Wednesday, October 26, 2022
HomeWealth ManagementDemand for Industrial Space Is Slowing Down Off Record Highs

Demand for Industrial Space Is Slowing Down Off Record Highs


As U.S., like the rest of the world, continues to grapple with stubborn inflation (at 8.2 percent in September), there are worries that consumer spending is going to falter and impact industrial owners’ ability to raise rents. Industry insiders, however, say such fears are over-stated.

At the moment, industrial real estate fundamentals remain strong and rental rates continue to rise, especially in key coastal markets, according to San Francisco-based Al Pontius, senior vice president, national director for office, industrial and healthcare, at real estate services firm Marcus & Millichap.

Pontius does cite nuances in the marketplace that might point to slowing demand for warehouse space. Such indicators include the depth of prospective tenants and change in landlords’ approach to lease up of new build-to-suit properties. For instance, in January and February of 2022, rental rates were rising so fast that landlords held off on making final deals with tenants until the date of occupancy. “Now landlords are locking in rates right away.”

Industrial tenants also are slower than they were before to make decisions, Pontius adds. As a result, absorption in secondary markets and absorption of older industrial product has slowed down.

In the third quarter, the national industrial vacancy rate rose by 10 basis points, to 4.0 percent from an all-time low of 3.9 percent, according to research from real estate services firm Savills. That change was distributed unevenly, however, with vacancy in Houston and the Pennsylvania I-81/78 Corridor falling by more than 350 basis points and vacancy in Detroit going up by 30 basis points. Year-over-year national rent growth reached 12.5 percent, which is considered a modest increase compared to rent growth of 40 percent in some markets in recent times. Industrial leasing activity fell below 200 million sq. ft. for the first time in eight quarters, Savills researchers report.

Leasing activity has decelerated over the past several quarters, in part due to constricted supply, agrees Matthew Dolly, leader of national industrial research with real estate services firm Transwestern. As a result, U.S. overall net absorption is at its lowest level in two years, and the national vacancy rate has ticked up slightly in the third quarter, to 3.9 percent, according to Transwestern research. Meanwhile, some warehouse owners are intensifying property marketing efforts, which could be another indication of a slowdown in demand, as Dolly notes that this has seldom occurred for the better part of the past 10 years.

New deliveries are expected to move average vacancies further up, despite continued strong demand. According to Dolly, more than 130 million sq. ft. of industrial real estate product was delivered nationally during the third quarter, which is consistent with the previous several quarters. And additional 970 million sq. ft. is currently under construction—a record high. Slightly more than one-third of that product is pre-leased, according to Dolly. That corresponds with Savills’ estimates, which put the share of under-construction space pre-leased nationally at 36 percent, though the figure also varies greatly by market. In Baltimore, more than half of under-construction space is pre-leased. In Houston, that figure is 17 percent.

But, overall, demand is strong enough that it’s still a landlord’s market, Dolly notes, especially in key locations. In Dallas, for example, demand for new industrial construction has rebounded in the third quarter to tie with the previously all-time high set in 2021, adds Andrew Matheny, Dallas-based research manger with Transwestern. That is pushing up forecasts for the industrial vacancy rate in Dallas-Fort Worth over the next 12 to 18 months to 8.5 to 9.0 percent (that rate today is 6.2 percent, according to Savills research). But while new projects could experience longer lease-up periods than they have over the past few years, the long-term outlook remains positive, says Matheny.

In fact, several of the most populated metropolitan areas in the U.S. are still underserved when it comes to the amount of industrial space they need, particularly those experiencing substantial population growth, says Dolly. The vacancy rates in the Inland Empire and in Los Angeles markets are currently under 2.0 percent, according to Savills. In Northern New Jersey, South Florida and the Pennsylvania P 81/78 Corridor they are under 4.0 percent.

In addition, rising demand for manufacturing space could tighten industrial vacancy, Dolly notes. Over the past few months, the number of manufacturing companies leasing space in the U.S. has increased, a good indicator of how much on-shoring is taking place. Plus, transportation and retail companies also continue to actively look for industrial space. “Large tenants continue to dominate leasing activity, but smaller tenants may get an opportunity if some of the larger users are able to unload some of their inventories during the holiday season,” Dolly says.

Meanwhile, Matheny notes that current trends may make the industrial property sector more resilient to economic downturns. He points to the continued growth in e-commerce shopping, which remains 25 percent above pre-pandemic levels, and the fact that prevalence of remote work has geographically shifted centers of consumer demand, creating the need for last-mile industrial facilities in suburban and periphery locations.

“Higher market share and geographic dispersion may increase inefficiencies and costs that discourage consolidation, partially insulating industrial vacancy in a downturn,” Matheny notes.

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