Statistically speaking, the Mid Counties and Orange County industrial markets remained tight in Q4.
Vacancy remains at 1% and average asking lease rates rose again. Year-over-year, rents are up 30% in both markets. Leasing demand got a lift from the decline in sales demand, as would-be buyers, discouraged by higher mortgage rates decided to continue leasing. Orange County got a nice bump in net absorption due the delivery and occupancy of the Goodman Logistics Center in Fullerton. Mid Counties absorption turned negative, as there were no new deliveries that would allow for growth in a market that is 99% occupied.
Seemingly, these metrics would be good news to landlords, but they reflect decision making under economic conditions that have since deteriorated. Inflation and higher borrowing costs have thrown a wet blanket on new requirements since the middle of last year. Sale requirements have fallen sharply and even with such low vacancy, buildings are taking longer to lease. The bidding wars have evaporated and it is now common for buildings to sit for months without significant activity. This is likely to result in higher vacancy and softening lease rates looking forward. With that in mind, the savviest landlords are working harder to get the first offer they receive across the finish line, as they see things getting worse before they get better.
Those sellers who were hoping to get peak pricing have been disappointed, and that has resulted in a proliferation of price reductions on offerings in both regions. Buyers are paying twice as much to service mortgage debt than they would have just a year ago, and they are looking to offset the higher cost of capital by paying less for property. It remains to be seen just how flexible sellers will be heading into 2023, but pricing pressure is definitely to the downside.
Of note is the fact that the yield on the 10-year Treasury Bond, the benchmark used for setting commercial property mortgage rates, pulled back in recent weeks. If that trend holds, we could see mortgage rates at least level off, even with the Fed’s indication that it will continue raising the Fed Funds Rate to whip stubborn inflation.
From altitude it appears that both markets are in position to handle a recession that many predict will arrive this year. Neither market is overbuilt or over-leveraged as has been the case in previous downturns. Lease and sale activity could fall much further than current levels and vacancy would still be low by historical standards. Though property values and lease rates may suffer declines in the short term, they are still roughly double what they were in 2008 when the market last corrected. So, property owners are still sitting on equity they never dreamed could be possible even though the market peak is in the rear view mirror.