Hey buddy, can you spare 10,000 square feet?

By SCOTT CARTER
Pacific Real Estate Partners

The South Puget Sound industrial market has become the land of the giants. Over the last three or four years, the size and scale of buildings has increased. A few years ago, a 250,000-400,000-square-foot building was extremely uncommon; now it has become typical.

With the exception of the 2.1 million-square-foot Northwest Corporate Park built by the Benaroyas in the late 1970s and The Boeing Co.s facilities, large building projects were a rare occurrence. This was particularly true from the early to late 1980s to the early 1990s when buildings were designed to cater to tenants in the smaller size range of under 50,000 square feet.

In addition, leases of 100,000 square feet or more were few and far between; now they are nearly as common as a traffic jam.

The Puget Sound region was not known to be a major distribution hub compared with such places as Nevada, California and the Mid-West, markets where its not uncommon to find buildings of one million square feet. But the Puget Sound region is coming into its own.

Several factors influence the type of buildings that are being designed and built these days:

Rising land costs and construction costs have forced developers to consider the economies of scale in building larger buildings and achieving better coverage to maximize rentable area on more expensive land.

Constrained capital in the early 1990s helped to stabilize market construction, raise rents and underwrite real income streams with more realistic rent projections and investor friendly leases.

Material handling systems have evolved to allow distribution companies to rack higher and take advantage of cubic space, and philosophical changes have occurred leading facilities planners to locate large distribution centers near population centers, with outlying areas serviced from these hubs.

The most significant influence has been what I call the retailing of the Puget Sound area.

Over the last five to seven years, there has been an explosion of retail in the Puget Sound area, driven by population growth. This growth has created demand for more distribution space in the Puget Sound area which has been the driver of many of the large leases that have occurred over the last few years.

Many of the most significant leases have occurred with third-party public warehousing entities which provide goods to retail stores that you and I buy from. Many retailers and manufacturers use these distribution systems and third parties to get their products to the retailers without setting up their own warehouses or holding onto inventory.

What is the little guy to do? For the reasons already stated, it is difficult to build small buildings any longer. There has been a significant squeeze of smaller tenants in the marketplace as they have seen a sharp rise in rents over the last two years. The tenant looking for 10,000-15,000 square feet will likely have to move quickly for the prime spaces as tenants queue up to capture any opportunity.

Although we have not actually seen bidding wars just yet, the lack of new inventory of 25,000 square feet or less will continue to haunt tenants looking for smaller spaces into the new millennium. The selection is going to be relatively small and tenants are going to get little to no concessions from landlords and little more than new or cleaned carpets and new paint on the walls for existing office space.

In addition, tenants will need to make commitments quickly since many spaces do not stay on the market long. Even large corporations with great credit will miss opportunities because of bureaucratic processes or by trying to drive a hard bargain in lease negotiations. Tenants need to assess what is more important, securing a space for the business or satisfying their ego.

In contrast, larger spaces will continue to be price competitive as there continues to be balance in the marketplace between demand and construction. Available opportunities for land are shrinking ever further. With nearly four million square feet of new construction during 1998 and another three million proposed for 1999 in the South Puget Sound area, the number of large space opportunities should drop below 10 by the end of the year.

Our firm created the PREP Laws Index to track these larger units of space and monitor the mean rental rate in the marketplace. As of Jan. 11, the index indicated that 16 buildings are available of 100,000 square feet or greater, down from 21 in October of 1998. I expect this number to continue to shrink. As new product comes online towards the latter part of the year, I expect the total number of spaces to rise slightly, but stabilize in the low teens. I think this is our future. The land of the giant box.

I would like to highlight one other trend I see: positioning. With the growth of catalog sales and the explosion of e-commerce, we will see positioning in the marketplace by delivery systems such as Federal Express and UPS. Like retailers, these companies will pay for specific locations in order to access their customer base.

This is why we have seen in the city of Pacific UPS pay $5.50 a square foot for nearly 12 acres, a piece of property that two years ago was considered to be fringe. Late in 1997 in Issaquah, Federal Express paid $14 a square foot for property upon which they built a building costing nearly $100 a square foot. Thats a cost comparable to an office building.

Expect to see some anomalies in the market due to these positioning plays. They are driven by location. These players will pay to lock themselves in.

In summary, barring any unforeseen significant down turns in the economy, expect rental rates for larger distribution space to remain relatively flat and rates for smaller space to rise. Expect to see more distribution buildings as large as 500,000 square feet built over the next few years, but they are going to have to built down south.

The next node of significant development will be in north Sumner. Construction of a new interchange at state Route 167 and 24th Street East, will open up nearly 500 acres of zoned industrial land which will become the new land of plenty. This North Pierce County location will become the extension of the Kent Valley. Itll be the land of the giants. I feel sorry for the small guy.

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