The times they are a changin’

by Justin Lamontagne, CCIM, SIOR, Partner, Broker at NAI The Dunham Group

My mind wandered recently while on a long solo drive, as it often does. I had the music cranking and, in typical Maine fashion, cell phone coverage was spotty. It was nice to effortlessly jump from thoughts of the holiday season with my young kids… to my (gulp) 20-year high school reunion and old friends… to the prospects of another long playoff run by my beloved Patriots. But as I passed commercial buildings and warehouses, my attention drifted to the bricks and mortar of the Greater Portland industrial market.

And sure enough, some classics from the past lined up nicely with my thoughts on the near future of our market:

The times they are a changin’ – Bob Dylan said it simply. And the statistics in our market suggest the same. The nearly 8-year run of a clear Landlord’s market has finally shown indicators (albeit slight) that the pendulum is swinging the other way.  This year’s overall vacancy rate of 3.47 percent is significant increase from our historically low 2017 rate of 1.25%.

Of course, a 3.47% rate is still what I would call a “Landlord’s market”. However, what concerns me is that our added industrial units are highly comparable spaces and competing with one another. Since early Spring we have seen several 10-20k SF Class-A/B industrial spaces come on the market and linger. In years past, we’d often have prospects on the sideline ready to pounce. In 2018, these spaces sat (and are sitting) vacant for months at a time. The challenge is lack of tenants. In Maine, we simply have a limited number of industrial style businesses to put into spaces that size. And when 5-6 of the same quality and size come on-line at roughly the same time, all of a sudden the 1-2 larger tenants in the market carry leverage they haven’t had in years.

In the air tonight – Phil Collins sensed something was amiss. And so did we in the industrial market. The phones slowed down mid-year. Quality inventory that we turned over with such regularity, started to sit. What was wrong? We began to hypothesize and then confirm through conversations with our Tenant clients. There were some big-picture concerns happening.

The macroeconomic pressures we have been tracking, primarily inflation and lack of labor force, finally became material reasons not to expand or relocate. Tenant’s began to tell us that they couldn’t hire enough people to support the workload that would come with additional square footage. Additionally, the cost of virtually everything rose. From taxes, to gas, to electricity, to raw materials, to a loaf of bread… everything got more expensive in 2018. Which indirectly squeezed real estate budgets.

Hold on… this classic Wilson Philips song (of course belted at the top of your lungs – admit it) raises a good question. Will the interest and activity we’ve seen in industrial new-construction “hold-on”? I am not entirely sure. The existing lease inventory we’ve added is renting well under new construction rates. And the cost of construction continues to skyrocket. Add to that, a lack of quality industrial land, a rising interest rate environment and unsteady economic trends, and my unfortunate prediction is that, yes, the new construction window of opportunity will close in 2019. Farewell, we hardly knew thee…

For the Love of Money – President Trump’s favorite tune is best known for the simple yet powerful chorus, “Money, money, money, moooonnnneey…. Money!” So how did we close any deals this year, with all the challenges referenced above? Sales prices continued to climb as we have a dramatic lack of purchase opportunities. Rising interest rates did not temper owner/user interest in acquiring industrial real estate. However, as sales prices climbed (cresting $100/sf for Class-A owner/user space) our sales volume was down. This was largely due to lack of motivated sellers.

And leasing demand didn’t just drop off a cliff. We have had steady interest in smaller units, under 10,000 SF. And there are currently a handful of large end-users touring the market in the 50k+ range. Interestingly, the most consistent demand is coming from traditional industrial businesses. Until recently, these companies have been begrudgingly on the sidelines, often losing out to start-up and well-funded industries like craft brewing and the marijuana cultivation trade.

Much like my long-drive, the industrial market has been a nice ride. But there are clearly bumps in the road forthcoming. For the first time in over eight years, the data suggests a softening market. Tenants finally have some leverage and can expect more incentives and better overall deals. And Landlords? Well, they may be singing a different tune. Regardless, it should make for a rocking 2019.

Click to view NAI The Dunham Group’s 2019 Greater Portland Industrial Market Survey

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