By Jack Stubbs
Rising rents, perpetually low vacancy rates and a shortage of available inventory across the region mean that the tight regional industrial market is set to be constrained for the foreseeable future.
The industrial and logistics market in Seattle and the wider region is in a period of growth, and it continues its strong performance as one of the top markets on a national scale. According to a recent report released by CBRE, “Global Industrial & Logistics Prime Rents,”—which examined 71 global logistics hubs for state-of-the-art industrial space—the city of Seattle saw a 13.4 percent increase in rents year-over-year as of first quarter 2018, and is now ranked fourth globally for the fastest growing prime logistics market. Seattle came fourth, globally, in terms of year-over-year rent growth after Oakland (14 percent), Beijing (19.8 percent) and Vancouver (29.1 percent) and, nationally, experienced the second fastest rent growth after Oakland.
The wider Puget Sound industrial market, also, is set to continue its forward trajectory in the year ahead but continues to be constrained, according to similar reports from brokerage Kidder Mathews. “If I’m looking at [figures] compared to 2017 in general compared to 2018 first and second quarter as our most recent reference points, I’d say the market is certainly still improving, but it’s still very constrained. We’re seeing low vacancy rates, high rental rates and high sale pricing…over the last couple years, not a lot has changed with that, and those rates are also continuing, generally speaking,” said Matt McLennan, an industrial broker out of Kidder Mathews’ Tukwila office.
At the end of 2017, in the Seattle CBD and close-in markets (as far south as SoDo, Georgetown and SouthPark), vacancy decreased from 1.79 percent to 1.56 percent, according to a fourth quarter 2017 Seattle Industrial Market report written by Kidder Mathews. With a positive net absorption of nearly 2.3 million square feet, the Puget Sound region’s vacancy decreased from 3.3 percent to 2.98 percent. The majority of industrial projects in the pipeline are in Pierce and Snohomish Counties, with the positive absorption of 6 million square feet across the region. This is the second highest figure of all time, according to the report.
McLennan highlighted how, as the cycle enters into the later stages of 2018, growth is not occurring as quickly as it did in 2017 due to a more constrained market overall. “Heading into third quarter  looking at the first and second quarter [of this year] in comparison to 2017, I don’t think we’re seeing things move at the same [rate] as we did in 2017. 2017 was a record year by several accounts just as far as the amount of activity that happened,” he said. “Our [regional] rent growth over 2017 was on average close to 17 percent, which was almost unheard of. [I] was predicting 9-10 percent growth in 2018…[and] generally speaking I think we’re on pace to meet that number.”
As a result of the tighter markets closer in to the Seattle CBD, prospective tenants are looking further south outside of the core markets for available inventory and better pricing options. And in terms of the land that is available across the region, prospective developers are also having to contend with the associates challenges that industrial projects often represent, according to McLennan. “Looking at the available land [in the region], anything that is core industrial in South King and Pierce [counties], the amount of available land is scarce, and any land you are able to find often has environmental and wetland issues and mitigation issues in some way, shape or form,” he said.
However, even in spite of the relative dearth of available industrial inventory in relation to 2017, demand in the industrial market remains intense as competition increases across the board, thinks McLennan. “Industrial demand is still incredibly high, both from an investor and user standpoint. Investors love the idea of buying industrial right now,” he said. “Looking at per square foot prices, industrial properties—excluding in the core Seattle CBD—throughout the Kent Valley, south King County and Pierce County, are often trading at or above the same rate as office and retail, which is crazy; we haven’t seen much of that over the last decade.”
There were several large-scale industrial sales last year. The highest price per square foot sale in 2017 was Kurt E. O’Brien’s acquisition of the 66,700 square foot Market Street Properties in Seattle in September 6th, 2017 for $24.9 million, or approximately $373 per square foot, from Goodman Real Estate. Also in September, Bentall Kennedy acquired the 241,140 square foot Western Distribution Services building in Burien from Bridge Development for $57.5 million, or approximately $239 per square foot. In June 2017, Compact Information Systems purchased the North Creek Center, a 97,216 square foot building in Bothell, from Gerlicher Company for $26.75 million, or $275 per square foot.
In the broader economic context, industrial properties remain in high demand—though the perpetual lack of marketable for-sale properties continues to drive up prices, meaning that there are fewer options for users to target, according to McLennan. “With the economy doing well, a lot of users in the area that have been renting are highly interested in purchasing properties. That being said, properties for sale at the moment are scarce. There just aren’t a lot of user buildings being marketed for sale,” he said. “And the price point is unrealistic for what a user might be willing to pay, given that owners know they can fetch top dollar for their properties right now.”
In terms of sales activity in 2018, there were 118 transactions totaling $917.4 million, according to Kidder Mathews second quarter 2018 report. Notable sales over $20 million last quarter included The Blackstone Group’s sale on May 16th of the 292,100-square foot Redmond East Business Campus to Kennedy Wilson Properties for $52.125 million, or roughly $179 per square foot; The Carlyle Group’s sale on April 13th of the Fife I-5 Commerce Center to Black Rock for $37.5 million (approximately $149 per square foot); and Prescott Realty Group’s sale of the Boeing-occupied 335,000 square foot Harbor Point Tech Center in Everett in early May for $25 million, or approximately $76 per square foot, to MRM Mt. Vernon LLC, an entity affiliated with InCity Properties.
Looking ahead and in terms of whether supply in the industrial market will be able to keep up with demand and relieve some of the pressure on the regional market, this dynamic will depend on whether projects in the pipeline will be able to fill the gaps. A total of 1,355,847 square feet of space was delivered in second quarter 2018, according to Kidder Mathews’ report, and there are currently 38 buildings totaling 7 million square feet now under construction. Approximately 22 percent of this space pre-leased.
Some of the notable projects under construction throughout the region include Panattoni’s 467,526 square foot Lakewood Tacoma Gateway project scheduled for delivery in third quarter 2018; the 229,000 square foot IPT Sumner Distribution Center, also scheduled for delivery in third quarter this year; DCT’s Blair Logistics Buildings A and B (totaling almost 971,000 square feet) scheduled for delivery in third and fourth quarter 2018, respectively; and Prologis’ 589,615 square Georgetown Crossroads development, scheduled for delivery later this year.
As has been the case for awhile—and with the increasing trend of e-commerce driving growth—developers are looking to pursue larger-scale projects to make their investments pencil out. “A lot of developers want the biggest park and want to build the biggest buildings possible to blend out the costs of construction and attract high-quality blue-chip tenants and e-commerce giants,” McLennan said.
However, while big-box projects in the works will—once delivered—ease some of the pressure on the market, the inordinate number large-scale developments in the pipeline somewhat skew the actual reality in terms of readily available industrial inventory, according to McLennan, who added that there remains a lack of smaller-scale projects to ease the pressure in the shorter-term. “There are some larger deliveries in Tacoma for million-plus square foot projects and some closer in to Seattle that are all getting delivered this year…but the big-box projects coming online will skew the numbers,” he said. “Looking beyond [the end of this year], vacancy is still really right. There’s such a high demand for projects under 50,000 square feet, especially between 10,000 and 30,000 square feet…there are users that can afford that kind of project, but there isn’t much of that size range coming online right now, which is adding another constraint to the market.”
Looking ahead, the lack of diversity of upcoming in-the-works projects—as many developers opt to pursue larger-scale projects—mean that the perpetually high rental rates and low vacancies have to some degree become an accepted condition of the current market. “What’s maybe stunting the growth [of the market] slightly is that tenants, users and brokers in general have almost gotten used to these high rental rates and low vacancies. People are spending more time preparing for the future and biding their time if they’re looking to purchase or lease; that’s where activity has slowed a little bit,” McLennan said. “More people are sitting on the sidelines and watching; some are thinking that the bubble is going to pop and wondering how long we can sustain this for.”