Real Estate recovery shows shift from “Flight to Quality” to “Flight to Value” in Frederick’s commercial industrial market.
The U.S. seems to be continuing a slow and messy climb out of this dreadful recession. At least the experts seem to agree that what we are experiencing is in fact an economic recovery, even if it doesn’t always feel that way. It’s more of a two steps forward, one step back dance.
The performance of the industrial real estate market uncannily mirrors Gross Domestic Product (GDP) growth (or lack thereof), primarily because demand for it is so closely tied to activity in the manufacturing and retail sectors of the U.S. economy. Right now, that’s a good thing.
Costar Group, the nation’s leading provider of commercial real estate trends and intelligence, reported that 1st quarter results for the industrial segment continued a trend of sustained, but marginal, improvement during the past year. (Just like the U.S. GDP). Overall, U.S. industrial vacancies are down and rents are beginning to climb, especially in markets experiencing job growth.
Economists at Costar expect this trend will continue for several reasons:
- Corporate profits are still at all-time highs, and the economy is on target to add two million jobs this year.
- Manufacturing output has increased significantly. American manufacturing businesses have learned to get a lot more done with a lot fewer people, so manufacturing jobs are not expected to recover to pre-recession levels any time soon (if ever). But that’s okay, because output is what drives demand for industrial real estate space, not jobs.
- There is virtually no new-build industrial real estate in the pipeline. What little is being built is build-to-suit, so it won’t impact vacancy rates. (Interesting to note that Amazon alone is responsible for 22% of new industrial construction during the past quarter: they are building millions of square feet of warehouse space all over the U.S. for their distribution channels.)
- The U.S. still has the cheapest energy costs because of our gas glut, and our currency is undervalued which is good for exports.
One interesting side note of Costar’s presentation (unrelated to real estate): natural resources job growth is very strong, and if the U.S. finally starts drilling for oil, energy could be our next dot.com boom.
The Frederick industrial market is enjoying proximity to Washington D.C., which is the 15th highest in the nation in terms of employment growth and retail sales (both of which drive demand for small bay warehouse space). Warehouse and flex space vacancies declined in Frederick during the past quarter, and rents are beginning to climb slightly again.
St. John Properties has been the biggest player in Frederick industrial real estate this year, representing nearly 40% of all industrial lease transactions (in terms of square footage) for 2012 so far. The firm is also the largest developer of flex industrial real estate products in the state of Maryland.
Matt Holbrook, regional partner of St. John Properties, isn’t feeling as optimistic as CoStar about the remainder of 2012.
“There was lots of energy and momentum in January, February, and March. Everything pointed in the right direction. Now in May, large macroeconomic factors are giving people pause,” said Holbrook. “Between the stock market, the Euro, the election, and the fiscal cliffs our state and federal governments are facing—not to mention that Maryland is ever increasing taxes—it’s hard to tell whether the industrial real estate market will enter a sustained recovery.”
Holbrook did note some positive trends in Frederick’s industrial market. “Usually in a down market, you hear people talking about ‘flight to quality’ because tenants will leverage declining rents to get better space for the same money. But instead what we are seeing now is a ‘flight to value’—businesses are seeking lower rents in better locations. People see value in our flex products for office build outs, so we are snagging tenants who would normally lease traditional office space. And part of that “flight to value” is a migration of Montgomery County businesses to Frederick. Taxes and rents are cheaper here, and Frederick is so convenient to the I270 corridor. We expect to continue to enjoy that for a while.”
Holbrook continued, “I think this is the new normal. We are seeing a big reset in spending patterns. The lines for $5 coffees at Starbucks are shorter, and the lines for expensive Class A office space are shorter.”
As noted in the MacRo Report Blog’s Commercial Office Market Update of May 10, 2012, it was noted that certain sectors of Frederick’s office users have been attracted away from the traditional office building setting to the more economical flex market, which averages at least $2.00 to $3.00 per square foot less in annual lease rates.
As we have covered in previous posts, the overbuilding of commercial, industrial and residential product that took place in the early to mid 2000’s will take some time to flush out. There is no question that there is increased activity throughout the Land and Commercial Real Estate market here in Frederick County, Maryland and around the nation … the “Flight to Value” that Matt Holbrook referenced is actually a good sign that the real estate recovery is progressing ahead … albeit a slow and fragile one.
Rocky Mackintosh, President, MacRo, Ltd., a Land and Commercial Real Estate firm based in Frederick, Maryland. He is an appointed member of the Frederick County Charter Board. He also writes forTheTentacle.com.