The industrial real estate market will likely see low vacancies and high rents for at least another two years, according to a report from commercial real estate services firm JLL Inc.
On the demand side, companies are taking on larger inventory positions to avoid future supply shocks and stockouts, which have been prevalent throughout the pandemic. Further, e-commerce platforms require incremental inventories positioned closer to the end consumer in order to meet tight delivery schedules. In the shorter term, some are also dealing with a holiday hangover as merchandise destined for shelves in November and December was stuck in transit too long, missing the year’s biggest buying window.
The other part of the equation, supply, remains constrained as new facility developments have been delayed by materials and labor shortages, a common hallmark of the COVID era. JLL said construction timelines are currently stretched to as long as two years, up from nine months historically.
“There isn’t a lot of availability in the industrial market, and many tenants are being forced to expand or relocate to secondary and tertiary markets with vacancies at the lowest on record,” a JLL (NYSE: JLL) research report read. “The construction pipeline is robust, with many projects set to deliver in the coming year; however, it is unable to keep up with the rapidly increasing demand, and the backlog of current projects will push anything new out.”
Available industrial space in the U.S. hit an all-time low, ending 2021 at 3.4%, according to logistics real estate giant Prologis Inc. (NYSE: PLD). JLL expects vacancies to remain below 4% moving forward.
“Demand from industrial uses, coupled with rising demand from traffic-clogged ports, has resulted in near-zero vacancy rates in many urban logistics markets,” the report added. “Urban coastal markets including Los Angeles and New Jersey and inland distribution hubs such as Salt Lake City and Columbus have seen the lowest vacancies on record.”
Since 2010, demand for industrial space in the U.S. has jumped 24%, however supply is up only 18% over the same time, JLL said. Markets like Chicago, California’s Inland Empire, Dallas-Fort Worth and Pennsylvania have experienced the biggest growth.
Aging facilities, high new build costs
The nation’s facilities are aging rapidly, which presents another headwind. JLL said almost 75% of U.S. industrial spaces are 20 years or older and more than 25% have been around for at least 50 years.
“Pandemic-related restrictions and a lull in new deliveries contributed to industrial inventory aging at a more rapid rate than ever before.”
The average age of industrial space in the U.S. is 42 years.
Contrast that with tenants that are seeking customized high-tech spaces with automation and robots to help solve for a lack of labor. Many of these tech advancements have only been in existence for a few years, which effectively expands the gap between supply and demand. Older facilities also have low ceilings, too few dock doors and limited trailer parking, making them less than ideal.
Construction costs have surged as well. The cost to build a new warehouse, including labor, is up 21% over the last year.
“Labor shortages and COVID-related restrictions delayed many projects from being able to come to fruition, and the volatility of construction material pricing was unparalleled to any point in history,” the report said. “While labor shortages and material costs are having significant impacts to the under-construction pipeline, deliveries are barely moving the needle on availability in the overall industrial market.”
JLL said most finished facilities delivered in 2021 actually broke ground before the pandemic or during the first round of shutdowns and that delays have pushed the pipeline out further. “As projects in the pipeline are not expected to deliver until 2023, the market is expected to remain in a supply shortage and to struggle to meet the short-term surges in demand.”
Densely populated urban logistics sites have seen more focus lately as operators struggle to find places to park trucks and trailers. That means incremental conversion of shopping malls and big box stores is possible. The large open spaces with high clearances and ample parking are ripe for conversion but the report cautioned zoning issues and high conversion costs will ultimately tamp down these changeovers.
Conversely, “mega-box developments” in less-dense areas have the biggest pipeline currently. While not ideally located, these sites mitigate zoning headwinds and allow tenants to realize the economies of scale associated with running bigger facilities.
Rents will continue to jump
Average rents for U.S. industrial space have grown 37% to $7.11 per square foot since 2016. Prologis recently reported that logistics rents in the U.S. and Canada grew at the fastest pace recorded during 2021, up 17.6%.
“With same-day and next-day delivery becoming an important strategy, some companies are willing to pay just about anything to provide this service to key customer bases,” JLL said.
JLL said Class A space is currently at peak demand with 70% of new modernized facilities being preleased prior to delivery. “Industrial users are willing to pay premium rents and will compromise on space quality if their business model requires them to be located within urban cores.”
The firm’s forecasting model predicts rents will increase more than 8% throughout the market in 2022, a level that “could be accelerated by year-end.”
“These trends are especially relevant for a number of coastal markets that are exhibiting the lowest vacancies on record and could potentially see significant rent increases in the coming year,” the report continued. “Intense competition for space will give landlords in the hottest markets the ability to hold space vacant if there’s a chance of landing a top-dollar tenant.”
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