Over the last decade, the industrial sector has become the most dominant force in the commercial real estate market. Long before the pandemic, the asset class was crowned the industry’s darling, and since the pandemic, user demand and investor appetite have intensified, resulting in an unprecedented level of growth. For the last decade, the market has been seemingly unstoppable.
Just look at the phenomenal fundamentals. In the second quarter, industrial sales volumes reached $40 billion with pricing up more than 30% year-over-year, national rents increased nearly 12%, the national vacancy rate fell to 3.1% and the construction pipeline grew to 613 million square feet. The stats are stunning, and they absolutely support an expanding new construction pipeline—but for the first time, the sector is facing headwinds that could derail growth.
Some of these headwinds, like land shortages and leasing challenges, are born from this tremendous growth spurt. In many ways, the industrial sector can’t keep up with its own progress. Other challenges are related to the shifting economic climate.
While the industrial sector has not yet begun to soften, there are some concerning trends that developers are watching closely. Here are the top five.
Inflation
In June, the inflation rate hit 9.1%, exceeding expectations and once again breaking a record for the highest rate of inflation in more than 40 years. While industrial developers are certainly concerned with rising construction-related costs, inflation’s effect on consumer spending is potentially more troublesome.
In 2021, e-commerce, third-party logistics companies and general retail and wholesale users represented a combined 79% of leasing activity in the industrial sector, and any reduction in consumer spending could have a negative impact on leasing activity. Research from Newmark shows that consumer spending has targeted services over goods this year, and demand from large retail users, those that occupy 500,000-plus square-foot boxes, has already cooled as a result.
However, price increases have mostly occurred in the energy, auto and food sectors, not in retail goods, and in June consumer spending continued to increase, up more than 1%.
Leasing Demand
The sector’s voracious growth has become a too-much-of-a-good-thing scenario. Industrial developers cannot seem to build fast enough. Many of the top industrial hubs across the country have a sub-3% vacancy rate, creating supply-starved markets where there is simply not enough industrial product to meet demand.
The Industrial Business Indicator (IBI) report from Prologis found that 70% of the current new construction pipeline is already preleased. To meet current user demand and generate a low 5% supply lift, developers would need to build 800 million square feet of product, well above the current national construction pipeline.
While insatiable demand is generally good news for a developer, lack of available space has stymied leasing activity with some markets reporting that leasing inquiries are down as much as 25% this year.
Land Shortage
Despite the severe shortage of industrial supply, new construction activity is struggling to keep up with demand. The second quarter netted only 72 million square feet of new industrial deliveries, among the lowest in the last three years—and it isn’t for lack of trying.
The top five US industrial markets each have more than 30 million square feet currently under construction. Many of these projects will deliver sometime next year, helping to buoy the market and meet demand.
However, many major industrial players have pointed to land scarcity as the biggest long-term challenge for the industry. To paraphrase Mark Twain, they aren’t making any more land, and industrial development will have to migrate to markets that can accommodate new construction. Cities like Austin, Charleston, Greenville-Spartanburg in South Carolina, and Las Vegas are now becoming popular for big box construction because they have the space to accommodate these projects.
Supply Chain Issues
Without question, supply chain disruption has been among the biggest challenges for industrial developers and operators. Logistics costs now account for 11% of total business revenue, according to research from Newmark, and many firms are re-strategizing to cope with higher costs. Nearly two-thirds of companies are stockpiling goods and materials and more than half are adding new suppliers to diversify the supply chain and mitigate the impact of delays and shortages. Still, many are simply working higher costs into the business model. While these solutions will help to ease the pain of cost increases in the short term, technology is the best fix for this problem.
Automation, cloud computing and artificial intelligence can address transportation challenges and labor shortages, reduce inefficiencies and better track and direct the movement of goods. Most warehouses are not equipped with this technology today, but the market is expected to grow 150% in the next three years.
Predictive development management tools like Northspyre are part of this emerging technology infrastructure. Northspyre uses automation and machine learning to oversee the budget and timeline of a project and ultimately produce considerable cost savings. These technologies work together to stimulate end-to-end efficiencies throughout the development cycle.
Government Regulation
The voracious growth of the e-commerce industry has not come without criticism. Communities are concerned about the development of industrial facilities near neighborhoods due to noise, pollution and truck-related traffic. The censure has culminated in restrictive legislation aimed at the industrial industry, and California is at the center of the conversation. Proposed bill AB 2840 in California would restrict warehouse development within 1,000 feet of a sensitive receptor, such as a school.
Many industrial players have referred to this as anti-development legislation, and while the bill has stalled in the state senate as of July, this is likely the beginning of increased regulation around industrial development.
Communities in Pittsburgh; Holbrook, New Jersey; and Madison, Wisconsin, have also protested new industrial development. Developers are enlisting the help of public relations firms to highlight the benefits of these projects and rally community support, but resistance is steadfast. Government regulation has yet to enter the mainstream narrative, but the industry is bracing for a battle.
Despite these bubbling new trends, the industrial sector continues to benefit from healthy fundamentals and attractive supply-demand dynamics that will ensure a long runway of growth, but as the sector matures, it has begun to see some growing pains. Industrial stakeholders should watch these trends closely, develop defensive strategies and leverage technology to navigate the road ahead.
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Real Estate Development