A tenant’s market
- September 28, 2009
Within a few years of opening its Isle of Wight County distribution center in 2001, Cost Plus World Market doubled its space. It needed more than a million square feet to meet consumer demand for home furnishings, gourmet foods, house wares and decorative items. Then the economy spiraled downward, leaving the international retailer with smaller inventories and several hundred thousand square feet of empty space.
Cost Plus is trying to capitalize on that space, even if it means storing another company’s goods. The company wants to sublease up to 240,000 square feet at its Shirley T. Holland Commerce Park facility. Cost Plus is open to short-term leases and offers to subdivide the space. “It brings in immediate cash flow to Cost Plus,” says Stephanie Sanker of S.L. Nusbaum Realty Inc., who is handling the lease. “They’re able to stay where they are. They’re just trying to be proactive.”
Responding to market change is the key to survival these days for warehouse space. The vacancy rate for manufacturing, flex and warehouse facilities across the country rose to nearly 10 percent during the second quarter in response to declines in consumer spending, employment and production. Consequently, many retail outlets have been forced to downsize and combine distribution centers, creating more vacancies.
Overall, rates in Virginia haven’t climbed as high as other areas, thanks largely to the Port of Virginia. In fact in Hampton Roads — home to much of the state’s warehouse inventory — the area’s 7.2 percent industrial vacancy rate by the end of the second quarter was among the lowest on the East Coast. Rates are higher in Northern Virginia, where industrial vacancy reached 9.5 percent, and in Richmond, 9.4 percent.
Still, Virginia warehouse owners and brokers are working hard to attract tenants. They’re cutting rates from 5 to 25 percent and offering periods of free rent. “We do what we have to do in this environment to make a deal,” says Craig Pope, vice president and city manager for Liberty Property Trust in Virginia Beach. Hampton Roads rents generally run $5 a square foot for a triple net lease (where renters pay a proportionate share of taxes and operating expenses), while Northern Virginia rates range between $7.50 and $10 per square foot.
While landlords typically prefer three- to five-year leases, many are accepting drastically reduced terms. “The mindset is get them in, agree to a six-month deal and hope they’ll stay,” says Scott Keeton, a broker in the Richmond office of Jones Lang LaSalle. “It’s definitely a tenant market.”
Landlords also are spending more to draw business. Along with paying higher commissions to brokers and additional advertising, many warehouse owners are touting high-density sprinkler systems, extra lighting and additional loading dock equipment. The extras are not lost on potential tenants who are playing the situation to their advantage. “Tenants are coming with both hands out,” says Caulley Deringer, senior vice president with Transwestern’s Northern Virginia office in Tysons Corner. In addition to free rent and lower rental rates, “They want the landlord to build out the space and complete it to the tenant’s specifications.”
Such enticements can work. “You don’t necessarily create activity by doing that, but you position yourself as the best opportunity to close the deal,” says Deringer. He notes that most Northern Virginia vacancies are due to companies downsizing or moving to other areas. Defense contractors like Northrop Grumman and Lockheed Martin have consolidated their space, while others move on when a government contract ends.
Port a magnet for distribution centers
Although the Port of Virginia recorded a 25 percent drop in business for its most recent fiscal year (due to global falloffs in revenue and container volumes), the region continues to attract companies looking to set up shop near an East Coast port. U.S. Auto Parts, a California-based automotive parts distributor, recently agreed to lease 115,000 square feet of warehouse space in Chesapeake for its East Coast distribution center. Proximity to the port, an attractive rental rate and an available work force led U.S. Auto Parts to Hampton Roads, says Rick Ellis, vice president of supply chain management. “Several buildings and several different landlords in the Norfolk area fit our needs. It was a very competitive atmosphere.”
Other factors in Hampton Roads’ favor? The region has not overbuilt commercial facilities, and its military/industrial companies create additional demand for warehouse space. “Even though we’re down, we’re still seeing activity,” says Worth Remick, a vice president of CB Richard Ellis in Norfolk, who handled the U.S. Auto Parts lease.
The port was a major factor in CenterPoint Properties’ quest to build a 900-acre, $325 million logistics center and intermodal park off Route 58 in Suffolk. The Chicago-based developer expects to begin construction early next year. As further proof of its interest in Hampton Roads, CenterPoint is one of three companies that have submitted bids to oversee operations at the Port of Virginia.
SAFCO, Cost Plus’ neighbor in Isle of Wight County, also moved to the area because of the port. The office products company opened a 302,000-square-foot East Coast distribution center in December. Although the recession forced it to close its Minnesota distribution center, SAFCO plans to introduce 200 new products this year and hopes to eventually expand its facility in Holland Commerce Park. “We’ve watched our spending and labor and weathered the storm,” says Scott Bauer, regional distribution manager.
Meanwhile, Denver-based ProLogis, the world’s largest owner and developer of distribution facilities, halted all new development projects last fall as the recession took hold. The company had purchased 132 acres in Suffolk’s Northgate Commerce Park earlier in the year. “The Northgate project was affected by this company-wide decision,” says Mark Levy, vice president and marketing officer for ProLogis.
The company now looks for development projects with a lower risk level and less capital-intensive investment structure. “We will have a focus on precommitted development and will engage in more development-for-fee business,” says Levy. The new approach will be tested at Northgate as ProLogis seeks potential tenants.
While there are signs that the economy is stabilizing, one insider doesn’t look for a rebound in industrial activity for at least another six months. Alan Pontius, first vice president and regional manager for Marcus and Millichap in San Francisco, an investment real estate brokerage, notes a number of challenges. “You have heavily weakened consumer demand, an unemployment rate that’s high and potentially growing, job losses and foreclosure activities,” he says.
As the economy improves, landlords expect to scale back on selling incentives. In the meantime, Warren Hammer, a project manager with the Virginia Economic Development Partnership, stresses that vacancies can be an asset in attracting new businesses, many of whom are under time constraints. “Sometimes it’s just simply a need for a company to move quickly, so to be able to market Virginia, we need available space. … The combination of the Port of Virginia and our location in the mid-Atlantic is a great bull’s eye for people to consider.”