A recent dramatic shift in the industrial sector has occurred. While the COVID-19 pandemic slowed retail and hospitality performance, the industrial market experienced an uptick in demand, driving rental rates upward and compressing cap rates. Driven primarily by a change in consumer demand and an increase in ecommerce trends, the industrial market sector is now predicted to lead major property types in U.S. rent growth.
In this article, we explore the recent shifts in the industrial sector and the factors that are contributing to this historical change.
Amid the global pandemic, industrial demand spiked as the demand for ecommerce products increased. At a time when expenditures should have declined, stimulus checks gave American consumers a unique opportunity to spend. According to Trading Economics, an organization that provides data on economic indicators and financial markets, consumer spending has seen a stable increase quarter-over-quarter since July 2020.
Through the law of supply and demand, a direct relationship between consumer spending and the industrial sector exists. In fact, analysts predict that the country may be witnessing a permanent change in consumer behavior that will ultimately transform the industrial sector. In the fourth quarter of 2022, CBRE, a global leader in commercial real estate services and investments, reported that “the U.S. industrial market had record rent and supply growth in 2022, as well as the second highest annual total of net absorption.”
Although supply chain challenges emerged early in the pandemic, any global issues caused by shortages were soon resolved, and the United States once again saw an increase in consumer spending. CBRE explains: “Supply chain resiliency was the main driver of demand for industrial real estate [in 2022] as companies tapped multiple ports of entry, used more onshore manufacturing, and hired third-party logistics providers to lower supply chain costs and protect against import disruptions.”
As a result of increased demand for distribution, warehouses, and transportation centers, as well as improved supply chain efficiency, industrial construction hit a record high in 2022. CBRE reports: “Construction completions totaled 134.5 million square feet in [the fourth quarter] — the highest quarterly total on record. For the year, completions increased by 24 percent to 446 million square feet, 73 percent of which was occupied by year-end.”
Demand, however, is projected to slow down in 2023. According to global commercial real estate services company JLL, “the 632.3 million square feet currently under construction is still a record-breaking figure but is largely unchanged from the previous quarter, indicating a slowdown in new ground breakings. Furthermore, speculative developments account for 84.4 percent of assets currently under construction.”
Another indicator of a potential slowdown, according to JLL’s “United States Industrial Outlook, Q4 2022” report, is the slowdown of global ecommerce giant Amazon. During the first two years of the pandemic, Amazon had doubled the size of its logistics network, a rapid buildout that exceeded rivals such as Walmart, the U.S. Parcel Service, and FedEx.
However, by September 2022, MWPVL International Inc., the firm that tracks Amazon’s real-estate footprint, estimated that the company had either shuttered or killed plans to open 42 new facilities, totaling almost 25 million square feet of usable space. The firm also reported that the company had delayed opening an additional 21 locations, totaling nearly 28 million square feet, and had canceled a handful of European projects, mostly in Spain.
It should be noted, however, that the industrial sector expands far beyond ecommerce. For some industries that aid in manufacturing, shipping, and production, growth has been evident, and increased demand for industrial space has spurred rental growth, so much so that it may surpass the multifamily sector, which has long reigned over rental growth performance.
CoStar, an industry leader in commercial real estate information, analytics, and news, suggests the industrial property sector “has the potential to keep leading all property types in rent growth resulting from continued demand and lower vacancy. This comes in part because the apartment sector, typically a close competitor in terms of its ability to generate out-sized rent gains, has shown clear signs of weakening demand.”
Meanwhile, CBRE reports that “average asking rent rose by 3 percent quarter-over-quarter [in the U.S. industrial market] and 13 percent year-over-year for a record $9.63 per square foot. Taking rent was [also] up by 6 percent quarter-over-quarter and 18 percent year-over-year.”
In addition, JLL claims leasing demand was active, vacancy rates remained low, and rental rates dramatically increased year-over-year.
The firm reports that “demand was very active with more than 115.7 million square feet leased this quarter in a variety of industry sectors. While e-commerce has accounted for a high percentage of industrial leasing over the last two years, we are starting to see demand diversify among other industries such as logistics and distribution, 3PL [third-party logistics], construction materials and building fixtures, traditional retailers, and food and beverage.”
JLL goes on to state that “2022 closed with an average asking rate of $8.80 per square foot, marking a 19.2 percent year-over-year increase.
“As expected, the nearly record-breaking sum of new deliveries attributed to the vacancy rate increasing by 10 basis points quarter-over-quarter to 3.4 percent,” the firm reports.
Recent activity by Southern California's most active industrial buyer, Rexford Industrial Realty, indicates major players continue to believe in the future of the industrial sector. Indeed, the firm “expects to spend another $125 million on the purchase of property after acquiring a whopping $2.4 billion in properties in 2022 … [with the expectation that] industrial rents [continue] to go up to 15 percent in 2023 in Southern California.”
As inventory becomes more limited, cap rates start to compress, and companies move to obtain larger space to accommodate steady customer demand, real estate investors are turning to alternative investments to penetrate the sector.
Those individuals in a 1031 Exchange are leveraging Delaware Statutory Trusts (DSTs) to defer capital gains and acquire a partial interest in strong industrial portfolios, while cash investors are turning to available funds. Through alternative investing, real estate investors can access this growing sector, potentially benefiting from the progressive appreciation that may be experienced by industrial properties into the foreseeable future.
Today’s alternative investment opportunities vary according to the level of risk and include everything from oil- and gas-related assets to strong-credited ecommerce tenancy. Individuals who are currently in or considering a 1031 Exchange or are looking for an opportunity to invest in the industrial sector should contact the team at Perch Wealth to learn how alternative investments may help them better meet their investment objectives.
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