Low supply drives demand for new industrial real estate

Industrial real estate seems to be the one bright spot in commercial real estate currently, with demand far exceeding inventory.

“We are supply-constrained across the board with construction costs and rents that don’t jibe,” said Nathan Klein, partner and commercial brokerage manager for LC Real Estate Group LLC in Loveland. Because of that, the cost feasibility for speculative construction is not there, he said.

“While we’ve got a little bit of construction going on, it is not widespread. It has to be end-user driven. I’ve seen end users reluctant to build at $200 per foot for a metal building. It’s crazy. Those that have to will; they certainly will. Business pressure at some point outweighs the cost,” Klein said.

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He points out that it takes about 18 months to get a new industrial building through city approvals, design and construction.

“If we rely on end-user construction to supply the market, it is a long, slow process. For me, it is a natural supply constraint, not an artificial one. It suggests that the market ought to stay pretty good for a while until something changes, either rents keep climbing for it to make sense for more spec construction or we will find more decent space at an affordable price,” he said.

Demand is high for both the sale and lease of industrial buildings, Klein said. Any industrial building that goes up for sale gets multiple offers. For example, a million dollar industrial building by the Northern Colorado Regional Airport garnered six offers in three days of its listing.

“We have clients on the sideline waiting to find something. This is not glamorous real estate. It is pretty ugly industrial,” he said, adding that he believes it is a really interesting dynamic in the marketplace for industrial because there needs to be some spec construction to get the market caught up but the more that happens, the more lease rates will be held down and the less sense it is going to make.

“It is an interesting circular series of events on what it takes but I think most of our clients are banking in the near term we are going to continue to see modest rent increases based on lack of inventory,” he said.

According to a Northern Colorado Industrial market summary prepared by CBRE for McWhinney, Northern Colorado has 30,823,051 square feet of inventory in 750 buildings. In the first quarter of 2018, there was a 5.2 percent availability rate with a 6.6 percent vacancy rate and a weighted average asking rate of $9.74 triple net per square foot.

Nationally, there was 7.58 percent availability in the industrial market with a 4.5 percent vacancy rate. Industrial properties were asking $6.92 per square foot. In Denver, the asking rate was $7.67 per square foot with 8.2 percent availability and a 5.8 percent vacancy rate.

“I think we will see continued appreciation of existing product, at least in the short- to median-term future,” Klein said. “It’s good for anybody who owns real estate and it is a good time to buy real estate even. We have some people concerned about it being overheated or overpriced. I look at the fundamentals. It is definitely expensive; it is not cheap. It is an expensive time to buy but there are a lot of fundamentals that suggest we’re not done. There is still room to grow.”

McWhinney, a large developer in Northern Colorado, is still developing industrial properties on spec.

The company is developing buildings that are between 24- and 32-foot clear and range from 100,000 to 170,000 square feet.

“We’re exploring doing some larger format developments as well,” said Ashley Stiles, McWhinney’s vice president of commercial development for Northern Colorado, which has mixed-use developments in Broomfield and Loveland.

In Loveland, McWhinney is on its third industrial building in Centerra, which is a master planned community. It has 350,000 square feet in industrial between those three buildings. All of those buildings were built on spec, Stiles said.

In Broomfield, the company recently completed a 153,000-square-foot industrial building that already has three tenants occupying 50 percent of the building.

“We are still actively marketing that space. We’ve seen really great interest,” she said.

Part of the reason McWhinney’s properties do so well is that they are integrated into master planned communities. Industrial buildings are surrounded by many amenities, including trails, outdoor activities, retail and restaurants and housing.

“It feels a little more inclusive of the entire community than just stand-alone industrial parks. It is one of our competitive advantages,” she said. “There’s a lot to do in our community for those businesses and their employees who work there, which is something that is really appealing to folks.”

The businesses interested in industrial space run the gamut, she said. In Centerra, one tenant is a manufacturing and distribution facility and another does auto glass repair. In Broomfield, one tenant is using part of its space for offices and the other part for research and development. Another is a distribution company for lighting equipment. A large fitness user has also expressed interest in the Broomfield development.

“We are seeing a broad range of uses and different company types,” Stiles said.

Many developers won’t build industrial space on spec currently because they are worried about the lease up risk, Stiles said.

“We are watching the market demand for space and what inventory is in those submarkets. Nobody is filling these needs,” she said.

McWhinney went spec because of the size of tenants it was attracting.

“Really, if you can figure out how to finance it and buy yourself enough time to lease it up, it is really the way to go. It allows the tenants to make decisions they didn’t feel like they could, particularly around timing,” Stiles said.

She compares the industrial market to the multifamily development market. For years there were no new multifamily developments and then, recently, multifamily development has blossomed.

In the Denver market, the cannabis industry has taken up most of the older industrial product on the market, fueling the demand for new industrial to fill the needs of everyone else, Stiles said. Much of the industrial development is taking place along the major transportation corridors, like along I-25 and I-70.

Jim Neufeld, a broker with RE/MAX Commercial Alliance in Greeley, said that the industrial market in his area is kind of frustrating and confusing right now. Greeley relies on the oil and gas market for much of its industrial tenants and many of those are picking up and moving to Wyoming because they are worried about Colorado politics and the proposed ballot Initiative 97, which would require a 2,500-foot setback around all oil and gas drilling operations. Add to that the high cost to build an industrial building and the “risk is so high,” he said.

Mike Eyer, vice president of CBRE Brokerage Services in Fort Collins, said that vacancy rates are at all-time lows. Depending on which buildings are included in the averages, vacancy rates sit somewhere between 3 percent and 5 percent.

“The challenge in the market right now is a lack of functional product for tenants in unique companies. Lease rates probably haven’t caught up to support new construction so there’s not a lot of new speculative construction going on. The market continues to be really tight and it has actually had an impact on leasing activity as it has slowed down a bit this year,” Eyer said.

He added that there is still “pent up demand for industrial space but just the lack of product has kept that on the sidelines.”

Lease rates are going up, he said, but they haven’t maintained the same pace as construction costs.

“I think a lot of developers look at it as a risky proposition to build speculative space because they are not confident the market will absorb it with the lease rates needed to get fair return on the money,” Eyer said. “Something will give eventually. I’m not smart enough to say when it is going to be.”

McWhinney and Schuman Companies Inc. have both been successful with their speculative buildings. Eyer said that as others see these projects succeed, more people will be willing to take on the risk.