Is the Market Absorbing New Industrial Construction?

The industrial market in San Diego rebounded in the second quarter, following slow leasing activity at the start of the year. According to recent research from Cushman & Wakefield, the market has 632,000 square feet of positive net absorption in the second quarter, making it the strongest quarter leasing activity in the last three years. As a result, occupancy gains in the first half of the year topped the first half of both 2017 and 2016. Most of the occupancy gains were driven by new construction deliveries, however, industrial vacancy rates for the quarter inched up nominally 10 basis points to 4.9%.

“While distribution users absorbed the most square footage in the second quarter of 2018, manufacturing tenants are the most active in the market,” Bryce Aberg, executive director at Cushman & Wakefield, tells GlobeSt.com. “Over twenty percent of the tenants currently looking for space have a manufacturing requirement. Last Mile-related business increased their demand for Retail Trade and Warehousing/Transportation space as a result of increased consumer demand for faster delivery of online goods.”

The new supply helped satisfy pent-up demand. As typical for the market, defense and technology users were the most active during the quarter. “Contributing to the majority of the total square footage absorbed in the second quarter of 2018, distribution space continues to attract the greatest number of users,” Ryan Spradling, director at Cushman & Wakefield, tells GlobeSt.com. “These occupiers come from a variety of sectors including defense, technology, and construction. During the second quarter, key companies either taking occupancy or signing leases in the distribution segment included Stone Brewing, which took 273,000 square feet, Veritiv, taking 212,000 square feet, Northrop Grumman, at 114,150 square feet, BAE Systems, at 86,254 square feet, and NEOTech Manufacturing, taking 80,257 square feet.” In addition, there were also significant leases signed by non-distribution tenants, including General Atomics, which signed a 303,000 square-foot lease; HM Electronics, taking 140,000 square feet; and D&K Engineering, which took 66,448 square feet.

While the new construction drove significant leasing activity, the majority of it was pre-leased prior to completion—meaning many of the leases had been signed in advance. “Year to date there has been 1.2 million square feet of industrial product delivered and over 70% of that space was pre-leased—which is an impressive number.  There is currently approximately 2.6 million square feet under construction, with 27% of that being pre-leased as well,” says Aberg. “The demand for larger blocks of new class-A functional space has been driving the absorption and we see that trend continuing into the future.”

The leasing activity in the second quarter illustrates the strong demand for industrial product. The poor leasing activity in earlier quarters is a reflection of the limited supply. “A lack of inventory has been the greatest contributor to the continued rise in rental rates. Coming out of the recession, diminishing supply did little to impact asking rates until San Diego’s direct vacancy dropped below 6%,” says Spradling. “Since that occurred in late 2014, rental rates have been rising ever since, now at a historically high level of $1.06 per square foot per month triple net. Incubator multi-tenant has a 50% jump in asking rates, from $0.80 in 2013 to $1.20 year-to-date. Surprisingly, manufacturing rents have been the slowest to rebound, but still grew at an impressive 25% over the same period. R&D and Distribution grew 35% and 32%, respectively.”