What’s Impacting Industrial? A 2023 Forecast for Industrial CRE
Industrial Market Overview
The United States industrial market is anticipated to see increasing supply growth as leasing activity continues to hold near record highs, up approximately 60 percent compared to levels seen before the pandemic. Containerized imports entering the United States increased because of heightened consumer product spending, creating a dire need for warehouse and distribution space. Potential oversupply may occur in the coming year but is not an immediate threat. However, it is a factor to keep an eye on as the record hikes in supply transition into a trying economic climate. There are currently more buyers than sellers in this market, which can widen the disconnect between the parties’ expectations as financing costs increase due to rising interest rates. Despite the country’s largest industrial user, Amazon, slowing down distribution expansion, the industrial sector remains an in-demand asset class. 2023 will see a large pipeline of new development, driving a moderate increase in vacancy, which will bring down rent growth slightly, to the delight of tenants. Delays of materials seen in the previous two years will no longer be an issue in the coming year, and investors can anticipate shorter construction timelines pushing new development. Industrial will continue to be a CRE sweetheart, although shifts in the market inevitably impact the sector.
How Is the Industrial Sector Reshaping Supply Chains?
Shortages in supply chains were an overarching issue impacting the industrial sector throughout the pandemic. Slow movement in construction timelines due to a lack of available materials hindered the market’s development. However, 2023 can anticipate shortened construction timelines contributing to vast new development across the market. The internal manufacturing process is being modified to aid supply chain quality, resulting in suppliers being able to grow their capabilities. Investors are seeking to build smaller-scale manufacturing sites, otherwise known as “micro-factories,” that are easier to build, hire for, and manage.
Where Is Rent Growth Heading?
2022 saw rent growth hit 11.6 percent year-over-year, according to CoStar but is anticipated to decelerate as owners lose confidence in the near-term. In the third quarter of 2022, quarterly gains dropped for the first time since the pandemic as rent growth tailed 2.2 percent in the third quarter of 2022. Anticipated development will drive vacancy rates, in turn increasing rent growth to nine percent in 2023 and dropping to five percent in 2024. Developers should expect rent gains to underperform in the upcoming year as levels go back to pre-pandemic numbers.
Is Sale & Deal Activity Expected to Slow Down?
Sales are not anticipated to take a significant hit from rising inflation rates and mortgage costs, as many buyers want to gain exposure in the industrial sector. However, there is an inequality in motivated sellers and buyers, which can result in high asking prices. Property sales by owner users and sale-leaseback deals will continue to be an attractive option for investors looking to achieve sizable gains without worrying about timing and optimal interest rate environments. Another deal type anticipated to continue in the coming year is investors targeting fully-leased properties with below-market rents in place and lease expirations coming up during the buyer’s projected hold period. Ultimately buyers and investors will continue to look for assets that boost net operating income without having to hold vacant assets, as future leases can be produced with the existing tenant in place. On the development side, as project completions continue to push forward, there will be large amounts of new inventory on the market to meet buyer demand.
Leasing by Numbers
Leasing has remained consistent at a record-level high despite rising inflation and interest rates. Leasing has increased by more than 60 percent from typical third quarter activity during the three years prior to the pandemic. During Q3 2022, industrial leasing in the U.S. totaled 320 million square feet, according to CoStar. Areas with exceptional leasing activity are East Coast ports, including Charleston, Savannah, and Norfolk. Additional markets such as Phoenix, Reno, and the San Francisco Bay Area are receiving a high record of leases in the tech manufacturing sector, where warehouse space is essential. An increase is expected in long-term leases in industrial tech centers, as a wave of electronic vehicle and battery plants are set to open in 2024 and 2025. Amazon, a top shareholder in the country’s industrial net absorption, has been relinquishing smaller, older distribution spaces and focusing on newer, larger facilities it already owns. However, since the number of investors looking to enter the industrial sector is greater than those looking to exit, lease activity and deal volume will remain consistent as new players enter the field.
How are Land Constraints and Land Availability Impacting Industrial Development?
There is currently 1.2 billion square feet of industrial space available for lease among existing properties across the 391 largest metropolitan areas in the United States, according to CoStar. With incoming industrial development reaching record highs, the fight for land continues. To remedy this, investors have been utilizing non-traditional industrial land space, such as grasslands, for development, primarily in the South. Investors are seeking large quantities of land, which is not available in dense metros. Georgia, Texas, and Florida are hot spots for new non-traditional industrial development. As land constraints are pushing environmentalists to preserve regional population centers, land cost is already increasing.
What Does Demand Look Like?
The current and incoming supply pipeline in the industrial sector outweighs demand. The second half of 2022 saw a surge in new development, which will continue into 2023 as the timeline for materials and construction shortens, pushing more properties onto the market. There is a high demand for industrial properties, particularly in the clean energy sector, which is anticipated to increase global construction spending by $5.6 trillion over the next 15 years, a 60 percent increase from current levels, according to CoStar. Upcoming clean energy construction spending in the United States is expected to reach $1.2 trillion in solar energy, power grid enhancements, and electric vehicle infrastructure.
How Did COVID-19 Impact Industrial Real Estate?
The onset of the pandemic had a positive impact on industrial real estate, as it sent demand for warehouses and distribution centers to all-time highs since consumers were heavily reliant on e-commerce. While COVID-19 lockdowns are in the past, it did have lasting effects on industrial. For example, work-from-home orders influence migration rates, increasing the need for personal and vehicular storage across the country. Additionally, medical supply storage and industrial space for laboratory facilities became a trend stemming from COVID-19.
How Is the State of the economy Affecting the Supply Chain?
The rise in inflation and interest rates is impacting the United States economy in all aspects; however it is not anticipated to hinder growth in the industrial supply chain. As certain sectors see minor lulls, including e-commerce, other areas push forward, such as high-tech development, including electric vehicles. While warehouse space demand may be slowing down, the acceleration in demand for electric vehicles and clean energy will push the market’s overall growth.
The risk of consumers tightening the strings on spending because of rising inflation and interest rates is a threat impacting the entire economy. For the industrial sector, this could potentially lead to a decline in demand for warehouse space for e-commerce goods, however there are no current statistics that make this an imposing threat. Consumers are still spending money on durable goods, which can be seen by a 1.5 percent increase in sales in July, mainly in recreational goods and vehicles. There has been a significant increase in automobile and recreational vehicle sales, pushing an increase in storage facilities for these vehicles. However, as hiring freezes come into play in 2023, business investments are expected to slow down as factories report declines in product orders.
What are the Top Emerging Markets for U.S. Industrial?
Thriving industrial markets are popping up across the country. Recently, large hikes in leasing activity have been seen in Reno, Nevada, which has turned in 9.5 million square feet through the first three quarters of 2022, according to CoStar. Reno attracts high-tech manufacturers, like Tesla, which produces lithium batteries. Stockton, California, is another emerging West Coast market that receives large interest from e-commerce and third-party logistics firms.
The state of the market causes economic uncertainty across all sectors in commercial real estate. However, rising interest rates and inflation are not expected to decelerate overall growth in the industrial market in the coming year. 2023 will see tremendous growth in clean energy development, including lithium batteries, as well as recreation goods spending. The construction timeline will shorten, pushing new development in emerging markets across the country, primarily in western and southern submarkets. This rise in new property will raise vacancy, but this is a positive since industrial development has been in such high demand since the pandemic, and supply has not been able to keep up. The coming years will include many new industrial properties featuring both traditional and non-traditional properties.