The past decade has ushered in a host of emerging trends and changes that have played out across the commercial real estate spectrum in a variety of ways. The majority of the driving factors stimulated positive impacts in the industry, though perhaps the most dramatic change was the massive transformation of the industrial sector.
We will take a look at what has occurred during the past ten years within the industrial sector, and examine where key West Coast industrial markets may be headed in the coming year. The overarching economic growth, combined with new technology, shifting consumer shopping preferences, and an insatiable appetite for quality assets in which to place capital, has driven the industrial sector towards some rather staggering, albeit revealing, numbers during the past decade.
The U.S. is in the 11th year of economic expansion and continues a record-breaking streak of job gains. Over the course of the long-lasting recovery, since the Great Recession hit the American economy in 2008, a series of events set the stage for what today is considered just about the healthiest time ever to be in business in the U.S. The overall economy has recovered strongly, and notwithstanding the headwinds of a simmering trade war, the uncertainty of an upcoming national election, or interest rate fluctuations, the jobs market shows no signs of relenting. Unemployment has held steady at a record half-century low of 3.5%, dropping from a recession-high of 10% in 2009. In fact, today’s tight labor condition may actually hold back growth, simply because there are more openings than there are candidates to fill those positions. The U.S. economy did grow 2.3 percent in 2019, a solid pace that was boosted by strong consumer and government spending.
E-commerce: The Amazon Effect
A major factor propelling the industrial sector, and a large portion of the U.S. economy as well, is e-commerce. The advent and emergence of technology that facilitates and aligns with how people want to buy things today is largely behind the remarkable adoption and growth of online retailers like Amazon. The Amazon Effect, as it is being called, reflects the incredible growth of online shopping and search for the most efficient ways to get those products into customers’ hands. That has benefitted industrial developers, owners, and investors up and down the West Coast.
Amazon now occupies more than 13 million square feet of office space in the Puget Sound, and its industrial footprint has expanded exponentially on the West Coast. Globally, the giant e-retailer’s footprint of leased and owned properties has swelled to nearly 334 million square feet, the majority of which is fulfillment and data centers. This impressive growth also mirrors what’s transpired across the board in the key industrial areas. A closer review of the past decade’s statistics in Seattle, the Bay Area, Southern California, Arizona, and Nevada shows this industrial growth trend remarkably clear. New construction started to ramp up in 2010 but really accelerated in 2013, about the time Amazon exploded.
Industrial Markets in Review
Kidder Mathews found there was a 16% increase in industrial occupancy in the past ten years on the West Coast’s base of 3.2 billion square feet, which equates to 450 million square feet of space. The firm tracked 356 million square feet of new industrial space constructed over the past ten years. Interestingly, 58% or 207 million square feet of those new deliveries were in just two regions: Inland Empire and Phoenix. West Coast lease rates increased 73%, and sale prices increased 103% over the past ten years.
The areas that experienced the largest percentage increase of inventory or new construction were the Inland Empire at 34%, followed by Reno at 31%, Phoenix at 20%, Seattle at 11%, and Portland with 10%. As a whole, the segments experiencing the most growth corresponded to those that had available land, though opportunities are starting to dry up in some locales. The West Coast markets that reported the largest 10-year increases by square feet of inventory or new construction were the Inland Empire with 153 million square feet, Phoenix with 54 million, Los Angeles with 35 million, Seattle with 34 million, and Reno with 25 million.
Kidder Mathews researchers note the new construction numbers for areas like Silicon Valley and Orange County were low over the decade. Largely because they were either landlocked or industrial product was being converted to higher and better uses like creative office, multifamily, or life science. In the case of Sacramento, the region was overbuilt in 2010, thus had a higher vacancy (20%) to fill in order to return to a more normal balance and for construction to move forward again.
The regions that had the largest percentage increases in occupied industrial space over the last decade were the Inland Empire at 39%, Reno at 36%, Phoenix at 27%, Seattle at 13%, and Sacramento with 12%. Those numbers ran in harmony with new construction because they had the warehouse supply to accommodate increased demand over the decade. In general, that was a result of those markets having the room to accommodate the state-of-the-art buildings’ e-commerce occupiers desired, compared to the functionally obsolete spaces available elsewhere. These areas had the capacity to meet demand by adding new buildings with better racking systems, space that better accommodated tech robots, automated picking systems, and racking or had better fire suppression capabilities and were built with higher ceilings to be more efficient. The need for this type of modern space drove development and involved complex projects that covered more land and were built by increasingly sophisticated and deep-pocketed investor developers.
The West Coast markets that reported the largest percentage increases in lease rates were in the East Bay (Oakland) at 122%, the Inland Empire at 108%, Silicon Valley at 97%, Los Angeles at 89%, and Orange County with 85%. The East Bay increase was surprising since San Francisco’s industrial base was being converted to higher and better uses, and that pushed tech industry users to the East Bay. In turn, pricing was driven up to record levels, though there may still be room to run. Companies are expected to continue seeking locations near industry clusters, though they will strive to be as space-efficient as possible and may relocate to outlying areas in an effort to save money.
The areas that experienced the largest percentage increases in sale price on the West Coast were in the Inland Empire at 141%, Los Angeles at 124%, East Bay (Oakland) at 120%, San Diego at 116%, and Silicon Valley with 103%.
The Inland Empire stood out since it had the most state-of-the-art buildings, which generally command higher prices on a per-square-foot basis. It stands to reason this sector would experience overall transaction price increases for new and existing industrial assets. Yet, the quest to add new industrial facilities to portfolios drove institutional investors’ interest over the decade, as they worked to place capital in what had previously been an under-allocated asset class for them. They were willing to pay up for high-quality industrial assets with credit tenants in the right location. That was particularly true for the Inland Empire, because it is located near the Ports of Los Angeles and Long Beach, as well as Southern California’s mega-consumer base.
The future remains bright for the industrial sector because it will continue to ride largely on the growth of e-commerce, and the U.S. economy is expected to remain steady in 2020. Industrial real estate has risen into a position as the “darling” asset class for investors, and stands among equals with the commercial real estate property types, finally. The sector must figure out how to continue adopting technology, as well as where it fits in the complex supply chain logistics ecosphere. Industrial owners and developers will continue to refine where “last-mile” or even urban infill neighborhood facilities fit in the overall landscape as they work to meet the demand for modern logistics facilities that generate revenue and meet operational efficiencies. Those factors add up to a promising year of expansion for the U.S. industrial real estate market.