Industrial market growth, expansion continues

The 1.4 billion-square-foot Chicago area industrial market has recovered quite nicely. According to board members of the Association of Industrial Real Estate Brokers (AIRE), and in keeping with national economic predictions, there doesn't appear to be any end in sight to the bull market run that has been evident from DeKalb to the submarkets that sit on the Wisconsin and Indiana borders.

"This economic expansion is in its 77th month, making it the fourth longest since World War II," said Adam Marshall, a senior managing director with Newmark Grubb Knight Frank and an AIRE board member. "The longest expansion on record was 120 months (1991-2001) so this one could easily continue for another 2-3 years. With inflation and interest rates still low, there is nothing visible on the horizon to derail it."

In drilling down his response, John Coleman, a Managing Director with Transwestern and another AIRE board member agreed that the industrial market prospects are good, but not necessarily on all fronts.

"We see vacancy rates continuing to improve in the B- and above asset classes and we see better absorption next year in new construction, high-cube spec," Coleman said. "We see users aggressively paying up for good quality, 40,000-square-foot to 120,000-square-foot industrial buildings to accommodate their existing and future facility needs."

At the same time, Coleman believes one of several standard industry metrics helping to characterize the value of buildings - capitalization rates - will flatten a bit on value-add mid-size portfolios.

Adam Tarantur, a Principal with Podolsky|Circle CORFAC International and a member of AIRE's board, noted "a great deal of positivity in all asset classes, especially within the industrial marketplace."

A frequent conversation within the organization, at recent meetings and in discussions among members, is the potential impact to the industry and its space users of an interest-rate increase by the Fed. "There is a certain cautiousness surrounding the prospect of an interest-rate increase," Tarantur said. "While an increase seems likely, no one expects a significant increase. Rather, we expect that rates would rise slowly."

According to Tarantur, the interest rate climate weighs heavily on the mind of executives when making overall business decisions, not just whether to buy a building. However, he said, there are many other factors, like material, transportation and labor costs, they consider when making business decisions.

"Most savvy business leaders recognize that rates have been so low for so long, which is atypical, so they won't be alarmed if and when a rate increase does occur," Tarantur said.

Marshall says an interest-rate increase could begin to restrain investment sales and construction loans, but the increase may be slow depending on economic data.

Coleman generally agreed, saying, "We think an uptick in rates of 25 basis points won't have a material impact on new construction, but any more than that and it probably would. User sales will slow somewhat from the reduction in buying power and the lag between seller expectation and market reality."

Coleman also expects that land sales, which have been steadily increasing as developers look to control land for new business park development, may also slow some for deals where the total time to market is greater than five years.

In new industrial construction activity, Newmark Grubb Knight Frank is tracking 9.5 million square feet of space currently under construction and an additional 6 million square feet already in planned construction for 2016.

"I see great discipline in the marketplace, to the credit of both developers and lenders," Tarantur said. "Developers are realistic. They aren't acting erratic or irresponsible; and they are benefiting from their actions. I don't see a change in that mindset at all; development overall is in line with what the market has demanded."

Coleman thinks infill development will continue, especially in North Cook, O'Hare and along I-55. "We see new spec construction in Southeast Wisconsin (Kenosha and Racine Counties), but not necessarily far west or far south," he said.

Marshall's perspective is that construction is rising but has actually trailed demand, which has pushed vacancies lower and rents higher. "Look for industrial vacancies to level out in the first half of 2017, though rents will continue to rise," he said.

From a tenant perspective, Tarantur characterizes the leasing decisions of many users as "a flight to quality." "With that flight to quality there is a certain increase in occupancy costs, but businesses aren't as pressed financially as they were several years ago," he said, "so it is being accepted as a cost of doing business; a price that comes with a flight to quality."

Marshall believes there are great opportunities in 2016 for users, including the ability to lease more functional Class A distribution space with all of the new speculative construction delivering in the next year. He also says that with interest rates still at a historical low there is a lot of buying opportunity for companies seeking to own industrial assets.

• Adam Marshall, a senior managing director with Newmark Grubb Knight Frank and an AIRE board member.