Episode #2 - Market Update
The Industrial Advisors discuss the Puget Sound industrial market as of the end of the third quarter of 2019, give us their thoughts on trends, and forecast the direction for the near future.
Bill Condon: Welcome to, this is Bill Condon and Matt McGregor, to another podcast that we're going to do. We're going to kick things off by talking about the overall markets and dive deep into the different segments throughout the Kent Valley.
Matt McGregor: Yeah, hello everyone. You can catch our podcasts on Apple Podcasts or Google Podcasts. industrialadvisors.com is our website and we're excited to talk about the market. So let's just kick it off. So Bill, in general, how do you feel about our market?
Bill Condon: Yeah, it's been another, I think, really good year. It seems like each year we say that and the market continues to do great things-
Matt McGregor: For sure.
Bill Condon: Both from a rental growth standpoint, from a demand standpoint, and certainly continues to be a lot of capital out there chasing deals.
Matt McGregor: Absolutely. Let's talk a little bit about, I think the hot topic in our market is development and construction. Everybody seems to be chasing it, everybody wants land. Good luck finding it. But let's talk about the numbers, and then get into a little bit of commentary about where we think the demand is going to be driven from.
Matt McGregor: So total numbers on construction delivered in the last 24 months is 9.6 million, and then we've got about 4.2 million under construction. But I think the theme here is what's available, what is still about 6.3 million, and that's a lot of product. The net absorption being about three million feet a year. So how are you feeling about the overall amount of product available?
Bill Condon: Yeah, it is a lot of product, and what's interesting is a lot of that product is south, right?
Matt McGregor: That's right.
Bill Condon: We start looking at Lacey and DuPont and Frederickson and we're starting to see spec in those markets. And it seems like that happened almost overnight. Right?
Matt McGregor: True.
Bill Condon: All of a sudden those markets are markets that developers are comfortable building spec in, and we'll see how it plays out. I mean, I certainly think that Tacoma North, I would build spec all day long in those markets. I think Lacey, DuPont and Frederickson, we're going to find out how those are going to perform on a spec basis.
Matt McGregor: That's a great point. Because honestly speaking, I don't think we really included those areas say in Lacey, DuPont, and Frederickson in our market, what we would have said 12 months ago. I mean, that's how quickly this has changed. Right?
Bill Condon: Right.
Matt McGregor: I feel like the flood gates all of a sudden opened up and everybody, including ourselves says, "Okay, this is now the south end of our market." Where we would have all said Lakewood-
Bill Condon: Yeah.
Matt McGregor: Was the cutoff.
Bill Condon: Right.
Matt McGregor: And as I said, we put Best Buy in Frederickson. Right? Prior to Best Buy, I think somebody could have put $10,000 on the table and asked me to drive to Frederickson and I would have failed. Right?
Bill Condon: Yeah, yeah.
Matt McGregor: Right?
Bill Condon: Yeah. What about you?
Matt McGregor: I might still, yeah. [crosstalk 00:02:24]
Bill Condon: But you're not alone.
Matt McGregor: You know, it's interesting because it kind of reminds me of Sumner back in 2004-
Bill Condon: Yeah.
Matt McGregor: Two thousand five, I mean that was pioneering at the time.
Bill Condon: That's right.
Matt McGregor: and [crosstalk 00:02:35] now you have, yeah, exactly. Penn Tony did a great job. Right?
Bill Condon: Yep.
Matt McGregor: And then others followed. And I mean, you look at where deals were getting done at, at that time, right? And now you look at Sumner their rents have doubled in that time period. Right. But you're seeing more and more developers getting comfortable pushing South. Part of that is just, that's where that lands is that's left, right?
Bill Condon: That's right. That's where it is. But the interesting thing is, okay we've seen some, you know, not build a suit but you know market deals going down there and to development. It was that because there wasn't product available. Cause what we're seeing now with the Sumner golf course come back online. You've see the Tarragon green water site coming online. I think the Milton project with bridge development's going to come online and then Weyerhaeuser's site, right? It to name a few other ones are coming online. How do you think it's going to compete now that the Valley can deliver large projects again?
Matt McGregor: Yeah. I think that that's a really good point that you make. There are projects that next year or 2020 in some there are going to be delivered and in my opinion, the majority of tenants would still pay more and be in Sumner and prefer to be in Sumner, then they would save, you know, $0.05-$0.08 a square foot whatever it may be. Maybe it's $0.04 And go to, to Frederickson or Lacey or DuPont. So I think the Sumner projects will fill up quicker and that the ones further South will probably set a little bit longer. Now bigger is better as you go further South.
Matt McGregor: Right. In Sumner, you know, the perfect building in my opinion, would be, you know, 400,000 square feet with a little bit of trailer storage. [crosstalk 00:03:54].
Bill Condon: [inaudible 00:03:55]
Matt McGregor: Yeah. I mean that's all day long. Right? And so what's attractive to those users in those South end markets is they can go find a million footer and then go lease that big of a space. Now what do you think about the tenant activity once you get above, you know, 600,000 square feet, how do you feel about, would you build a spec building that's 800,000 feet and Lacy or DuPont or Frederickson?
Bill Condon: As long as nobody else was. Right,
Matt McGregor: Right.
Bill Condon: So as long as I was the the show, I think I would. And so that's the interesting thing is can you customize your building to be that one, you know provider maybe two, right. You start seeing three, four projects down there that are looking similar and I would get very, very nervous. I think the question going back, so the answer to that is I would build it if I felt like I was one or two options of a unique building. So 800,000 foot cross loaded, perfect shape building, no strangeness to it, trailer parking, you know, not too far off the main corridors. I would build that. The question is some of these deals that went down there, you know Kimberly Clark for example, Best Buy it and we know the answer to that or even the latest one with home Depot. Would those gone to the Valley if say the product in Sumner was available, would they pay the difference? Would they have
Matt McGregor: Right.
Bill Condon: What do you think?
Matt McGregor: I think they would, I [crosstalk 00:05:06] think, I think most, I think most tenants would pay up and be in Sumner compared to going down South.
Bill Condon: Yeah. Then it will be interesting as as we start to now see these projects come online that are competing size-wise mm-hmm (affirmative) because the pricing discrepancy is 15 cents on the shell, plus probably what, $0.07-$0.08 on nets difference.
Matt McGregor: Yeah.
Bill Condon: So it's a big difference because at the same note when Best Buy went down to Frederickson, they did have options in the Valley.
Matt McGregor: Right.
Bill Condon: And chose that based on the labor logistic studies and combination of real estate costs.
Matt McGregor: Sure, sure. Yeah. [crosstalk 00:05:36] A lot of it too depends on who the, who are the customers, who are they serving, right. If it's a local play, obviously location, you know, being close in is more important. Whereas if they're, you know, serving a couple of surrounding States, being further South doesn't matter that much. Right.
Bill Condon: That's right.
Matt McGregor: So, so a lot of it depends on that, but on that topic of the South end markets, maybe you could talk a little bit further about Frederickson and I know you dove into that pretty deeply with Best Buy going down there. Maybe talk a little bit about your experience with that and how you feel about Frederickson as it relates to Lacey and DuPont.
Bill Condon: Yeah, so I would say those are interesting markets, and I get white. DuPont and Lacey were developed first cause they're right on the I-5, so if you're looking down the corridor, you're going, what's the next available city? It makes all the sense in the world when Best Buy looked at it, and when I look at it today, Frederickson offers some unique things, from a labor perspective, when you do the studies, it looks very favorable. That market is also a lot bigger than, than most people think it is. It's 5 million feet where Lacey and DuPont together, this was pre home Depot was about 7 million feet compared to 5 million feet in Frederickson. So Frederickson individually was larger than either of those markets individually, but smaller collectively when we looked at it with Best Buy after I found it. Right.
Matt McGregor: Yeah, right.
Bill Condon: That took [crosstalk 00:06:47].
Matt McGregor: You did the pre-drive.
Bill Condon: a little bit. Yeah, that's right.
Matt McGregor: Secret pre-drive.
Bill Condon: It was interesting from a logistics study, because going down I-5 you got six lanes leaving Tacoma, going south and everybody's on it, right? We know it's a grind. If there's a wreck, you're done, right. There's no alternative options. So your labor sitting there tallying up by the hour. Frederickson, although no road is as perfect as I-5. You have three exits that you can take off 512 and I think there was a total of 14 lanes over the three exit. So if one's bad, you have alternative and overall you got a whole of a lot less people driving to Frederickson on those Canyon road or steel, then you do going down I-5 right,
Matt McGregor: Sure.
Bill Condon: Heading to Portland. So the volume is less and then you put that in with the labor studies and the cost of the real estate. That was a pretty good deal. Right? Those combinations made it a no brainer. So do I like it more than DuPont and Lacy? Look, I like DuPont and Lacy, but I would say if you're a tenant you take a very hard look at Frederickson if you're looking at those other markets.
Bill Condon: Sure, sure. Well and, and just, you know, to make it clear for our clients to know. Matt is the expert in our partnership on, on Lacy, DuPont and Frederickson, and then I have everything from Seattle to Tacoma. So just want to make that clear.
Matt McGregor: And speaking of those areas that net absorption, you know, get this, if you look back, take out the last 36 months and you look back over 10 years, Sumner was where most of the absorption happened, about 42% over 10 years of the entire market is absorption had hit Sumner. Now you look at the last 36 months, almost 70% of the total market absorption of new product has happened between Tacoma, Frederickson, DuPont and Lacey, with Lacey really jumping out there at 26% of the market's absorption over the last 36 months. So pretty amazing numbers with a shift down South. But to your point earlier, bill, where you know, Sumner was that pioneering market. Clearly we have shifted, right? That pioneering market is now down South and the numbers don't lie here.
Bill Condon: Yeah, absolutely. I mean Tacoma's 30% of that Fife is about 15 and Sumner is still at 15%. I think a big reason why is obviously that's where the big tenants have gone because of that's where the lanes are,
Matt McGregor: Availability.
Bill Condon: Right?
Matt McGregor: Yeah, for sure.
Bill Condon: But certainly it shows that there is great tenant demand. Those tenants will go South if they need to.
Matt McGregor: No question about it. And you know, we touched on this a little bit, but let's talk about rent growth and where we see it was so much product going on in the South of the Valley. Will we see good rent growth with so much competition coming online and where is the rent growth coming from? We've had three straight years of double digit rent growth in our North market. How high can we go? Are we going to see another double digit? What should people be forecasting? What do you think?
Bill Condon: I think we have room and I think, you know, from a location standpoint, are you seeing South Seattle push rents, you know, $1.25 $1.30 right.
Matt McGregor: Yep.
Bill Condon: I believe that North Valley has tremendous upside for rent growth. You can be in South Seattle and pay a $1.25-$1.30 or you can go down to the North Valley and pay $0.70-$0.75. So I think that that gap is too big. You can get more functional product in the North Valley. You're only eight miles, call it South of South Seattle if you're in rent in Tukwila in North Kent. So I think that the North Valley has the most upside for continued growth and we're seeing [crosstalk 00:09:56] that, I mean we're seeing rental rates. I mean I was out with a tenant yesterday, we got a renewal on 60,000 feet and the good building, the first renewal was at $0.76 on the shell. Right.
Matt McGregor: Yep.
Bill Condon: And so that's where tenants are going to have to pay if they want to stay North Valley.
Matt McGregor: That's right. [inaudible 00:10:10] I couldn't agree more. And we've seen, we've done deals, you know, at 85 on the shelf and in that region. And so you've seen the biggest rent growth in that Tukwila, Renton, North Kent area. And I agree. I think that's where you're going to continue to see big numbers. The interesting thing is, and we've started to see this on a couple of leases, is will people project in leases greater than 3%.
Bill Condon: mm-hmm (affirmative).
Matt McGregor: right? As a asking tenants, we're now starting to see the first phase of that and proposals. I won't name any landlords, but there's a big one that we've seen that on and really it makes sense because if we're talking about double digit rent growth for the last few years, most people would say we're at least going to be 7%, 8%, 9% in the next year or two. So why are these as fixed at 3%? So a lot of landlords are now challenging that and you're seeing it in proposals for the first time. How do you think tenants are going to react to that?
Bill Condon: Well, I think it's you named, you know, a couple of big landlords that do it and it will become the norm. It was like.
Matt McGregor: [crosstalk 00:11:04] That's right.
Bill Condon: When you know office rents, right? They've gone from $0.65 to a $1.10 right? In a span of 10 years. Right? So the fact that increases have stayed at 3%,3%,3% for so long. I think that's going to change and it should change depending on location. Right. Tacoma, North, I feel like you can push that and you should and tenants will get comfortable with it because it'll become the new norm.
Matt McGregor: Right. Agreed. And where do you see the challenges in rent growth? And we're going to be flat or even sell, you know, even dropping.
Bill Condon: Yeah, it'll be interesting to see. I think the markets to watch will be those really South end markets. Right. As we mentioned earlier, there's new product coming online in Sumner, I think that will perform extremely well. So I think Fife, Tacoma, Sumner Valley, all those rental markets will continue to go up. The Lacy, DuPont's Frederickson's of the world, I think will increase, but not at the rate that those other markets will.
Matt McGregor: Yeah, I would agree with that. And then what about challenges? Like what are we seeing out the, what do you think about the Kent moratorium?
Bill Condon: Yeah, I think that's, I mean there's not a lot of land left in Kent, right? So I think that will continue to push rents in that market because you aren't going to be able to build more product there. I do think that, you know, the South Seattle market is a bit slow from, and I know Amazon just lease the triple Decker, but there's not a ton of activity in that market from a tenant standpoint. I, I'm hoping and optimistic that'll increase, but I think that that is a challenge that there's just, there's not a ton of tenant activity in that South Seattle market soft. Yeah.
Matt McGregor: Yeah, I agree with that moratorium. I think that'll continue what we were saying earlier about pushing rates in the North end because you just don't have new product coming on competing, right? So you're just going to continue to see rate push because people can't develop, I mean, what is the moratorium is like one door per 40,000 feet, so you pretty much can't build. Right?
Bill Condon: Right.
Matt McGregor: So with that, mostly if you're a newer asset, you're going to be that newer asset for some time until they figure that out. And so you should be able to drive very, very high rates.
Bill Condon: I agree with that.
Matt McGregor: So with that, Bill, I think, you know overall I would say the market is pretty hot. Still vacancies ticked up, but that's just because we finally were able to get a supply, right. It took a lot of years to entitle some of this land and now the developers finally caught up, but we haven't even reached 5% overall. So I would deem it as a very, very healthy market. Getting close back to some equilibrium between tenants having options and landlords still being able to push a little bit of rent but a very healthy market.
Bill Condon: I would agree with that. I think we've had another really good year. I feel like the market has momentum heading into next year and I'm optimistic that we're in a really good position to have another great year from a market standpoint heading into 2020. So appreciate everybody listening and hopefully you found this interesting. We will continue these podcasts here in the future and so be on the lookout for our next podcast. But thank you for, for listening to us and we'll look forward to talking to you guys soon.
Matt McGregor: Thanks a lot.