Industrial Supply After Prologis’ Warning: What Happens When New Construction No Longer Pencils?
The industrial real estate sector is entering a period of adjustment as rising development costs and higher financing expenses challenge the economics of new construction. Following several years of aggressive development, the industry is beginning to confront a different reality: building new industrial space is becoming increasingly difficult to justify at current rental rates.
During its Q3 2026 earnings call, Prologis warned that rents would need to be approximately 27% higher than current market levels to justify new development. The widening gap between construction costs and achievable rents could significantly reduce speculative development over the next 12 to 24 months, creating potential opportunities for owners of existing industrial properties.
However, the effects of a slowing construction pipeline will vary across markets and asset types. While larger distribution facilities continue to absorb recently delivered inventory, smaller industrial properties, flex facilities, and industrial outdoor storage (IOS) may be better positioned to benefit from increasingly constrained supply.
Rising Development Costs Are Reshaping Industrial Supply
The economics of industrial development have shifted considerably as elevated construction costs, expensive financing, and higher return requirements place greater pressure on developers. Projects that were financially feasible just a few years ago are now being reconsidered, particularly those relying on speculative leasing assumptions to generate returns.
According to First Vice President & Associate Director Jeff Miller, these challenges are already influencing development activity across Central Texas, where developers are becoming increasingly selective about which projects move forward.
In both Austin and San Antonio, we are seeing pure speculative projects delayed, re-traded, or put on hold,” says Miller. “The consistent message from developers is that the math no longer works at today’s rents once you layer in higher construction costs, elevated interest rates, and the returns their capital partners now require.
While speculative construction faces growing scrutiny, build-to-suit and pre-leased developments remain more viable because they offer greater certainty around occupancy and future income. This distinction is particularly evident in manufacturing and owner-user projects, where committed tenants help offset development risk. Associate Vice President Ashton Miller says that developers with favorable land bases may still be able to move projects forward despite broader cost pressures.
Increased construction and carry costs are limiting what developers can pay for land; however, developers that have a low basis in the dirt are still making projects pencil on spec or a build-to-suit basis,
explains Ashton Miller.
The slowdown is not occurring uniformly. Austin continues to work through a larger wave of recently delivered industrial inventory, while San Antonio has experienced a more pronounced pullback in speculative development. As fewer projects break ground, the industry could gradually transition from an environment defined by new supply to one where existing buildings capture a greater share of tenant demand.
Small-Bay and Flex Industrial Could Benefit First
Although reduced construction activity may eventually support the broader industrial sector, small-bay and shallow-bay properties could be among the earliest beneficiaries. These facilities have historically been more difficult to develop profitably because of higher per-square-foot construction costs, smaller tenant footprints, and the complexity of accommodating multiple users. With development expenses remaining elevated, the financial barriers to introducing new small-bay inventory have become even greater.
Small-bay (and shallow-bay) benefits first. It has always been harder to develop profitably at scale because of higher per-square-foot costs and more fragmented tenant demand, and the current cost environment makes new small-bay supply even less likely,
says Jeff Miller. While larger industrial facilities continue to face competitive leasing conditions in certain markets, smaller spaces have generally maintained tighter availability and greater stability in asking rents.
At the same time, the tenant base for small-bay and flex industrial space is expanding beyond traditional service-oriented businesses. According to Senior Vice President Michael Tran, industrial flex properties are increasingly attracting users that previously occupied traditional retail space or operated within larger distribution facilities. Third-party vendors supporting major e-commerce operations, for example, are seeking smaller industrial units near large fulfillment centers, creating additional demand for spaces ranging from 5,000 to 15,000 square feet.
Small and shallow bay properties are starting to benefit from their proximity to big-box facilities, as third-party Amazon vendors seek spaces ranging from 5,000 to 15,000 square feet,
says Tran.
This shift is also extending into industries not historically associated with industrial real estate. Tran notes that pharmacies, fitness studios, and other destination-based businesses are increasingly considering flex properties as an alternative to traditional retail locations. Some pharmacy operators, for example, can reduce occupancy costs by approximately 20% to 30% by transitioning into flex industrial space. As the range of tenants seeking these facilities expands, existing small-bay properties could benefit from a more diversified demand base at a time when new construction remains limited.
Existing Buildings Face Different Leasing Conditions
A slowdown in development does not necessarily mean an immediate recovery in industrial rents or occupancy. Markets with substantial recently delivered inventory must first absorb existing supply, while differences in building quality, location, and functionality continue to influence leasing performance. In some submarkets, newer big-box facilities are still competing aggressively for tenants, while older industrial buildings face challenges meeting modern operational requirements.
Ashton Miller points to a growing distinction between industrial building classes, noting that Class C and D facilities have experienced rising vacancy while Class A properties are generally achieving higher rents and shorter marketing periods.
Tenants are asking for concessions across the board, whether it’s tenant improvement packages, free rent or a combination of the two,
says Ashton Miller.
These conditions suggest that reduced development alone will not benefit every industrial asset equally. Properties with outdated specifications, limited functionality, or substantial capital improvement requirements may continue to face leasing challenges, even as future supply becomes more constrained. Conversely, well-located buildings capable of accommodating evolving tenant requirements may be better positioned to maintain occupancy and rental performance.
Flex industrial properties could see an additional advantage as tenants invest more heavily in their occupied spaces. Tran notes that users are increasingly committing capital to improvements beyond standard tenant buildouts, reflecting a greater emphasis on adapting industrial space to specific operational needs. With new-construction flex rents in Texas generally around $15 per square foot annually on a triple-net basis, varying by location, existing facilities that meet these requirements may become increasingly competitive as replacement costs continue to rise.
IOS Faces Additional Supply Constraints
While traditional industrial development is being challenged by construction economics, industrial outdoor storage faces a different set of supply limitations. IOS properties have attracted increasing investor attention because of their importance to transportation, logistics, construction, and equipment-intensive businesses. However, expanding the inventory of suitable outdoor storage facilities remains difficult, particularly in markets with restrictive zoning and limited industrial land availability.
Construction costs for IOS remain elevated, just as they do for traditional industrial buildings. The bigger constraint is supply: it is still difficult to assemble land and navigate the entitlement and development process for outdoor storage,
says Jeff Miller.
Unlike traditional warehouse development, where new construction may resume once rental rates rise sufficiently, IOS expansion often depends on securing appropriately zoned land and navigating lengthy approval processes. These structural barriers can limit the industry’s ability to respond to increased demand, even when market conditions support higher rents. As a result, existing IOS properties may retain stronger pricing power relative to bulk warehouse facilities, particularly in locations where developing comparable sites is increasingly difficult.
Higher Capital Costs Are Changing Industrial Strategies
The same economic pressures affecting development are also influencing industrial investment activity. Elevated borrowing costs and more conservative lending conditions have prompted investors to reassess acquisition pricing, financing structures, and projected returns. Buyers are placing greater emphasis on current income, tenant credit, lease duration, and opportunities to increase rents over time rather than relying primarily on future appreciation.
Investors are adjusting in a few clear ways. They are underwriting higher going-in yields, using more equity or lower leverage, and focusing harder on credit quality, lease term, and in-place mark-to-market upside,
says Jeff Miller. These adjustments have contributed to wider pricing expectations between buyers and sellers, particularly when owners remain anchored to valuations established during periods of lower interest rates.
Ashton Miller similarly notes that industrial pricing has adjusted to reflect a higher cost of capital. For sellers, this places greater importance on establishing realistic pricing expectations and demonstrating the underlying strengths of an asset. Well-leased properties with durable income streams, favorable locations, and clear opportunities for future rent growth may continue attracting investor interest, while buildings with significant vacancy or near-term lease rollover could face greater scrutiny.
Despite these challenges, reduced construction activity may strengthen the longer-term investment outlook for existing industrial properties. As replacement costs rise and fewer speculative projects move forward, acquiring existing facilities at valuations below the cost of new development could become increasingly attractive. This dynamic may be especially relevant for small-bay, flex, and IOS properties, where limited new supply and diverse tenant demand can support long-term investment fundamentals.
What Comes Next for Industrial Real Estate?
Prologis’ warning reflects a broader shift in industrial real estate, where the rising cost of development is beginning to influence the sector’s future supply. Although the immediate effects may be muted in markets still absorbing recently completed projects, a sustained reduction in speculative construction could gradually improve the competitive position of existing buildings.
The implications will depend on asset type and local market conditions. Larger distribution facilities may require additional time to stabilize, while small-bay, flex, and IOS properties could benefit sooner from limited development and expanding tenant demand. At the same time, building quality, location, and operational flexibility will remain important factors in determining which properties capture that demand.
For industrial owners and investors, the next phase of the cycle may present opportunities that extend beyond traditional rent growth. As fewer projects become financially feasible, the ability to acquire, reposition, or retain well-located industrial assets could become increasingly valuable. The question is no longer simply how much industrial space the market needs, but how much new space developers can afford to build.
