Industrial Vacancy Rates Expected To Decline

A sizable portion of industrial leases are due to expire this year, but tenants may be losing some longheld advantages when they renegotiate deals with landlords.

About 29 percent of tenants in flex buildings will see their leases end in 2011 and nearly 18 percent of warehouse tenants face lease renewals this year, according to CoStar.

As the recession and its after-effect took a toll on South Florida in 2009 and 2010, ample vacant space in industrial buildings allowed tenants to negotiate lower rents by threatening to relocate.

But space availability in warehouses and other types of industrial buildings may shrink. Domestic economic recovery and robust international trade are combining to fatten the flow of goods to and through South Florida, putting downward pressure on industrial vacancy rates.

Even so, in certain submarkets, large tenants with expiring leases still can negotiate so-called “blend and extend” lease renewals with substantially lower rents, a blend of pre-recession and post-recession pricing. “Landlords will still do a blend-and-extend type scenario, but at least for our portfolio, it’s not as prevalent as it was a year or two ago,” said Dan Heisler, executive vice president of Adler Realty Services, the brokerage arm of industrial real estate firm Adler Group.

As usual, size is important. Market conditions still favor tenants with 50,000 square feet to 100,000 square feet or more in Airport West, the bustling cluster of warehouses and distribution centers just west of Miami International Airport, South Florida’s largest industrial real estate submarket.

Still available are “Airport West blend-and-extend [deals] if you’re a larger tenant and you’re willing to commit for a longer term and allow the landlord to make that money back over time,” said Brian Smith, executive director of industrial brokerage at the Miami office of Cushman and Wakefield. “Those are still somewhat alive. They are still happening. But not very prevalent. Tenants with less than 25,000 square feet may bring dwindling leverage to lease renewal talks with their landlords. For the smallest tenants in the newest industrial parks, “the blend-and-extend deals and just a straight reduction of rent — those have started to fade away,” Smith said.

Landlords have become more resistant to relocation threats by smaller tenants because “you probably will have a good chance of re-leasing the space pretty quickly, compared to a year ago, when you were looking at a long down time,” Smith said

High industrial vacancy rates probably will persist for a while in certain pockets of South Florida’s industrial real estate market, concentrated in Miami-Dade County. For example, in the city of Medley, just north of Miami International Airport, “there are still very good deals to be had,” Smith said. “As you move farther north, the blend-and-extends are going to be a little more popular just because the vacancy level in Medley and the rest of the North Dade market is still pretty high.”

Ryan Nee, associate in the Fort Lauderdale office of commercial real estate brokerage Marcus & Millichap, said foreclosures have limited the rents that industrial building owners can charge. He said investors who buy industrial buildings at foreclosure auctions often can afford to charge lower rents than the previous owners. “You have landlords getting into properties at a much lower cost basis and a much lower debt level than the people who bought from 2004 to 2008, so they can offer a much lower rental rate,” Nee said.

Though the economy has been recovering from recession, the foreclosure trend “continues to drag down rental rates” because “the leasing market is a function of who has the lowest lease rate.” Nee said that foreclosures are most common among owners of Class B and Class C properties and that they still negotiate blend-and-extend deals, typically reducing rents by 20 percent to 30 percent over terms from one year to three years to retain tenants.

Marcus & Millichap reports that the gross annual cost of leasing one square foot of industrial space in South Florida currently ranges from $9 to $12 for Class A buildings down to $6 to $8 for Class B and Class C buildings. “In Class A, I don’t think we’re going to see any of them [in foreclosure] because a lot of that debt was modified,” Nee said, “but in the B and C properties, I think we’re in the beginning stages.”

But landlords generally have stabilized rents and occupancy rates at Class A industrial buildings in prime locations. “They don’t have a tremendous amount of choices for people who want to be near major highways or an airport,” Nee said.

Indianapolis-based Duke Realty, a leading industrial building owner in Broward and Palm Beach counties, has seen an up-tick in the number of tenants seeking more space. Duke claims to be the largest owner of premium-priced industrial buildings in Broward, with 3.7 million square feet there, and among the largest in Palm Beach County, with 1.2 million square feet. “We’re hearing a word that we hadn’t heard for a while, and that’s ‘expansion,’ ” said Ed Mitchell, Duke Realty’s senior vice president in charge of South Florida operations.

By Duke Realty’s estimate, industrial vacancy rates in Miami-Dade, Broward and Palm Beach counties”are all under 10 percent again. Specific submarkets are even tighter than that. They go down to 5 and 4 percent. One bullish trend Mitchell has identified is a realization among many industrial tenants that their prerecession space no longer matched their post-recession need for more: When the economy started sliding into recession in 2007, many companies that had leased too much industrial space “overcompensated” by signing contracts to lease too little for too long. “They panicked in 2007, when everybody panicked,” he said. “Now, in 2011, they’re finding that they’re out of space, and they can see a rosier future.”

Like other leasing agents who handle industrial properties, Wayne Schuchts, a senior vice president of Flagler Real Estate Services in Miami, said the pace of his firm’s leasing activity went from languishing to lively last summer: “Business since last July has been very good.” As a result, Schuchts said, industrial tenants and landlords now have comparable leverage in lease renewal negotiations. In the early stages of the recovery from recession, he said, there was “a big swing” in negotiating leverage toward tenants of Class A buildings. “A year from now, you could make the case that it returns back to the landlords.”

Source: DBR