Speculative development is on the rise, but competition is heating up

In the Cleveland industrial market, the vacancy rate in the third quarter was 3.9 percent, which historically is the lowest it’s ever been. That’s driving demand for newer, more functional structures, particularly high-bay bulk distribution warehouses, as the economic pendulum continues to swing towards a service-oriented rather than production-oriented market.

Though speculative properties in Cleveland tend to be constructed by homegrown developers, competition in larger markets such as New York and Chicago means Cleveland is getting some attention from national developers.

“We’re getting calls each week from developers that want land for spec buildings,” says George J. Pofok, CCIM, SIOR, senior vice president at Cushman & Wakefield/CRESCO Real Estate. “Out-of-state developers definitely are taking interest in the Northeast Ohio market.”

It’s difficult now to find large tracts of available land in Cuyahoga County, so interest is picking up in tertiary markets such as Summit and Medina counties. That means opportunities abound for developers capable of striking while the iron is hot.

Smart Business spoke with Pofok about speculative development in Cleveland and the surrounding markets.

What is happening to the real estate market as building on spec increases?
Tenants are seeing an increase in occupancy costs. In the past, a tenant could do short term one- to three-year flat deals. But the market has shifted and landlords are getting five- to seven-year deals with 2 percent annual increases.

Costs are also increasing for buyers. A company that recently purchased a property in Parma set a high benchmark for value per square foot, and the building the company left and put on the market came under contract after just three showings.

That’s not to say all buildings sell quickly. It’s really about connecting the right buyer to the right property at the right time.

What effect does an increase in spec-built properties have on lessees?
With the vacancy rate so low, tenants could benefit from a couple million square feet of spec construction because there’s still such a demand for more modern facilities. Developers are building more distribution or light assembly structures.

These buildings range from 125,000 to 250,000 square feet, have 28- to 32-foot ceilings, truck docks in the rear and nominal office space. Companies are often able to take advantage of the cube height, thus reducing their footprint, which helps offset the higher rents for new construction.

Who should capitalize on this trend?
Developers that are aggressive, have cash and can react quickly should act now to take advantage of the current market. There is an element of, ‘if you build it, they will come’ in the market right now. Companies that are aggressive and can move quickly should see a lot of success in this market.

It’s really about getting a shovel in the ground as quickly as possible. Once a property is purchased, developers need to be out there, breaking ground within days or weeks. Developers that have bought land and expect to wait until next spring will be six months behind the curve.

While expediency is important, so is due diligence. Developers also need to complete zoning and environmental work, and have site layout discussions with the municipality. Developers that have experience with that will do well.

There is demand in the market from tenants, and there is investor money looking for deals and a return. Both are relying on developers to initiate the process.

What are the risks?
Timing and location are as critical as building the right product. It doesn’t yet make sense to go out to an extreme tertiary market and put up a 500,000-square-foot spec building. The focus still is in the primary and secondary markets.

There is significant opportunity in the market now. But looking into 2019, though the economy seems to be moving along at a good pace, there is less certainty.

The Cleveland market can easily absorb another couple million square feet of spec properties without a significant impact on the market vacancy rate. But that requires developers to be aggressive, find the right piece of dirt and get to building.

Insights Real Estate is brought to you by Cushman & Wakefield/CRESCO Real Estate