Although there are significantly less lease deals taking place, South Florida’s office market is on…
As industrial rents continue to rise in South Florida, investors are looking to buy sites and build warehouse space. The only problem is there’s very little land left.
Squeezed between the ocean and the Everglades, South Florida’s industrial developers are increasingly turning to smaller sites and footprints as they look for opportunities in a severely land-constrained market. But rising development costs, whether from high land prices or increased construction costs, has led investors to shift away from evaluating sites based on historical lease prices and instead betting on the potential for rent growth that could be spurred by a lack of supply.
“Everybody down here is really betting the trend line,” said Ryan Battistoni, chief operating officer at Timber Hill, a private equity firm specializing in logistics properties.
The lack of developable land has shifted the value proposition for industrial development, Battistoni and other developers said at Bisnow’s South Florida Industrial and Logistics Summit on Thursday, which was held at One Financial Plaza in Downtown Fort Lauderdale.
“[Tenants] have to be located on this island,” he said. “If you’re only underwriting deals based on what the comps will tell you, it’s going to be very hard to make deals. You have to bet the trend line.”
Industrial vacancy in Miami was flat at 1.6% in the first quarter, according to a report from JLL, with asking rates rising to $15.78 per SF. Pandemic-spurred construction put 8.7M SF in the development pipeline, but the large amount of space coming online is offset by a large amount of move-ins, with first quarter absorption at more than 2.2M SF.
The story is similar in Broward County, where vacancy fell to 3.7% and rents rose to $13.32 per SF in the first quarter, according to JLL’s industrial report for the region. Absorption was smaller, at nearly 179K SF, but the market only has around 1.3M SF under construction.
While there’s been a robust development pipeline in recent years, Broward and Miami-Dade counties are running out of space for large developments. The two counties together only have around 1,800 acres of developable industrial-zoned land left, Butters Construction & Development principal Malcom Butters said. That shortage, he said, is driving up sale prices.
“There’s definitely a shortage of land,” Butters said. “You have to get into this mindset that there’s no more million-dollar-an-acre sites. You have to start buying into that $1.5M, $2M, maybe $3M sites.”
The rising prices and lack of space will help keep South Florida from reaching an oversupply of industrial space despite the robust amount of construction taking place, he said.
“Developers are not necessarily the smartest or most restrained,” Butters said. “They’re like a dog, they’ll keep eating until they throw up. And while that can happen in Texas or Arizona, it can’t happen here. We don’t have enough land. We only have room for five or six more years of demand.”
That shortage of space creates a long runway for rent growth, developers said at the event, and they’re relying on those rising rents to make deals financially viable.
“You have to make very large leaps of faith about rent growth and comps,” said Richard Previdi, the founder and operating managing partner at Alliance Partners HP, a vertically integrated real estate investment firm. “You have to buy into the idea that even though your tenants are at $8 net, you’re going to be able to get them to $13, and the next owner is going to be able to get them to $17.”
While industrial leasing in South Florida has retreated from the highs of the pandemic, it’s still keeping pace with 2019 and earlier. But because there’s a shortage of developable land, developers and investors say that decreased velocity will still be enough to drive rent growth.
Lenders who expected the demand to stay at record levels, however, may face difficulties moving forward, said Mark Levy, president of BBX Logistics Properties, a speculative and build-to-suit real estate development firm.
“From 2020 to 2022, set that aside as an anomaly,” Levy said. “There are people who underwrote deals based off of that trend, and from a rent growth and demand perspective, I think they’re going to come to regret that decision.”
“We’re going to get back to a normal pace of leasing and a normal pace of market fundamentals,” he added. “And that’s OK.”
The tenant mix in South Florida has also shifted, with the new-to-market tenants that proliferated in recent years giving way to local tenants looking to expand or upgrade their space. That decreased the average tenant footprint, which has in turn incentivized developers to build smaller.
“The overarching theme in South Florida is that anything under 25K SF is going to fly off the shelf,” said Bradlee Lord, the vice president for acquisitions and leasing in Florida at Seagis Property Group.
Butters said his firm was starting to target those tenants, building suites as small as 5K SF at sites with dock-high truck loading and going as small as 2K SF in places with grade-level loading.
“We’re definitely seeing more organic growth than newcomers,” Butters said. “The days of Amazon coming and taking a lot of space are done, but we do see a lot of expansion from local companies that are growing.”
Local tenants are also looking to capitalize on the robust development pipeline by swapping antiquated warehouse space for new construction. By increasing their vertical height or consolidating locations, many tenants are able to reduce their overall footprint and decrease costs.
“With South Florida having some older buildings, you’ll see tenants that they are in one, two or three buildings that are materially obsolete, maybe they have a low clear height,” Colliers Executive Vice President of Industrial Services Erin Byers said. “If you can shrink your footprint by 20%, you’ll end up really saving overall because you’ll have the ability to scale with the clear height.”
Even with continued demand, panelists at the event said it was a challenge to identify financing for new projects. Facing high interest rates and a lack of liquidity in the financial sector, many are turning to sellers to help finance deals.
“The current market has been incredibly challenging for investment sales and we’ve had to think outside the box to get deals across the finish line,” Native Realty CEO and founder Jaime Sturgis said. “We’ve seen some seller financing and that’s really how we’ve been able to get deals closed this year.”
The downward pressure on office assets is also weighing down lending in the industrial sector, Previdi said, as banks hold on to capital to hedge against the falling value of office properties.
“Even though warehouse is great — and we believe it will stay great — as you see office buildings headed back to lenders, I think that entering the next eight months, 12 months it will be very difficult getting liquidity and getting debt,” Previdi said.
Timber Hill’s Battistoni said the relative safety of industrial assets compared to office buildings or other properties has made them an attractive investment for lenders and banks that are looking to diversify their portfolio.
He said Timber Hill has been in talks with several banks that have gone through a reallocation of their balance sheet and are now looking to get into the industrial development space.
Industrial lenders are especially interested in South Florida because of the strong tenant demand, and developers expect lending in the sector to loosen once the Federal Reserve indicates it is finished raising interest rates.
“There’s so much pent-up demand in South Florida right now that there’s dry powder that’s been sitting on the sidelines waiting for distress, waiting for opportunities,” Sturgis said. “If the Fed holds rates or the Fed pulls them down, the floodgates will open.”
While developers and investors are confident that the South Florida industrial market will continue to grow, there was wide agreement at the event that market conditions had increased the time horizon for them to see profits on new construction.
The cost to build projects continues to rise, in part because of increased land prices and stubbornly high construction costs, and developers are assuming strong rent growth in their financial models before they break ground. By factoring in rent growth to offset costs, industrial assets will need to be held for a longer amount of time to become profitable.
“It’s the long game here,” said Todd Carter, a principal covering the Southeast region for Exeter Property Group. “ If you think you’re going to get in and out, bad strategy. It’s one where you take that leap of faith, stay in, and know that over time those dynamics are going to increase value.”