It’s been dubbed “sticker shock” for logistics warehousing lessees, but given the extreme tightness of industrial real estate and the bullish demand trends seen for the rest of the decade, the prospect of soaring renewal rates on multiyear warehouse leases shouldn’t come as a surprise.
That said, the magnitude of the projected increases, at least those published on Monday by CBRE Services (NYSE:CBRE), is eye-popping. For example, the average five-year rent on renewals in the Philadelphia market is currently $7.65 per square foot, according to the report. That’s up from $4.72 per square foot when the lease, signed in 2016, expired in the second quarter of 2021.
In California’s Inland Empire east of Los Angeles, home to the country’s largest warehouse complex, the average asking rent for renewed leases has jumped to $10.92 per square foot from $6.75 per square foot when the most recent five-year term expired in the second quarter, according to CBRE data. Most industrial lease agreements with major occupiers run three, five or 10 years.
For the 18 big industrial markets surveyed by CBRE, the lowest cumulative percentage increase from the average rent at a lease’s five-year expiration date to the current asking rent levels was 29.1%. The average nationwide increase was 25%, according to CBRE data.
Those figures don’t include the 3% annual rent escalators built into industrial contracts, CBRE said. For example, the average rent in the Philadelphia market during the second quarter of 2016, which would coincide with the start of a five-year lease term, was $4.19 per square foot. The rent would then rise 3% a year from that level.
An occupier with a 10-year lease expiring this week can expect steeper hikes, CBRE said. In the third quarter of 2011, the average asking rent was $5.32 per square foot, compared with $8.92 per square foot today. The overall vacancy rate was 8.7% compared with a 3.6% vacancy rate today. In addition, annual rent increases were smaller than they are today, CBRE said.
In 2011, the U.S. industrial market was shedding the last vestiges of the Great Recession. More importantly, e-commerce, by far the most important factor in the decadelong warehouse bull market, had not begun to truly take off.
Despite the specter of sizable rent increases, no one expects available logistics warehouse space to go begging. Net absorption, which measures the difference between occupied and vacated space during a given time, is at record highs, indicating sky-high demand. All year long, occupiers and their advisers have been scouring the country to secure hard-to-find warehouse capacity, and are unlikely to care how much it costs when they do.
In addition, warehousing represents only 7% or so of a company’s total logistics costs, while transportation can account for 50% to 70% depending on the scenarios, according to a CBRE report from earlier this year, Many occupiers would be willing to pay dearly for prime warehouse space to put their goods nearer to customers. This would reduce shipping costs and increase delivery speed and reliability.
While the current rate of increases on lease renewals may level off in the years ahead, demand and rents are likely to remain smartly elevated. Today’s consumers are fickle and intolerant of delivery delays, and will shift brands at a moment’s notice if they are dissatisfied. Businesses unwilling to risk losing those buyers will push as much inventory into as many warehouses as possible. More warehouses will dot the American landscape as the decade progresses. In that highly plausible scenario, market conditions will surely favor lessors.
CBRE bases its forecasts on data from triple-net lease agreements, in which a tenant or lessee promises to pay all of the property’s expenses. These include real estate taxes, building insurance, maintenance, rent and utilities. The firm classifies logistics and manufacturing space as industrial property, though logistics makes up the bulk of the category.