenants, McManus said.

“C buildings will probably suffer,” McManus said.

He said rent growth is also becoming more modest than the 20% per year reported in the past. He said the industry should expect 3% to 5% rent growth each year going forward.

High Demand Expected To Continue In Bay Area Industrial, But Challenges On Horizon
Coblentz Patch Duffy & Bass partner David Gold, Dermody Properties partner George Condon and srmErnst Development founder Joe Ernst

A lot of users also have been moving to the Central Valley and not just because of the low vacancy rates. That region is benefiting from warehouse distributors and manufacturers leaving the 880 corridor and moving toward the Tri-Valley area, where they don’t have to compete with Apple, Facebook or Tesla for employees, Condon said.

The Central Valley has added significant build-to-suit properties in the last two years, adding 18M SF to the market, Colliers International Executive Managing Director Michael Goldstein said. In the next 12 months another 5M SF to 6M SF could be added to the market.

“There has been a tremendous amount of growth in our market,” Goldstein said. “Demand has been there and is why we continue to build.”

Capital still remains flush in the industrial segment despite the shifting headwinds.

“More capital is flowing into the industrial sector than any other sector,” HFF Senior Managing Director Scott Pertel said. 

Year-over-year industrial transactions are up 26% nationally, compared to retail transactions up 1%, office transactions down 13% and apartment transactions up 8%, Pertel said. 

Labor Costs, Constraints Hitting Industrial

High Demand Expected To Continue In Bay Area Industrial, But Challenges On Horizon
HFF Senior Managing Director Scott Pertel

Long-term trends point to many challenges that will need to be addressed to keep users in the market. 

“I’d love to tell you that costs are stable or flat, but I would be misleading you,” Millie and Severson General Contractors Division President – Northern California Bob Wissmann said.

Labor costs are rising, especially since much of the labor force coming into the 880 corridor doesn't live close by and often commutes from the Central Valley, Wissmann said. Raw concrete costs are 30% to 40% higher in the East Bay 880 corridor compared to the Central Valley, he said. Additionally, materials costs are increasing due to tariffs, Wissmann said. 

“In a stable marketplace, you might see 3% to 6% [in costs] on an annual basis,” Wissmann said. “In the San Francisco area, our cost of doing business from a construction standpoint is 20% to 30% greater.”

Labor costs and labor availability are increasingly becoming issues that go beyond the construction of industrial buildings. Industrial users, especially smaller users in 20K SF to 50K SF, are having trouble hiring and retaining qualified employees, Dermody Properties' Condon said. Employees also don’t have housing options close to these industrial employers, he said.

High Demand Expected To Continue In Bay Area Industrial, But Challenges On Horizon
Colliers International Executive Managing Director Michael Goldstein, Black Creek Group Vice President Steve Young and Millie and Severson General Contractors Division President – Northern California Bob Wissmann

Alongside increasing costs to develop, developers are still having to jump through many hoops to get their projects approved, especially since they are fighting against a negative perception of industrial. 

Paceline Investors principal Mark English said many cities perceive distribution, fulfillment and logistics jobs as not being the high-wage, highly educated jobs that many would prefer to bring into their cities.

The perception remains that warehouses are just large boxes with a few employees in them that don’t act as economic drivers that bring high wage-earning individuals into the community, he said.

Infrastructure around the building also has to endure heavy traffic, which typically includes trucks 24 hours a day, which makes it difficult to build near any residential area, English said.

“Developers really need to get out there and interact with the communities and talk directly with community members so they know someone who is making decisions in their community,” srmErnst Development founder Joe Ernst said.