A new method of ranking industrial markets using a two-dimensional grid reveals changes over time in both sales volume and volatility and claims to offer new insight into risks that may not be apparent in traditional one-dimensional models.
The grid was developed by NAIOP. “This may help investors and developers create better strategies around market entry and exit, and to more easily identify markets that match risk and return objectives or merit further examination,” stated a report by NAIOP.
The report analyzes transaction volume and capitalization rates data provided by CoStar. It sorts industrial markets into two groups — the largest 51 markets, and the next largest 51. The vertical axis measures transaction volume and the horizontal axis volatility. The report uses this technique to compare the positions of large and mid-sized U.S. industrial markets at the end of Q1 2019 and Q1 2023.
“The grids reflect e-commerce’s continued positive impact on industrial markets. The largest industrial markets were more likely to experience increased transaction activity between Q1 2019 and Q1 2023 with fewer notable changes in volatility,” the report stated. Sharp transaction increases occurred in Orlando, Northern New Jersey and Las Vegas, while Kansas City dropped to the lowest level of the largest industrial markets with a decrease in accompanying volatility.
“On average, the 51 largest industrial markets in Q1 2023 experienced 30% higher volatility in cap rates and 22% lower volatility in transaction volumes compared to the second-largest 51 markets in the same quarter. Larger industrial markets attract more investors, which explains their greater liquidity, and may also explain greater cap rate compression and expansion during periods of economic expansion and contraction.”
The report noted that land scarcity limits the supply of new industrial space, affecting capital flows, while contributing to additional development in smaller industrial markets where land is more abundant.
Q1 2023 saw Durham, Palm Beach and Savannah join the list of the largest 51 industrial markets, replacing Charleston, Cleveland, and Harrisburg which dropped to the lower tier of industrial markets.
“Savannah’s growth is particularly interesting, as its rise into the largest 51 markets is an indication of its growing significance as a port city. Savannah’s location, including its proximity to Atlanta and to major rail lines and interstates, gives it a strategic position to serve 45% of the U.S. population,” the report commented.
Indeed, several Southern industrial markets grew in transaction volume, especially those in Florida, Virginia and Alabama. Bakersfield and other California markets also experienced growth as development moved inland due to a lack of development opportunities in Los Angeles.
However, some smaller markets dropped out of the second-largest set of 51 industrial markets altogether. Supply chain issues, pandemic effects or diminishing availability of developable land may have contributed to this trend.
“The largest office and industrial markets experience lower transaction volume volatility but higher cap rate volatility than mid-sized markets,” the report stated. “Investors and developers with shorter investment horizons may be attracted to larger markets for the greater liquidity they provide and their greater potential for cap rate compression when business conditions are favorable. However, these markets’ higher cap rate volatility also presents downside risks.
“Investors with longer time horizons may look to mid-sized markets, which generally offer lower cap rate volatility and higher yields.”