Projected rents are more than adequate in many markets to justify additional development of warehouses and distribution centers according to a new report from CBRE. And Chicago is positioned as a top market for this activity.
CBRE looked at various markets and analyzed the gap between pro forma rents—the rental rates that developers can reasonably expect to obtain on newly built warehouses—and breakeven rents—the rents they’d need to recoup in order to cover overall development costs. In the 10 major markets that CBRE examined, the former exceeded the latter by 20 to 40 percent.
Chicago led all markets for rent spread for new construction (pro forma versus breakeven) at 43 percent. Atlanta (38 percent), Phoenix (35 percent), Pennsylvania’s I-78/I-81 corridor (30 percent) and Los Angeles (27 percent) rounded out the top five.
“Chicago continues to see a huge demand for distribution space, particularly along proven logistics corridors,” said Whit Heitman, senior vice president with CBRE. “With the number of tenants active in the market, demand is still not being met by the current construction pipeline.”
These spreads also confirm that the current market for industrial and logistics real estate has room to grow. Typically, a sign of waning momentum for a market comes when spreads between pro forma and breakeven rents narrow or vanish.
“This huge gap implies that if demand slows and the market cools a bit, there’s still a lot of cushion there,” said David Egan, CBRE global head of industrial and logistics research. “This means that the development market is quite healthy, underwriting remains conservative, projects under development should preform quite well and the incentive is there for continued development.”
According to the report, Chicago currently has 9.3 million square feet of product under construction. Though Chicago’s development remains robust, that’s well behind the activity planned for California’s Inland Empire, which has 19.6 million square feet in the pipeline, as well as Atlanta (19.4 msf) and Dallas/Ft. Worth (18.7 msf).
While climbing construction costs are giving developers pause on some projects in other asset types, they haven’t constricted new warehouse development. Strong demand and limited supply of modern logistics facilities continue to create need in the marketplace.
The CBRE report looked at the average new construction cost breakdown for a 500,000-square-foot warehouse in the various markets. They broke down the cost components to the price for the land, hard costs—physical construction, land preparation, labor, materials, etc.—and soft costs—architectural, engineering, legal, permit and other fees.
The report concluded that the quickly rising land cost component of the development process can represent more than half of a project’s total price tag. While this is true for land-constrained markets like Los Angeles and the Inland Empire, in Chicago hard costs still make up the bulk of a project’s total cost.