SMALL DEALS DRIVE GROWTH
Industrial vacancy in the Sacramento region fell from 6.3% to 6.0% in Q2 2024 with the market recording just under 576,000 square feet (SF) of positive net absorption. Vacancy fell in ten of the region’s 16 distinct submarkets, with occupancy gains spread across multiple geographies. Those occupancy gains came from a mix of smaller to medium size space users; we know of only a couple of deals above the 100,000 SF threshold so far this year which reflects a significant shift from where the market was just a couple of years ago when the region experienced an explosion of demand from larger (200,000 SF and up) eCommerce distribution, logistics and distribution center users.
5,000,000
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1,000,000 2,000,000
Sacramento Industrial Market
Source:GallelliRealEstate;CostarGroup
Sacramento Industrial Market: Supply/Demand/Vacancy
One telling statistic: in 2020, the average industrial deal size in the Sacramento region was 38,000 SF. Through the first six months of 2024, the average industrial deal size is just under 13,000 SF. Yet despite this, the market turned in its strongest occupancy growth in a year, reversing a three-quarter trend of negative net absorption that returned a combined -313,000 SF of space to market. As recently as 2021, eCommerce distribution users accounted for 213 million square feet (MSF) of industrial leasing activity across the United States, or 39.9% of all industrial net absorption. But as eCommerce supply chains have increasingly built out, it was only a matter of time before this trend came back to earth. For eCommerce players, the mega requirements of 2020 and 2021 that regularly drove distribution centers deals of 300,000 SF or more have been replaced by smaller ones—often infill hubs for same or next day delivery. But the trend is not completely over.
After a record growth spurt in 2020/2021 that saw the eCommerce behemoth lease, purchase, or buy land to develop roughly 100 MSF of industrial space, Amazon hit the brakes on new deals over the next couple of years. They are active once more, however, and recently acquired 84 acres in Rancho Cordova for a price of $23.6 million in May. According to media reports, they plan to build a 600,000 SF regional distribution center there that will be valued at $85 million. The site is within the Rio Del Oro master plan approved for industrial use two years ago by the local city council after reviewing plans proposed on Amazon’s behalf by Panattoni Development.
Amazon project aside, after years of outsized demand, rental rate growth and new development, Sacramento’s industrial market is reverting to more historically normalized trends.
SUBMARKET REVIEW
The West Sacramento submarket led all other trade areas in terms of growth in Q2. It recorded just under 194,000 SF of positive net absorption as its vacancy rate declined from 8.0% to 7.2%. Notable deals include Waxie’s Enterprises lease of 72,000 SF at 2421 – 2481 Del Monte Street and Redstone Print & Mail’s lease of 60,000 SF at 8200 Riverside Parkway. There is currently just one project under construction in West Sacramento; Reyes Holdings’ 190,000 SF speculative development at 2975 Ramco Drive in the Southport Logistics Center that should deliver in Q3.
In Q2, the usually quiet Northeast submarket recorded its strongest occupancy growth figures since 2010. It posted positive net absorption of 92,000 SF as vacancy fell from 6.1% to 4.6%. Leases from ARB Digital (28,000 SF at 161 Commerce Circle), Budget Truck Rental (31,000 SF at 2097 – 2101 Evergreen Street) and a 35,000 SF undisclosed user at the Railroad Drive Industrial Park helped to fuel the strongest growth this tertiary submarket has experienced in 15 years.
The McClellan submarket saw its vacancy rate drop from 4.2% to 3.7% thanks to 85,000 SF of positive net absorption fueled by leases from Big Duty (23,000 SF at McClellan Park). Additional significant deals included leases for two Buzz Oates buildings under construction that will be delivered in Q3. The Lion Electrical Company took 40,000 SF at 4450 Raley Boulevard), while an undisclosed user will take 26,000 SF at Buzz Oates’ 1645 Bell Avenue upon its completion. There are only three buildings under construction currently in the McClellan submarket and all of them area accounted for including an 82,000 SF structure that has already been leased to Lund Equipment that should be completed in Q1 2025.
Sacramento Industrial Market: Median Price
Source:GallelliRealEstate;CostarGroup
The Power Inn submarket currently has a vacancy rate of 3.4%, down from last quarter’s reading of 3.7%. Power Inn recorded 84,000 SF of positive net absorption in Q2. Significant deals include eSolutions Furniture’s lease of 90,000 sf of space at the Elsie Industrial Park.
Other submarkets that ended Q2 in growth territory include the Downtown submarket, (37,000 SF), Mather (82,000 SF), and South Sacramento (79,000 SF). The East Sacramento (0 SF), Richards Boulevard (0 SF), and Natomas/Northgate (19,000 SF) trade areas all either experienced flat or near-flat occupancy growth. In the Natomas/Northgate submarket, just under 19,000 SF of positive net absorption in Q2 as vacancy there ticked downward from 11.8% to 11.7% in what was an unusually quiet quarter. Since 2020, this has been one of the focal points of growth in the region with developers adding just under 7.9 MSF of new product. But that development wave is finally ebbing. One year ago, there was 2.1 MSF of new space in the construction pipeline—all of which was speculative in nature. Currently there is just one 525,000 SF distribution center under construction which will be occupied by Target upon its completion in Q1 2025.
At the other end of the spectrum, there were no Sacramento submarkets that experienced occupancy declines of 100,000 SF or more. In the Roseville/Rocklin trade area, -80,000 SF of space was returned to market as vacancy crept up from 3.0% to 3.5%. This uptick was entirely attributable to two sublease spaces that hit the market, Homewood Building Supply’s 28,000 SF availability and a 58,000 SF vacancy at 8860 Industrial Avenue. Given the tight availability of this trade area and the fact that there is no new industrial product under construction, we think these vacancies will be short-lived.
Meanwhile, the Auburn/Newcastle (-31,000), Davis/Woodland (-42,000 SF), and Folsom/El Dorado Hills (-38,000 SF) submarkets all experienced
modest occupancy declines. In each case, upticks in vacancy were minimal and driven by small space givebacks. For example, the largest block of space to come online in the Davis/Woodland submarket in Q2 was a 16,000 SF availability at 1107-1111 Gibson Road in Woodland that drove this trade area’s vacancy rate up to a still tight 1.7%. There is just one building under construction in this submarket; Buzz Oates’ 108,000 SF advanced manufacturing and life science building at 3808 Faraday Avenue in Davis.
DEVELOPMENT PIPELINE CONTINUES TO MODULATE
At the height of the pandemic in 2020, nearly 4.1 MSF of new product came online. In 2021, the industrial inventory increased by another 4.1 MSF. That dropped slightly to 4.0 MSF in 2022 and last year developers added 3.8 MSF of new space to the Sacramento market. Since 2020, the local industrial inventory has grown by a whopping 10.0% in the largest wave of new development in the region since has been the late 1990s/ early 2000s. The big difference is that vacancy levels were in their teens when that wave of building slowed, while the current 6.0% vacancy rate is much closer to the classic market definition of equilibrium. Market equilibrium is when there is enough available product in the marketplace to accommodate expansion from tenants (and economic growth), but not so much as to prevent sustainable rental rate growth in line with overall inflation.
There are currently 17 projects under construction across the Sacramento region totaling just over 1.5 MSF of new industrial space. While this number has stayed the same over the past three months, it is the lowest level of new development in the pipeline since 2019. The Natomas/Northgate submarket leads the way with Target’s 525,000 Sacramento Industrial Market
SF distribution center slated for Q1 2025 delivery. In the Folsom/El Dorado Hills submarket. PacTrust’s Gateway El Dorado Park has two new advanced manufacturing buildings under construction that will add 148,000 SF of new speculative inventory upon their completion in September, while a 148,000 SF warehouse build-to-suit is under construction at 4490 Golden Foothill Parkway with a slated delivery of January 2025. Likewise, all the 150,000 SF of space under construction in the McClellan submarket is already leased. In fact, of the 1.5 MSF of space that will be delivered over the next nine months, less than half (639,000 SF) is available for lease.
No other local submarket recorded occupancy growth more than 100,000 SF, though we are still tracking a substantial number of existing tenant requirements in the region and our brokers report that touring activity is solid, albeit not at the breakneck pace of a couple of years ago. But there has been a noticeable shift in tenant requirements. From 2019 through 2022, space users in need of 100,000 SF of space or more proliferated the landscape and helped to drive the outsized leasing activity and occupancy growth of those years. Active space requirements in the region remain plentiful from smaller to mid-size users, but we are seeing far fewer tenants actively seeking space above the 50,000 SF level, much less the 100,000 SF deals that were driving local activity for much of the past five years.
Local developers have been responding to the decrease in demand from large space users. Elevated interest rates, project costs and labor shortages have also been significant factors in the development pullback. Sacramento appears to be ahead of the curve on this trend—it is possible that the amount of new product under construction by the end of this year will drop below the one million SF level for the first time since 2018.
According to the Costar Group, since the pandemic the US has averaged 302 MSF square feet of industrial deliveries per year. There is 349 MSF of space in the development pipeline now, with less than half of that pre-leased. Costar forecasts that the current national industrial vacancy rate of 6.6% may reach the 7.0% threshold before the end of the year. However, once this wave of new deliveries hits, the development pipeline drops off. We could potentially be looking at a 10-year low in national industrial development by midyear 2025.
For the Sacramento marketplace, however, we see some opportunities ahead for developers. New construction in recent years has heavily focused on larger bulk warehouse users while there has been only limited development of product geared towards small and midsize space users. The local vacancy rate for buildings that are 20,000 SF or smaller is just 3.0%. with an average age of 37 years old.
RENT TRENDS
The current average asking rent for industrial space in the Sacramento region is $0.84 per square foot (PSF), on a monthly, triple net basis. This
metric is up just 1.2% from where it stood a year ago ($0.83 PSF), but up 13.5% from the $0.74 PSF rate of two years ago.
Though the market has experienced a general trend of rising vacancy since 2022, that shift has been one towards equilibrium between supply and demand. As recently as Q1 2022 when local vacancy hit an alltime low of just 3.7%, landlords held all the cards. Tenant bargaining power has improved since then, but the pendulum has not fully shifted to favor space users. It has simply become more balanced. Keep in mind that the average asking rate for industrial space at the end of 2019 was $0.69 PSF. In the pandemic era, rents have skyrocketed 27% since the pandemic (Q1 2020). They have more than doubled (the average asking rate was just $0.40 PSF in Q2 2014). No doubt that much of this has been driven by the naturally higher costs inherent in new development, particularly the elevated costs of building modern eCommerce fulfillment, distribution, or cold storage facilities.
While this quarter’s positive performance is a good sign for local market participants that have been growing increasingly concerned about potential overbuilding in this latest development wave, we anticipate a mixed performance through the end of the year with rents staying at or near current levels. We’re not sure that there is room for rent growth until the economy is in a more robust growth cycle, which we think is still likely not to happen before 2025 at the earliest.
LOOKING AHEAD
June inflation numbers are widely forecast to continue a three-month trend of near flat inflation. Meanwhile, the June 2024 jobs report from the Bureau of Labor Statistics (BLS) reflected a cooling job market— which bodes well for the Federal Reserve to remain on track for at least one, if not two, interest rate cuts by the end of the year. The consensus view of most real estate economists is that this will not just trigger a rebound in investment activity but that it will also bode well for leasing fundamentals.
In other words, most economists believe that commercial real estate across all property types will get a bounce once interest rate cuts start to happen. The big question for Sacramento’s industrial landlords is what happens in the meantime? Despite this quarter’s positive industrial performance, the economy is showing some signs of a modest slowdown. Commercial real estate occupancy growth is a lagging indicator of the economy—not a forward looking one like the Consumer Confidence Index, the Purchasing Managers Index, initial jobless claims, durable goods orders, or the yield curve.
Assuming the Sacramento industrial market can maintain Q2’s momentum heading into the final half of 2024, against a backdrop of rapidly decreasing development levels, we could be looking at vacancy rates in the mid 5.0% range by the end of the year. But that might be a tall order.
Select Sacramento Region Industrial Leases Past Six Months
