Leasing activity in North American industrial real estate is up, although the sector is still vulnerable to mixed economic indicators, which could make sustained recovery slow or sporadic, according to a new report.

While labor market pressures and slow job growth continue to drag on the economy and hurt consumer spending, there have been positive indicators to offset some of the decline. Gradually improving corporate profits have renewed long-term optimism, which in turn has spurred a significant amount of second-quarter industrial leasing activity. This has been driven by large occupiers executing significant renewal, consolidation or relocation transactions, helping to temper overall vacancy figures, according to a new report from Jones Lang LaSalle.

For the first time in almost two years, national average vacancy rates in North American industrial real estate have tumbled 20 basis points, from 10.6 percent in the first quarter to 10.4 percent in the second quarter, the global real estate services firm reported last month.

“With the rise in corporate America’s second quarter profits and a need to restock inventories that were running at 50-year lows, a number of large occupiers have strategically captured high quality logistics space at cyclically low rates,” Craig Meyer, managing director and leader of Jones Lang LaSalle’s Logistics and Industrial Services group, said in a statement. “Opportunities remain in virtually every market at aggressive terms and even with the very modest levels of leasing and little or no speculative construction, choices are quickly becoming limited in some markets, especially in the Class A large block sector.

“In fact there is only 11.3 million square feet of new construction in the pipeline and 83 percent of that is pre-leased. With such low levels of new construction planned in the foreseeable future, we expect to see an increase in build-to-suit activity,” Meyer continued.

However, sustained deal volumes will be essential for a stronger turnaround in current trends, the report makes clear. While leasing activity across many markets is up, the sector is still vulnerable to mixed economic indicators, which could make sustained recovery slow or sporadic at best.

“While we can report some overall positive news for the sector, we are still very much at the mercy of this precarious economy,” Meyer explained. “Declining consumer confidence, the fading impact of the federal stimulus support and worldwide economic volatility are forcing many industrial landlords, tenants and investors to look back over their shoulders in fear of a double dip recession.”

According to the report, which tracks 38 key industrial markets in the United States, average net absorption is at 11.1 million square feet for the quarter. So far this year, however, average net absorption remains negative at 7.4 million square feet, down significantly from last year’s total of 126.6 million square feet.

Markets that also act as supply chains are performing relatively well. In terms of vacancy, New Jersey and Dallas markets are trending toward organic growth.

“Although some pent-up demand helped create some uplift in the market thus far in 2010, renewals still comprise a healthy component of industrial demand,” the report says, continuing:

Compared to last quarter, when the majority of significant industrial lease transactions were new leases, this quarter saw an even split among re-signings and relocations. Many businesses sensitive to cost control continue to hedge against near-term economic volatility and, along the same lines, the “blend and extend” market has not yet fully dissipated, both of which are keeping any broad sense of optimism in check.

The overall availability of sublease space has decreased across the country, pointing to rising demand. The highest volumes of marketed sublease space are in Northern and Southern California, particularly Sacramento and the Inland Empire, as well as mid-tier markets in the Southeast such as Nashville and Memphis.

Nearly 66 percent of all the industrial markets tracked by Jones Lang LaSalle experienced positive net absorption, with a further 20 percent showing declining absorption. Major industrial markets such as Chicago and Los Angeles account for a combined 8.3 million square feet of negative net absorption so far this year, although both are showing recent signs of stabilizing (albeit unevenly) in the second quarter, with submarkets around their ports and airports benefiting from recent growth in container traffic and cargo tonnage.

Demand for high-end, prime logistics space tops the general market and has given a boost to Midwest regions like Memphis, Dallas/Fort Worth and Columbus, as well as key distributions markets in the Northeast such as Central New Jersey, Philadelphia and Harrisburg.

Meanwhile, average asking rents continue to decline across the U.S., although the rate of decline is slowing and, in the second quarter, fell by 1.1 percent. The lowest industrial rents are in Columbus and Memphis; the highest are in San Diego, San Francisco’s Bay Area and South Florida. Jones Lang LaSalle forecasts “flat” to “slightly falling” rents throughout the remainder of 2010 and into 2011.

Competition for tenants is fierce in almost every market, and the rising level of concession packages — including periods of free rent and tenant improvement packages — continue to be a critical component when completing deals.

“While the economy is giving mixed messages and keeping real estate players cautious, demand for industrial real estate is slowly improving,” Jones Lang LaSalle explains. “If expansion requirements continue from large institutional users, the industrial market may keep its head above water and progress towards full recovery.”

Resources

North America Industrial Outlook – Q2 2010
Jones Lang LaSalle, Sept. 7, 2010

Industrial Real Estate Shows Signs of Recovery in the United States
Jones Lang LaSalle, Sept. 7, 2010