Region’s strong industrial market shows some signs of upward price pressure

The southeastern Wisconsin industrial real estate market has now experienced 16 consecutive quarters of positive absorption (absorbing 712,400 square feet of space in the first quarter) and the vacancy rate has fallen to 6.12 percent, the lowest vacancy rate in more than six years, according to the latest report from Xceligent and the Commercial Association of Realtors Wisconsin.

Some parts of the region have particularly hot industrial markets. The industrial space vacancy rate in Waukesha County has fallen from 5.57 percent a year ago to 3.54 percent in the first quarter. The vacancy rate in Kenosha County has fallen from 8.5 percent to 4.17 percent during the same period of time.

As the supply of high quality industrial space continues to dwindle, especially in prime locations, one would expect building owners to start increasing rental rates. The asking direct lease rate for industrial space in southeastern Wisconsin has increased from $5 a square foot to $5.12 a square foot over the last year, according to the Xceligent report.

The largest year-over-year increases in asking direct lease rate were in Walworth County, $5.50 per square foot in the first quarter, up from $4.33 a year ago; and in Racine County, $4.78 per square foot in the first quarter, up from $3.97 a year ago, according to Xceligent. The highest asking direct lease rate is in Waukesha County at $6 per square foot, according to the report.

“Asking” direct lease rate is, of course, not the same thing as “getting” direct lease rate, but the data provides some indication of which way the market is going.

“What you are observing is a classic law of supply and demand,” said James T. Barry III, president of Milwaukee-based commercial real estate brokerage Cassidy Turley Barry. “As demand increases and supply stays the same or decreases, prices go up. I think that is starting to happen.”

“The good quality product is starting to disappear,” said Sam Dickman Jr. president of Milwaukee-based real estate brokerage The Dickman Company. “The rates have definitely stopped going down and in some cases are increasing.”

However, some real estate brokers dispute the Xceligent data and say prices for much of the industrial market remain depressed.

“I don’t believe (data showing industrial lease rate increases) to be accurate,” said Jeff Hoffman, vice president of Pewaukee-based commercial real estate firm Judson & Associates. “I don’t see it, as somebody on the street doing deals.”

The class B and C markets for industrial real estate remain deflationary, Hoffman said. He defines class A industrial space as having 24-foot high ceilings, large bays and not older than 15 years old; class B space has 18- to 22-foot foot ceilings and is 20 to 25 years old; class C buildings have 18-foot or shorter ceilings and are more than 30 years old.

“Class B and C space is still under extreme price pressure,” Hoffman said. “Supply has dwindled, but there is not robust user demand yet.”

Most of the statistical increase in asking direct lease rates is a result of higher lease rates for new buildings that have been brought to the market, said Brett Garceau, vice president of Milwaukee-based NAI MLG Commercial.

“It’s the new construction projects that are seeing a premium,” he said. “Rates (for existing buildings) have been steady for a very long period of time.”

“I would caution (that the rise in industrial space lease rates) has been a very gradual process from the depths of the recession,” Barry said. “Unlike previous cycles that have had a quicker recovery, this cycle’s recovery has been a very slow and gradual process. It’s incredible that prices on lease rates and sales per square foot have not seen more dramatic increases over the last two years.”

Some tenants continue to hold off on plans to move and appear to believe that they will still be able to get good deals on lease rates, Barry said.

“There’s a mindset that deals are still out there,” he said. “But what’s happened is those deals are much fewer and far between.”

Barry predicts that some tenants will get to a point where they need additional space and then will have trouble finding it and will have to pay a premium for the space they need.

“I don’t think it’s going to be dramatic but on a case-by-case basis I think we’re going to see that start to happen,” he said.

Tenants that need more space increasingly seem to be opting for new development, but they tend to be build-to-suit projects or owner occupied projects rather than speculative developments, Hoffman said. Other than in the Kenosha area there is not enough demand for speculative developments and tenants are not displaying a willingness to pay higher lease rates for spec buildings, he said.

“User demand (in the region) is alright. It’s just not robust,” Hoffman said. “You may see one (spec development) here or there, but it’s going to be tough to do.”

Recently several industrial developments have been built, or are under construction, in Kenosha County and Racine County, but in other parts of the region plans for new buildings have been announced but in most cases construction has yet to begin, Garceau said.

Kenosha County has seen a mix of speculative industrial developments and projects built with tenants in place. Major industrial developments currently under construction in the county include the 1.1 million-square-foot distribution center for Amazon.com in Kenosha and Meijer Inc.’s 220,000-square-foot expansion of the former Supervalu distribution center in Pleasant Prairie.

In Racine County a 425,000-square-foot distribution center was built recently in Sturtevant for United Natural Foods. The facility is expected to be operational in June. The completion of the facility was the largest single industrial space absorption in the region during the first quarter, according to the latest Xceligent report.

Industrial developments planned in other parts of the region include several speculative buildings planned in Pewaukee by Interstate Partners LLC and by 2000 Development Corp., General Capital Group’s plans to build a pair of 52,500-square-foot multi-tenant industrial buildings at Century City in Milwaukee and Malvern, Pa.-based Liberty Property Trust’s plans to build a 172,000-square-foot speculative industrial building in Oak Creek. But it is unclear when any of those projects will break ground.

“We’re hearing of more and more (proposed spec industrial real estate developments), but there still is a gap between the announcements of new product and when they are getting shovels in the ground,” Garceau said. “I think (these developers are) trying to find an anchor tenant before they kick off their projects.”

In an example of a project that does have a tenant, Interstate Partners and Milwaukee-based Zilber Property Group are building a78,000-square-foot industrial building in the city of Pewaukee for Federal Manufacturing Co., which will move there from Milwaukee’s Walker’s Point neighborhood.

Industrial space lease rates vary by county, based on the condition of the market in those communities. Waukesha County has the lowest industrial space vacancy rate and not surprisingly the highest asking direct lease rate at $6 per square foot, according to the Xceligent report.

“Each geographic area is different,” Garceau said.

First quarter industrial real estate market performance by county:

  • Waukesha: 3.54 percent (down from 5.57 percent a year ago), 131,151 square feet of absorption
  • Kenosha: 4.17 percent (down from 8.5 percent), 77,597 square feet of absorption
  • Walworth: 4.26 percent (down from 5.34 percent), 0 square feet
  • Sheboygan: 5.07 percent (up from 4.35 percent), 0 square feet
  • Ozaukee: 8.57 percent (down from 10.04 percent), 0 square feet
  • Milwaukee: 9.23 percent vacancy (down from 10.09 percent a year ago), negative absorption of 36,637 square feet

But despite the low vacancy rate in Waukesha County, the industrial real estate market there could be shook up when American TV & Appliance, which is going out of business, places a pair of distribution centers in Pewaukee, totaling 287,000 square feet of space, on the market.

“Any smart developer would wait to see what is going to happen with that space before building spec in Waukesha County,” Hoffman said. He predicts that the addition of the American buildings to the market will result in negative industrial space absorption in Waukesha County during the second quarter.

But even with the addition of the American buildings to the market, there will still only be about four available industrial buildings in Waukesha County with more than 100,000 square feet of space, Barry said.

Spec industrial development has been much stronger in other Midwest markets, and development activity in the metro Milwaukee area could be poised to take off, Barry said.

“This is a very gradual process,” he said. “I do think we’re probably going to see the market continue to strengthen. It takes a while for spec building to get going.”

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