The industrial asset class has been on fire for the last three years across the nation, and specifically in the Chicago market. But is the market in danger of oversupply?
According to a report from Transwestern, new construction could indeed dampen industrial’s record gains. More than 7.3 million square feet of new constructions has been completed year to date, 65 percent of which is still vacant and available for lease. More than three-quarters of the nearly 10 million square feet of industrial/flex building development now in the pipeline is expected to deliver vacant.
The employment rate is down, but so is population
The Chicago metro unemployment rate decreased significantly this year from 5.3 percent in February to 3.3 percent in May 2018. While Chicago added 17,655 jobs in May alone, there were less than 100 job net additions to the metro area in a quarter-over-quarter comparison.
Year over year, however, construction jobs increased by 2.3 percent and manufacturing employment was up by 1.3 percent in the Chicago area. Much of this follows national trends as full employment, robust corporate earnings growth and soaring bank profits in the first half of 2018 set the stage for U.S. economic expansion to continue through the end of the year.
Healthy household formation and tax reform provided a significant boost to many businesses and individuals, fueling second quarter consumption and strong business sentiment. Though tightening labor conditions may impair business growth in some markets, the Transwestern research indicates that this likely won’t be the case in Chicago.
Vacancy is historically low, but absorption slows
Total net absorption slowed this quarter with 729,658 square feet absorbed in the overall Chicagoland market, compared to a whopping 3.8 million square feet in the first quarter. Deal lag, more than shrinking demand, is the main impetus for this slowdown.
For example, demand in the Central DuPage/Kane submarket continues to be strong with top deal signings of Glanbia and Dart in North Aurora this quarter, with each expected to move into over 400,000 square feet. This market tracks negative 289,527 square feet in absorption currently. Regardless, absorption should stay positive through the rest of 2018, though the 12.4 million square feet absorbed in 2017 is likely unattainable.
In yet another historic low for the area, overall vacancy declined in the Chicago industrial market quarter-over-quarter from 5.7 percent to 5.6 percent. Vacancy should continue to decline for the remainder of the year with a high demand in the market for distribution and warehousing. Transwestern expects this decline in vacancy to taper off with the 10 million square feet of space under construction.
More new construction could hold rental rates steady
Landlords are expected to stay true to asking face rents in 2018 as negotiations with tenants are tense. An influx of new inventory will hit the market in the next two years, giving Chicago tenants more efficient inventory to choose from. That said, asking rents probably won’t shift down next year, but are likely to plateau.
As new construction delivers a variety of high class amenities and technology that has never been seen in this market, renters will have their pick of Class A space. The average clear height has shifted up from 30-foot to 36- or even 50-foot, and more high-tech docks, lighting and air quality controls are becoming the norm.
Though industrial supply is expected to outpace demand by 2019, landlords will justify high rents with newer buildings and amenities. Transwestern’s investment outlook calls for Chicago industrial to remain stable and starting to taper off in 2019. A slowdown in industrial sales is expected in the Chicago industrial sector, but compared to the sales volume of other major industrial markets, the Chicago area has enjoyed a very good run.
Deals are still happening as volume is available
Buyers and developers alike continue to be attracted to the proven long-term cycle strength of Chicago’s industrial sector. Industrial investment reached $1.6 billion in the first half of 2018—$300 million higher in volume than the first half of 2017.
Private buyers accounted for 51 percent of industrial sales to date this year, with institutional investors taking on 33 percent of sales. Many of these transactions were in the I-55 Corridor, such as the 858,653-square-foot building at 2600 W. Haven Road in Joliet. Fortress Investment Group bought this Class A distribution building for $65.4 million ($76 per square foot) from Supervalu, which is expected to remain the tenant in the building.
Transwestern projects that industrial sales will begin to decline in Chicago by the end of the year. With a dearth of Class A industrial product on the market for sale, large institutional players may look to well-located Class B assets. However, yields on these properties are not meeting their yield requirements and may be pricing them out of the market. Long term, the glut of new industrial space about to enter the market—and a potential decrease in tenant demand—may push investors interested in adding industrial product to their portfolio out to secondary markets.