The Covid-19 pandemic saw more companies, especially in third-party logistics and e-commerce, clamor for mega warehouses measuring 1 million square feet or larger.
That trend appears to be waning, as companies reassess their space needs in the aftermath of the pandemic and tighten their belts as recession fears continue to permeate.
A recent analysis by CBRE Group Inc. (NYSE: CBRE) found a 36% year-over-year drop in lease signings that measured 1 million square feet or more in the first half of 2023.
James Breeze, vice president and global head of industrial and logistics research at CBRE, said companies during the pandemic saw a need to protect their inventory levels as global supply-chain disruptions made it more challenging to obtain products and get them to customers. More recently, companies have gotten comfortable with their inventory levels, meaning not as many massive warehouses are needed.
But the development market, as more industrial users looked for bigger and taller warehouses, responded to that trend, creating a significant amount of speculative new construction catering to tenants seeking space in excess of 500,000 square feet or even 1 million square feet.
As of the second quarter of 2023, less than 60 million square feet of industrial space was under construction nationally, according to CBRE — a significant decline from the 120 million square feet underway in Q2 2022.
“I would say larger facilities do make up a very large percentage of what’s under construction and what has been completed over the past few quarters,” Breeze said.
The bigger facilities that are already in operation are seeing their vacancy rates rise more quickly compared to buildings in other size categories. Warehouses between 700,000 and 1.2 million square feet went from 2.2% vacant in Q2 2022 to 4.9% in Q2 2023, CBRE found. The largest facilities — 1.2 million square feet and larger — had vacancy of only 1.1% in Q2 2023 but, Breeze said, those tend to be build-to-suits.
Net absorption in the overall U.S. industrial market was significantly weaker in the second quarter compared to most pandemic quarters and even levels of pre-pandemic years. Newmark Group Inc. (Nasdaq: NMRK) found that among markets it tracks, 45 million square feet of industrial space was absorbed in the second quarter compared to about 63 million square feet per quarter on average between 2015 and 2019.
Less mega warehouse leasing activity is reflected in the softer absorption observed in the second quarter, said Lisa DeNight, national industrial research managing director at Newmark. But, she added, demand in the 700,000-square-foot-plus category has actually stabilized to pre-pandemic levels.
“The challenge is, we do have a significant portion of the construction pipeline in that same category of space size,” she said, adding there’s about 180 such buildings underway nationally by her count right now. “It’s not a ton of facilities but it makes (up) a significant portion of the overall pipeline, and that is a segment I do expect availability to continue to rise.”
Right now, 67% of tenant activity in the industrial market is in the sub-300,000-square-foot range, which is what the average industrial tenant tends to occupy, DeNight said.
Softer market but no red flags yet
While tenant demand has cooled — as have construction starts — there are likely to be pockets of softness within the industrial market in the coming quarters as projects that broke ground during a more-robust market finish construction.
Gary Baragona, director of research at Kidder Mathews Inc., which works primarily within West Coast markets, said because so many metro areas have had such limited supply in recent years, there’s likely to be only a slight imbalance as new supply delivers in a slower market.
“You look at markets like Dallas, Phoenix, the Inland Empire (in California)… all of those are very, very strong and heavy distribution markets,” Baragona said. “As long as e-commerce is king, which it’s continuing to be, those drivers are going to be there.”
With fewer construction starts now, there will be a subsequent reduction in completions around mid-2024, Breeze said, and that will give markets a chance to catch up.
DeNight said even in the most extreme (and virtually impossible) scenario — if all 630 million square feet in the development pipeline delivered vacant, and tenant demand entirely evaporated — that would only push the national industrial vacancy rate to 7.9%. During the global financial crisis and other downturns, the national industrial vacancy rate was in double-digit territory.
Baragona said there’s already evidence the industrial market of 2023 is showing similar dynamics as pre-pandemic years, a trend he and brokers at Kidder Mathews anticipate will continue in the next six months.
There certainly are bright spots on the horizon, including an anticipated re-shoring of manufacturing in the United States, propped up by recent legislation from the federal government, including the CHIPS Act, the Inflation Reduction Act and infrastructure legislation. That’s widely expected to boost industrial real estate construction, including mega facilities, for operations like semiconductor fabs and electric-vehicle plants.
While there are fewer 1 million-square-foot-plus deals in the market today, those who track the market say many companies needing warehouse space will likely continue to prefer larger facilities.
Breeze noted that industrial tenants are seeking elements like higher clear heights and space requirements to perform tasks with automation in their facilities.
“(Companies) are doing more in buildings than they did before,” he said.
Source: “Fewer mega deals in national industrial sector as market returns to pre-pandemic activity“
