Industrial CRE Fundamentals

After consecutive periods of tremendous growth and mild contraction, the U.S. industrial market in 2024 is approaching stabilization. The year’s first quarter proved challenging for the sector, and trends like decelerating rent growth and increasing vacancy rates will persist for several months. But there’s a caveat: Early signs of normalization and eventual recovery in tenant demand are already emerging. As a result, the industrial sector’s fundamentals will stay resilient, though muted compared to recent highs.

Much of this resilience hinges on the U.S. economy avoiding a recession. Market observers had forecast a significant contraction to begin by mid-2023, but increased investment, slowing inflation, and job growth proved otherwise. According to CoStar Group, monthly job gains in January 2024 totaled 353,000, almost double consensus estimates. During that time, growth was 0.05 percent for Manufacturing jobs and 1.05 percent for Trade, Transportation, and Utilities jobs.

Analysts at GlobeSt and CoStar Group believe a new wave of industrial commercial real estate—advanced manufacturing—is fast approaching. They predict new construction for large electric vehicle, battery, and semiconductor plants will take off, while warehousing and distribution take a back seat. This trend may help balance the broader industry’s declining construction starts, making a case for strong industrial market performance by 2025 or 2026. Here’s how industrial CRE fundamentals, specifically supply and demand, will impact the market’s upcoming years.

Supply at a Record High

A record-high supply of industrial space will be delivered in the first half of 2024. As supply outpaces tenant demand, industrial property vacancy rates continue to rise after 12 months. The national vacancy rate, at 5.6 percent, is still relatively low and shouldn’t be of concern for most building owners. With new supply likely to push vacancies up soon, CoStar Group predicts rent growth in 2024 will be the lowest since 2012.

Here’s where things start to normalize. Since the average construction time for large industrial projects is 14 months (and most under-construction projects began in mid- to late-2023), the recent decline in starts suggests that by the end of the year, the number of projects being delivered will also substantially slow. This slowdown may set the stage for vacancies to stabilize or tighten again in late 2024 and for rent growth to rebound after that.

Demand Is Down, but Resilient

Last year was challenging for newly built and vacant big-box distribution properties in search of their first tenants. Higher interest rates weighed on everyone, and tenant demand for additional industrial space weakened as the year progressed. Although demand for industrial CRE is down, analysts expect it to remain resilient in 2024, suggesting a potential upswing next year.

As for the nation’s under construction pipeline, starts decreased by 300 million square feet year-over-year. The current pipeline is 2.2 percent of the total supply or 424.5 million square feet. Markets that account for the largest share of projects under construction include Phoenix, Dallas, and the Inland Empire.

Rent Growth Expected to Cool Briefly

In January, the average in-place rent for industrial space was $7.74 per square foot, indicating a year-over-year increase of 760 basis points and a slight 4-cent gain from the previous month. However, reduced tenant demand and the absorption of record supply will ultimately cool rent growth for industrial space in 2024. How long this cooling will last is less clear. Although demand is down, a consistently unpredictable global supply chain may drive ongoing demand for industrial space as the need for diversified sourcing and ports of entry grows.

Industrial Capital Markets

The industrial sector’s capital markets in January saw a sixth consecutive quarter of annualized declines in volume. Users, who own a small portion of total industrial space, were the only investor group to increase acquisitions in 2023 compared to 2022. Total investment in industrial space reached $2.6 billion in the first month of 2024, when properties traded at an average of $145 per square foot. Markets with the highest sales activity were Chicago ($243 million), the Bay Area ($229 million), Denver ($210 million), Phoenix ($161 million), and the Inland Empire ($138 million). Additionally, a record number of industrial loan maturities will come due this year, though the sector claims the lowest share of potentially troubled loans, according to GlobeSt.

Takeaways for Industrial CRE

The main story for industrial CRE in 2024 and beyond is one of resilience: After a tremendous bull run and signs of minor contraction, the sector is stabilizing and readying itself for eventual expansion in 2025 and 2026. A vast supply of industrial spaces is hitting the market this year on top of an underwhelming tenant demand. As a result, vacancies will rise in the short run but taper out once absorption catches up to incoming supply, making room for more completions, a lower vacancy rate, and a return to increasing rent growth.