With much of the country under shelter-in-place policies, developers raced to build fulfillment centers and warehouse facilities to meet the unprecedented demand for e-commerce and last-mile delivery. Industrial properties experienced record-low vacancies and accelerating rents.
To meet the record-breaking requirements, the U.S. delivered 1.8 billion square feet of industrial product since 2020, according to the recent U.S. Industrial Construction Overview report by Cushman & Wakefield. That’s more than what was built in the entire previous decade.
However, that voracious demand couldn’t last forever. The pandemic-fueled growth was unsustainable, experts say, and the industrial sector is stabilizing as it shifts to more normalized levels. Sources say this doesn’t foreshadow gloom and doom for the sector by any means, as industrial activity is still elevated compared to historical levels. In fact, despite the slowdown, industrial properties still report the highest rent growth compared to any other commercial real estate sector.
Tenant demand was tempered in 1Q 2024 but remains positive
“Demand is cooling but not crashing,” noted Cushman & Wakefield’s Q1 2024 U.S. Industrial Report. While vacancies are rising, the increase is occurring at a controlled pace and predominantly due to new supply. Meanwhile, rent growth is slowing yet solidly positive.
“This is exactly what a soft landing looks like for the industrial sector,” the report noted.
Vacancy still below historical average
New deliveries have outpaced demand, pushing the overall vacancy rate to rise. Still, at 5.8 percent as of Q1 2024, the vacancy remains below its historic average of 7 percent, according to Cushman & Wakefield.
According to Colliers, the U.S. industrial vacancy rate is forecast to stabilize at around 6.5 percent in the second half of 2024. In markets with significant numbers of new deliveries, vacancy could exceed 10 percent. However, for those markets with less new development due to geographical constraints or other factors, vacancy could remain below 5 percent.
Rent growth continues at decelerated pace
Cushman & Wakefield reported that industrial rent growth is “coming back down to earth.” In Q1 2024, rents grew 6 percent annually versus 10 percent in 2023 and 20 percent in 2022.
Colliers pointed out that while rent growth may pause in some markets where “rates got a bit out of hand,” more rent growth is forecast in most markets in 2024, although at a more tempered pace and closer to historical averages of between 4 percent and 8 percent.
The national average rent in February stood at $7.68 per square foot, up 7.5% over the previous year, noted ComercialEdge’s National Industrial Report 2024.
Southern California led the country in rent growth, with the Inland Empire boasting the highest increase at 12.7 percent year-over-year as of February. Orange County and Los Angeles saw rents expand 11.4 percent. Orange County topped the list for the highest rents in the U.S. for industrial space, averaging $15.29 per square foot, noted CommercialEdge’s report.
New construction pipeline thins with higher interest rates, lower demand
New industrial construction starts are down 50 percent year-over-year, Cushman & Wakefield reported. Fewer developers are breaking ground in today’s higher interest rate environment where costs of capital are increasing. That helps set the stage for the fundamentals to quickly tighten on the other side of the supply upsurge.
Nationwide, nearly 420 million square feet of industrial space is under construction, according to CommercialEdge. Phoenix has the largest development pipeline with 42.7 million square feet, followed by Dallas with 27.23 million square feet, Charlotte, N.C., with 13 million square feet, and Chicago with 11.44 million square feet.
Sales transaction activity slows but prices hold firm
High interest rates are also slowing transactions. Industrial transactions totaled $5.7 billion in the first two months of 2024, with properties trading at an average price of $132 per square foot, according to CommercialEdge.
Despite the drop in sales over recent quarters, average sale prices for industrial properties are holding up well, increasing by 9.6 percent from the previous quarter and up 2 percent year-over-year. CommercialEdge noted that is significant because higher interest rates, tightened capital markets, and the normalizing demand haven’t resulted in discounts on pricing.
There was strong investor interest in Los Angeles, which boasted the largest sales volume, with transactions totaling $435 million.
Other trends to watch in 2024
-Nearshoring and onshoring boosts industrial demand
After significant supply chain disruptions during the pandemic, U.S. companies continue to do more onshoring and nearshoring of their manufacturing facilities, which will increase industrial demand. Markets offering economic incentives, skilled labor, and collaboration opportunities with manufacturers are likely to benefit from these investments, particularly in the Southeast, Texas, and Midwest, according to Gallagher & Mohan’s recent Market Report: Industrial Real Estate Outlook 2024.
-E-commerce will continue to fuel demand for industrial space
While e-commerce growth normalizes, it remains solid. E-commerce demand will continue its “slow, steady growth over the next decade,” driving retailers and their suppliers to increase warehouse and distribution space, CBRE’s Industrial Real Estate Outlook 2024 pointed out. This will be particularly prevalent in the U.S. South, with many growing population centers.
-Sustainability is a big focus
CBRE notes that with pandemic-driven demand slowing, occupiers are focusing more on energy savings for their facilities. Requirements for sustainable energy sources including solar and wind will increase in 2024. CBRE’s report said commercial use of solar panels, for example, is expected to grow by 13 percent in 2024.
There also will be more sustainable construction materials used and more installation of electric vehicle charging stations. Investment in automation and AI for both order picking and inventory control will grow, CBRE noted. First-generation space that provides these features will be in highest demand. Markets that have reliable power sources and offer incentives for environmentally friendly power options will be particularly sought after by occupiers in 2024.
Check out CBRE’s top industrial markets to watch: Central Texas; Nashville, Tenn.; Salt Lake City; Louisville, Ky.; and Central Florida.