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For the last decade, the real estate industry has watched the industrial sector in awe. Industrial has evolved into the most coveted asset class with seemingly unstoppable growth and tremendously attractive yields. The pandemic only served to amplify industrial activity due to increased online shopping and the ecommerce industry’s voracious appetite for warehouse and logistics space.
The most recent surge in demand gave the impression that the bull market would have no end for the industrial sector—but of course, that couldn’t be true. Inflation, rising interest rates, and a destabilized banking market are putting downward pressure on industrial demand, marking the first period of weakening fundamentals for the sector in more than a decade.
At any sign of disruption, investors and developers step to the sidelines, but there is every reason to remain bullish on the industrial sector. With online shopping and re-shoring, industrial investments promise long-term growth and attractive return potential. As investors wait out the current—and likely short-lived—storm, there are a few ways developers can strategically pivot to mitigate downside risk while remaining open to new opportunities.
Analyze Nuanced Metrics
In office or retail, or even multifamily, the slip in performance metrics is consistent. When vacancy falls, rents slip, and then investors retreat, and development slows. In the industrial sector, the market metrics are unharmonious. Every data downside has an upside. According to the first quarter industrial report from JLL, industrial leasing fell 16.3% from the previous quarter. However, new deals made up nearly 62% of leasing activity, illustrating ongoing expansion and demand growth. Absorption fell 47% year-over-year, but the report attributed the decline to strong pre-leasing activity. Finally, the national vacancy rate increased 40 basis points, yet rents increased an impressive 20.6% year-over-year, with industrial occupiers now paying an average of $9.19 per square foot.
The metrics in industrial are also highly market specific. The Inland Empire, the country’s top industrial market, for example, is stable with flat metrics in nearly every category. New Jersey, on the other hand, is transitioning after record new deliveries and a development boom during the pandemic.
These metrics, however difficult to decipher, are important in determining the market’s capacity for new supply. When metrics don’t show an obvious trend, data and analytics technologies become a critical tool.
Data automation can process large amounts of information and alternative metrics to give developers deeper insight into demand trends and market trajectory, analyzing return potential for a wide market or a specific development site. Leveraging technology to analyze data will illuminate underlying market trends, ensuring more successful outcomes and helping achieve a targeted development strategy.
Pursue New Opportunities
The diminished fundamentals have had a clear impact on new construction activity. According to JLL, rising interest rates and slower pre-leasing activity have turned developer sentiment on new industrial builds, and a decline in new construction starts has followed. There are currently 620 million square feet of space under construction, and 90% of that activity will deliver sometime this year.
This is an interesting dynamic. The reduced development activity has begun while vacancy rates remain at historic lows, and new construction continues to see strong, albeit reduced, pre-leasing. However, as Ed Chazen, a senior lecturer at Boston College Carroll School of Management, recently explained in an interview with Northspyre, industrial is easily duplicated and quick to build, unlike other commercial assets like office, retail, and multifamily. Developers have an opportunity to pause new starts and easily scale activity again once the economy regains stability. The nature of industrial allows developers to be agile and respond quickly to economic fluctuations.
Still, developers should take care not to move too far off course. The underlying fundamentals are still positive, with record low vacancy rates and rents that continue to climb despite historic new deliveries. Organic new leases continue to lead leasing activity, and companies continue to pre-lease new developments. These are all positive trends that would otherwise support new development. Rather than stalling new starts completely, developers can pursue targeted strategic opportunities to continue to deliver new product and avoid a future shortage.
Create Cost-Saving Efficiencies
Today, interest rates are more than double what they were just one year ago. The higher cost of capital has made new construction much more expensive. With rising interest rates and signs of slowing industrial demand, it isn’t surprising that industrial construction starts are slowing. While there is no way to change demand dynamics—which are cyclical and move with the ebbs and flows of the broader economy—developers can leverage new tools and strategies to mitigate the impact of rising interest rates and gain better control over costs.
Automated technology is the cornerstone of cost-saving initiatives. By automating administrative tasks and using predictive analytics to monitor things like materials pricing and labor availability, developers can create efficiencies in the construction process that reduce costs and budget overages.
Northspyre has been shown to reduce budgets by 6% and budget overages by as much as 66%, but the most impactful aspect of technologies like Northspyre is actually the ability to reallocate professional expertise to higher-value tasks. When administrative busy work is automated, valuable professionals can spend more time on strategy and execution, creating efficiencies and baking success into every project.
The industrial sector stands to benefit tremendously from this dynamic because high capital costs and uncertainty around cash flow are driving the decline in construction activity. By reframing the cost structure and using technology to reallocate resources, developers can find the financial space to pursue new developments at a time when there are still compelling reasons to build.
The market is changing for everyone, and the change is likely to be permanent. Investors across sectors will have to pivot and develop new strategies, and technology adoption is going to be central to future investment and development. Through this transition, industrial developers should be reviewing metrics, looking for opportunities, and investing in technology to remain competitive today and through the next business cycle.
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Tag(s): Real Estate Development
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