Industrial real estate fundamentals improved during the fourth quarter at roughly the same pace as the prior three months. Demand for industrial space, while not robust, has been healthy most of the year.

Fourth quarter data from Reis Inc. indicates that occupied stock for the overall industrial market increased by 28.7 million sq. ft., slightly less than the 30.0 million sq. ft. absorbed last quarter, but still the second-highest amount since the recovery began. The warehouse & distribution subsector was the main driver of improvements in fundamentals as demand slackened a bit in the flex and R&D subsector.

Fourth quarter metro figures demonstrate a continued broad based recovery in the overall industrial market; between 40 and 44 out of a total 47 metros covered by Reis exhibited positive absorption and increases in occupancy and effective rent.

Warehouse and distribution

Occupied space for warehouse and distribution centers increased by 25.7 million sq. ft., the largest quarterly figure recorded since the recovery began. This was on par with demand for space exhibited in the third quarter. The vacancy rate shed 30 basis points during the period, mirroring the improvement in occupancy of the past two quarters. At 12.1 percent, vacancy is now down 110 basis points year-over-year and 210 basis points from the cyclical high in 2010.

New construction totaled 9.0 million sq. ft., up 50 percent from the 6.0 million sq. ft. added last quarter. Completions were up in each successive quarter during 2012 and the pace of new construction will continue to rise in 2013.

Asking and effective rents grew 0.2 percent and 0.5 percent, respectively, in line with increases seen in the third quarter. Total asking and effective rent growth for 2012 was 1.1 percent and 1.9 percent, respectively.

Flex and research and development

Meanwhile, demand for flex space slowed in the fourth quarter. The 3.0 million-sq.-ft. increase in occupied stock was the lowest since the first quarter of 2012. Still, 14.3 million sq. ft. of net absorption in 2012 is a large improvement from the 8.7 million-sq.-ft. figure posted in 2011. While demand growth slackened, supply grew at a quickened pace. Roughly 1.3 million sq. ft. of space opened its doors in the fourth quarter compared to just 223,000 sq. ft. in the previous period.

Given slowing demand and faster supply growth, improvements in occupancy waned over the last three months of the year. The vacancy rate fell 20 basis points during the period, half of the 40 basis point decline of the previous quarter.

The combination of slowing demand and higher construction activity for flex space has resulted in minimal rent growth over the past two quarters. Both asking and effective rents grew 0.1 percent in the fourth quarter, the same rate of growth exhibited in the previous period. For the year 2012, asking and effective rents increased 0.7 percent and 1.0 percent, respectively, most of which came in the first half of the year.

The macroeconomic picture

The macroeconomy was a mixed bag for industrial space users during the last months of 2012, and not much has changed in the beginning of 2013. Industrial and trade indicators were largely lackluster in late 2012, but continued to signal expansion. Additionally, the arrival of Hurricane Sandy on the east coast in late October disrupted almost all economic activity, including manufacturing, trade and distribution.

The ISM Manufacturing Index signaled contraction in November, partially due to the hurricane’s effects, and indicated only sluggish expansion in factory activity through the end of 2012. Activity appeared to pick up in January when the Index increased to 53.1. However, the Index tends to rise in the first month of the year so this may not be foreshadowing further increases.

The latest trade statistics are underwhelming. Rising exports had helped fuel economic growth in the years after the recession, but have stagnated for most of 2012. Fourth quarter GDP results were dented by a decline in exports that subtracted 0.81 percentage points from GDP growth. Moreover, retail spending growth is still modest at best, and payroll tax increases beginning in 2013 will only further crimp consumer spending.

All together, these data reflect an economy still plodding along at a measured pace. Restrained by similar risks to those experienced in 2012, GDP growth in 2013 is expected to be under 3%. Industrial property owners will likely contend with more of the same on the broad economic front in 2013.

Near-term outlook

In many areas, demand for large, high-quality warehouse and distribution space far outstrips available supply. Firms are focusing on newer and larger industrial space that can accommodate the large-scale, complex and technologically advanced supply chains and distribution networks of today’s companies. As a result, construction will begin to accelerate in 2013 as a lot of currently vacant buildings do not meet the needs of many firms.

One bright spot in the economy that could bolster future demand for industrial space (particularly warehouse and distribution space) is the housing sector. With the growth in housing starts accelerating, demand for construction materials and durable home goods (furniture, appliances, etc.) will increase and could bode well for owners of industrial space that can accommodate the logistics required for these types of goods.

Rent growth will increase in 2013, but not by leaps and bounds, especially as inventory growth picks up. Property owners will still face the same macroeconomic risks posed by a sluggish domestic economy contending with continued political uncertainty and uninspiring growth around the world.

Brad Doremus is Senior Analyst, and Victor Calanog is head of research and economics, for New York-based research firm Reis.