Market Report_Q1 2023 Industrial

As of the close of Q1 2023, total industrial vacancy in the Sacramento region stood at 4.3%. This is up from the 4.0% rate recorded at the close of 2022 and marks the fourth consecutive quarter that vacancy levels have increased after setting the region’s record low of 3.4% exactly one year ago. This still reflects an incredibly tight market—the ten-year average for vacancy in the region is 7.3%. In fact, the greatest challenge that the Sacramento market has faced over the last two years has simply been a shortage of available industrial product.

Industrial warehouse and distribution space, which accounts for 79% of the region’s 163 million square foot (MSF) inventory, experienced a slight uptick in vacancy from 3.5% to 3.6% while accounting for 579,000 square feet (SF) of positive net absorption (occupancy growth). The region’s 19.0 MSF industrial flex market experienced modest negative net absorption to the tune of -75,000 SF as local vacancy for that asset type increased from 6.5% to 6.9%. Meanwhile, Sacramento’s 15.1 MSF manufacturing market remained flat with vacancy holding steady at just 2.0%.

Vacancy up as new deliveries outpace positive net absorption

This most recent uptick in vacancies is primarily due to new construction. Just under 1.1 MSF of new industrial distribution space was delivered to market in Q1. Buzz Oates added two additional buildings (339,000 and 239,000 SF) to Metro Air Park in the Natomas/Northgate submarket while Christy Enterprises added a new 92,000 SF multitenant warehouse building in that same trade area at 3755 Pell Circle. The West Sacramento submarket accounted for the remainder of new projects delivered over the first three months of 2023; LBA Logistics added 155,000 SF and 136,000 SF distribution buildings at 3765 and 3783 Channel Drive. Meanwhile, Invesco delivered a new 148,000 SF multitenant warehouse building at 3095 Mary Place, while Dermody Properties added an additional 99,000 SF building to their LogistiCenter at West Sacramento project.

This wave of new construction will only intensify over the course of 2023; there is just under 2.5 MSF of additional new construction in the development pipeline with deliveries slated through early next year. Most of this new product will be coming online over the next six months. Metro Air Park continues to be one of the focal points for new industrial development—there is 1.4 MSF of product under construction currently in the Natomas/Northgate submarket. Meanwhile, the Roseville/Rocklin, Sunrise and West Sacramento trade areas also have projects in the works.

Is the industrial party over?

This uptick in new development is occurring at a time of heightened economic uncertainty and slowing industrial demand nationally. For example, Amazon--which had nationally accounted for nearly 130 MSF of industrial net absorption from 2020 through midyear 2022--has largely paused activity. Meanwhile, industrial sublease availability nationally has gone up nationally by 50%. Fear of a looming recession, consumer spending coming back to earth, inflation and rising interest rates have all combined to drive some firms to put the brakes on expansion and to control costs via supply chain optimization and consolidation.

The sublease trend has played out in Sacramento as elsewhere; of the 10.5 MSF of space available today, 923,000 SF of it (8.8%) is sublease. This amount has tripled over the past year. But it is important to note that it still accounts for just 0.6% of the entire market’s inventory. It is also worth noting that it is likely that many tenants putting this space on the market might not be too eager to vacate and sublet, hedging their bets if economic signals suddenly improve and the Federal Reserve manages to engineer a soft landing for the economy.

Is the industrial party over?

Meanwhile, net absorption both nationally and locally has been coming back to earth. From 2005 through 2015, the U.S. market averaged net absorption of 165 MSF annually. From 2016 through 2020, that total climbed to 255 MSF. In 2021 the market recorded 516 MSF of positive net absorption. Last year, it posted 401 MSF of net absorption.

The Sacramento market averaged 1.2 MSF of net absorption annually from 2005 through 2015. From 2016 through 2020, it averaged 2.5 MSF. Locally, we recorded a whopping 7.5 MSF of net absorption in 2021 and an additional 2.5 MSF of positive gains last year. This number came in at 504,000 SF during the first quarter of the year, which—assuming the same pace through the remainder of 2023—would place us in the 2.0 MSF range for growth. But we also think it a fair assumption that given the region’s shortage of available supply in recent years, that most of the new speculative construction in the pipeline will move briskly even if overall demand levels are coming back to earth. Clearly big picture economic fundamentals will determine this, but even with headwinds, we anticipate what would—by any historical measure—be another strong year for industrial growth ahead.

There is one factor, however, where we do see growth in greater question and that is rents. The current average asking rent for industrial space in the region is $0.80 per square foot (PSF) on a monthly triple net basis. While inflationary pressures and rising construction costs have been part of the mix over the past 18 months, this trend has been playing out locally for much longer. The average asking rent for industrial space in the Sacramento region has doubled over the past decade (it stood at $0.40 PSF in Q1 2013). This metric is up 11.1% over the past twelve months. We anticipate rent growth to slow over the next year from recent levels that simply are not sustainable in the long run. Slightly slower demand, rising vacancy rates and a steady pipeline of new product will help to move the market a little closer to equilibrium, though conditions will still considerably favor landlords in the near-term.

Is the industrial market slowing? Yes, but it remains the strongest of all commercial real estate sectors in terms of demand. The market may be downshifting, but it is going from white hot to hot.

INDUSTRIAL MARKET STATISTICS: Criteria based on: 10,000 SF and above, includes owner occupied, does not include flex buildings

Sacramento Regional Totals