How Much More Runway Does Industrial Have?

Years of unprecedented growth in warehouse and industrial space might finally be slowing down


A frantic search for warehouse space erupted after the COVID-19 pandemic disrupted supply chains and drove greater demand for space supporting home delivery to online shoppers. 

Warehouse owners enjoyed lots of leverage in lease negotiations with tenants during the last three years, when rents for warehouses and other industrial properties spiked. But warehouse rent growth may decelerate this year under the weight of a weaker economy. 

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“Some markets like Southern California have seen 12-month rent growth at 70 percent,” said Mark Russo, senior director and head of industrial research for North America at Savills, the real estate services firm. “To say they’ve had a good run is an understatement. It has been an unbelievable ride in terms of rent growth. … Certainly, in some markets — South Florida, Northern New Jersey, Southern California — we are hitting a bit of an affordability wall.”

In the summer of 2020, pandemic-driven demand for warehouse space was at its peak, said Mike McCrary, an executive managing director at brokerage JLL (JLL) and co-leader of the firm’s team in the Inland Empire region of Southern California. Back then, he said, a newly built warehouse with 250,000 square feet would draw as many as a dozen bids to lease within two to four weeks of the start of active marketing.

“Everybody was trying to ramp up their supply chains. Everybody was frantic” to find storage, McCrary recalled. “It wasn’t just toilet paper. It was PPE [personal protection equipment] and masks and hospital beds. It was scrubs. Everybody was trying to get everything they could.”

With so much demand for warehouse space, the average asking rent for U.S. industrial properties increased at high-speed annual rates of 17.2 percent in 2022 and 10.3 percent in 2021, much faster than the pace of the recent past, according to a market research report by Newmark (NMRK), another brokerage. Comparable Newmark data shows that, from 2011 through 2020, asking rent grew at a much more pedestrian annual rate, averaging 4.3 percent.

The average industrial asking rent nationwide surpassed the double-digit mark for the first time in 2022, reaching $10.31 per square foot. Rent growth is expected to persist throughout 2023, but at a slower pace, Newmark reported. What’s more, rents could decline in some areas. 

Signs of a 2023 slowdown in industrial rent growth include an increase in the amount of industrial space available for sublease and reduced leasing activity, Savills’ Russo said. “We think this slowing will become more pronounced over the next year, and tenants are going to gain some leverage,” he said. “In the last two years, tenants have had next to no leverage in the market. So, we think the market will get more balanced.” 

Generally, landlords have started to become more flexible with lease terms, Russo said. “Effective rents will likely decline due to things like months of free rent added to leases and lower annual [rent] escalations built into the lease,” he said.

JLL’s market research shows that industrial rents dropped in nine metropolitan markets from the third quarter to the fourth quarter of 2022, ranging from declines of 1.3 percent in Milwaukee and 2.7 percent in Pittsburgh to 4.4 percent in Des Moines and 4.9 percent in Memphis.

Slower growth in e-commerce is one reason why brokerage Colliers expects industrial rent growth this year in a compressed range of 4 to 6 percent compared with 2022. 

“We’re still expecting e-commerce to grow through at least 2025 but not at the same pace,” said Stephanie Rodriguez, national director of U.S. industrial services at Colliers. “We are seeing a slowdown in the growth trajectory of e-commerce, because of the monumental spike that we saw through COVID and coming out of COVID. … We will see an uptick in [industrial] vacancy in tertiary markets.”

Rodriguez said a promising segment of the industrial market are third-party logistics companies, also known as 3PLs, which increasingly handle outsourced distribution for retailers. Another hopeful segment are manufacturing companies that want to shorten their supply chains by “onshoring,” or moving operations abroad to the United States. “Coming out of COVID, and now with a lot of geopolitical unrest, companies are looking to bring their manufacturing facilities closer to the U.S., or back to the U.S.,” she said.

Brokerage CBRE (CBRE) predicted that industrial leasing activity in the United States will fall 10 to 15 percent this year to the range of 725 million to 750 million square feet. Demand will be led by 3PLs, and their share of the leasing market will rise to 40 percent by mid-2023.

In the fourth quarter of 2022, the nation’s industrial vacancy rate was 3.9 percent and almost a billion square feet of industrial space was under construction, according to a report by the privately held Transwestern group of companies. Late last year, vacancy rates were lower than average in multiple metro areas with easy access to seaports, Transwestern reported. In the fourth quarter, for example, the overall industrial vacancy rate was 2.1 percent in Miami, 1.8 percent in the Inland Empire, and 1.7 percent in Orange County, Calif. 

“We’re going to see a slight tick up in vacancy in 2023 but I don’t think it’s going to be extreme. We don’t see overbuilding,” said Barbara Perrier, a Glendale, Calif.-based vice chair of CBRE. “Vacancy is going to come in the smaller size ranges. Smaller businesses might be struggling a bit more, due to people spending less and inflationary factors.”

Investment in warehouses and other industrial properties has declined along with sales of income-producing properties in general since the Federal Reserve started to raise interest rates last year to reduce inflation. “Right now, it’s very slow. Anybody who doesn’t have to be a seller doesn’t want to be a seller now because they get hit on pricing, and pricing has adjusted,” Perrier said. “Buyers and sellers are not in sync because, for so long, we had such a big run-up on values. Now, we’re in kind of a new world, and sellers don’t like it, understandably.”

She said cap rates for industrial properties depend on lease terms and many other factors, but they are generally about 100 basis points higher than in March 2022, when the Fed began a series of interest rate hikes. Owners of industrial buildings for sale can increase their cap rates by lowering the price of the property or increasing its operating profit, through rent increases or other means.  

High rents in Southern California, however, are encouraging some industrial tenants to move to Phoenix, Reno, Las Vegas and other lower-cost metropolitan areas, Perrier said. “Rents in those markets haven’t gone up that much, maybe 10 or 15 percent, so they have running room as companies get priced out of the Southern California market,” she said. “We’ve come off such record rent growth that we do feel that it’s going to taper a bit.” (Which is not to say that developers have gotten the message quite yet. Commercial Observer reported earlier this month that Union Bank paid $53.5 million for an empty plot in the Inland Empire, still the heartland of industrial development.)

On the East Coast, veteran South Florida warehouse investor and developer Ed Easton also expects restrained rent growth this year but remains bullish on the industrial market. His Miami-based company The Easton Group owns more than 5 million square feet of industrial properties, mainly in the Greater Miami and Fort Lauderdale areas, and has another million square feet under construction, including joint venture projects with LBA Group and Prologis (PLD).

“The industrial market will be more normal in 2023 but show decent growth,” Easton predicted. “In the South Florida area, you’re going to see 2 to 3 percent growth in demand in 2023, and not as much growth in supply because of the constraints of the cost of money.”

Most of the tenants in Easton’s South Florida warehouses handle imports and exports, and a smaller number run e-commerce businesses. “About 13 percent of our warehouses are e-commerce-related, versus nothing 20 years ago. That’s an added component to the industrial market,” Easton said. 

Cap rates for industrial properties in South Florida generally have held steady at about 4 percent, thanks to higher rents in the market, Easton said. “I’m still very optimistic for 2023,” he said. “I don’t think rents are going to increase the way they have in the past couple years, percentage-wise. But I do think they will increase … I would say 5 to 6 percent.”

Some of the downward pressure on warehouse rents stems from the widespread cessation of pandemic precautions, such as social distancing in public places, and its impact on e-commerce, said Dov Hertz, president of New York City-based DH Property Holdings, a developer of industrial buildings in urban in-fill locations in the Northeast. 

“Once people were able to go out and shop, and you started to see a dip in consumer demand for e-commerce, you started to see a dip in tenant demand for industrial space,” Hertz said. 

“That caused a dip in the percentage of year-over-year [industrial] rent growth. At one point, it was 30 percent. It was ridiculous. It was unsustainable, frankly.”

Hertz made headlines last summer when his company DH Property and a partner sold a new logistics facility leased by Amazon (AMZN) to the investment arm of CBRE, which paid $330 million. A joint venture of DH Property and Goldman Sachs Asset Management developed the four-story, 400,000-square-foot facility at 640 Columbia Street in Red Hook, Brooklyn. The Real Deal reported that Amazon signed a 12-year lease for it in 2021. 

In evaluating industrial properties as potential investments, Hertz said he assumes their rents will rise annually in single-digit percentages. “We underwrite conservative rent growth,” he said. “We’re not underwriting 10 percent when we look at a deal. We’re underwriting a lot less, and if it works at a lot less, then I’m not worried. I only have upside.”