No sector of commercial real estate has gone unaffected by higher interest rates and the dampening they have exerted in multiple ways on investment. But if any have managed to move through with nary a scratch, it’s been industrial.
“Industrial is experiencing a slow-down, which based on where it is in its cycle, should be expected,” Ermengarde Jabir, director of economic research at Moody’s, tells GlobeSt.com. Growth had been accelerating rapidly in 2020 but then “really picked up speed” in 2021 and 2022.
E-commerce and the inability of many to shop in stores during the worst of the Covid-19 pandemic was a driving force for the industrial market, particularly warehousing and logistics. When people could again broadly return to stores, e-commerce supremacy stumbled. But now it’s back on track as though there had been a constant trend line through 2019.
Although vacancies have risen for six quarters to reach 6.1% in June and new inventory is on its way to delivery, things are about to change, according to Marcus & Millichap. More than a quarter of vacancies (27%) occurred across Atlanta, Dallas-Fort Worth, Houston, Riverside-San Bernardino, and Phoenix. They may see higher vacancies as, in the 31 metros the firm studied, they are to see 45.6% of new inventory delivered in 2024.
However, many occupiers will move to newer facilities with automation and robotics, Jabir explains. Upgrading is necessary for many businesses because of the competitive drive among retailers to provide next-to-instant product availability without people having to leave their homes.
Fast delivery, though, in addition to the retailers depends on manufacturers, distributors, and third-party logistics companies. Every part of the end-to-end supply chain has to hustle and needs the tools to do so. Some of the excess inventory may not matter in the bigger scheme of things, similar to the current office market where price, valuation, and success in transactions depend on the quality of the properties.
Other changes in requirements are also affecting the viability of new and existing inventory. Warehouses, for example, were typically horizontal in concept and construction, Jabir says. Now? “It’s typically a very tall one story,” she says.
But don’t expect a bubble, even with ongoing construction. There has been softening from both the demand and supply sides. “A lot was built in a short period of time,” says Jabir. “The labor shortages, increased costs of construction, wage increases, higher interest rates really put the brakes a bit on out-of-control construction. When people ask if there’s a chance of a bubble, if not for all these dampening headwinds, there very well could have been a bubble.”
“The good thing about industrial is that it has maintained value,” Jabir says. Trading cap rates “at the risk-free rate” couldn’t continue forever because they’ve given investors no “wiggle room” because of the lack of built-in risk premium.
Average effective rents nationally have been around $7 to $7.50, and that varies. San Francisco has seen just above $13, while in Memphis, about $3.70 has been the going rate. “If we think about location, we do see the highest rents in the hottest industrial markets,” she says, but even that can be deceptive. Memphis has lower rents because the activity is business-to-business, given its position as a logistics hub. Without the “consumer component,” there isn’t the fierce competition for last-mile locations.
Also, manufacturing, with nearshoring and reshoring, has contributed to industrial demand. What will happen depends. “Over the next five to ten years if all of the right incentives are in place and remain in place to ensure that” the expansion continues, Jabir says.