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February 25, 2016

Institutional owners move in on local market

  • Ownership goals of industrial projects have changed from short-term to long-term, thanks to the institutions.
    • By PATRICK GEMMA
    DCT Industrial

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    Gemma

    Of the 26 years I’ve been in commercial real estate, 15 have been focused solely on the Puget Sound industrial market. During this time I’ve seen Seattle mature into one of the most desired industrial markets in the United States. The result of our city’s growth is a change in owner composition.

    In the early 2000s, ownership was a mixture of private parties and institutional entities (real estate investment trusts like DCT Industrial, pension fund advisors and sovereign wealth funds). Fast forward to 2016, the overwhelming majority of industrial owners are institutional. Additionally, more than 90 percent of the purchasers and developers of industrial investment properties are either institutions or funded by institutional partners.

    What does this ownership structure mean for the Seattle industrial market? It means industrial developers are making more disciplined new project decisions.

    In past Puget Sound cycles, private developers completed most industrial developments. The motivation of these private developments was short-term profits: The goal was to lease and sell the projects as soon as possible after completion of construction. The thought was that more development would lead to more profit. The problem becomes evident at the end of cycles, when absorption slows to a crawl and large industrial buildings are left vacant, sometimes for long periods of time.

    In contrast, the motivation behind institutional industrial development is a long-term benefit to the market. Institutional owners value long-term income streams that grow over time.

    One of the best ways to ensure a continuous, growing income stream is to make sure supply and demand stay in check. Institutional owners are first and foremost concerned with supply matching demand. They constantly monitor the market to make sure there is enough demand to support the current development pipeline. These institutional owners are also in the market for the long-term; which makes deciding not to build a comfortable decision.

    Institutional owners are also conservative because of their internal structure. Institutions answer to Wall Street (REITs), internal boards (sovereign wealth funds) and fiduciary relationships (pension fund advisors). These parties value steadily growing returns over time. These returns are accomplished by making smart decisions.

    This institutional conservatism with a focus on long-term objectives is prevalent in the Seattle market. While demand fundamentals do play a role in the Seattle industrial market’s current success, the growth of discipline in the market has led to the best landlord market I’ve seen in 15 years, and probably ever.

    Since 2012, 24 buildings containing 6 million square feet have been completed in the Kent Valley, which is the largest industrial submarket in the Pacific Northwest. As of January, 5.35 million square feet of this space, or approximately 89 percent, has been leased and active negotiations continue. Remaining vacancy is primarily small portions of larger buildings, with the biggest vacancy being only 135,000 square feet.

    These statistics are strong evidence of a market that is in balance.

    During the first quarter of 2016, another eight buildings containing 2.4 million square feet will be delivered. As of January, approximately 1 million square feet, or 42 percent, of this space has been pre-leased. This level of pre-leasing is unprecedented in the Seattle industrial market and speaks to the lack of larger Class A options available.

    In past cycles, this kind of success would kick off a flurry of speculative developments. When the market was at its peak, some new developments were built with disregard to competition in the pipeline. Today only seven additional buildings totaling 1.9 million square feet are slated to start construction in 2016.

    In short, the new breed of decision makers is showing restraint. As a result, overall vacancies are at historically low levels and it’s becoming common to see tenants competing for new Class A space. More importantly, we’re witnessing the strongest rent growth the Puget Sound has ever seen.

    Seattle’s industrial market has matured into a shining star on the national stage. With recent strong demand continuing into the new year and supply being restrained by institutional decision makers, it looks as though the health of the market will stay strong through 2016 and beyond.

    As senior vice president for DCT, Patrick Gemma oversees development and capital deployment in the Seattle market, Gemma has over 26 years of real estate experience.





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