With nearly 60 markets across the U.S., we’ve utilized JLL local market intelligence to gather insightful information on the current supply conundrum. This report addresses the various challenges occupiers, landlords, investors, and developers are facing as the availability of industrial space and land to build upon continues to descend. 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. 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. While this is a snapshot of current conditions, we hope you find this report valuable and come away with a new perspective on the supply crunch.
The industrial market continues to grow, but can it keep up with demand?
Over the last decade, total U.S. industrial inventory increased by 18%, with markets such as Chicago, Inland Empire, Dallas–Fort Worth and Eastern and Central Pennsylvania seeing the most growth. Prior to the pandemic, a steady flow of tenants taking occupancy and projects being delivered to meet demand kept vacancy rates stable. However, in 2020 the pandemic shattered old consumer shopping habits, accelerating online shopping. This ultimately sent shock waves down the supply chain system and contributed to an increase in warehouse demand as tenants grappled with ways to prevent a future shortage of inventory. These events were defining moments that shed light on the fact that there is not enough supply to meet rapidly increasing demand in the industrial market. The surge in demand from tenants looking for space to store goods once they’ve left the port increased competition in the overall market, while COVID-related construction delays and material shortages pushed deliveries out and supply trailed behind. As a result, the gap between the amount of space being delivered to lease and the volume of tenant demand grew, resulting in a supply deficit. While deliveries are rebounding from the onset of the pandemic, supply growth is unable to keep pace. Given the heightened demand experienced in 2020 and 2021 and the velocity at which it is going forward, we are starting to see the first wave of a supply crunch.
Pandemic-related restrictions and a lull in new deliveries contributed to industrial inventory aging at a more rapid rate than ever before. To date, the average age of industrial product in the U.S. is around 42 years old. Sun Belt cities such as Las Vegas, Charleston, Inland Empire and Austin have younger-aged buildings on average and a larger inventory of modern product from recent population growth. Similarly, some of the oldest assets are located in old manufacturing towns such as New York, Pittsburgh and Cleveland. Older-generation buildings, or those built over 20 years ago, account for 75% of the total industrial inventory. Compared to newer-aged facilities, these buildings typically have lower ceiling heights, fewer dock doors, limited trailer parking and larger footprints.
What do industrial tenants want in 2022?
In the last decade, the way tenants utilize their space and the markets they want to be in has changed considerably. Companies in industries such as e-commerce, 3PL and logistics and distribution have been leading the way with increased demand and utilization of modern facilities to attract labor as well as move goods in and out of the facility at a much faster rate than seen before. These facilities are being built with higher ceiling heights to accommodate mezzanine structures and higher inventory stacking capabilities, providing amenities that are seen in office buildings in hopes of attracting and retaining talent. 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.
Location above all else
To meet consumer delivery expectations, industrial users are adapting to older, smaller and less functionally sophisticated spaces as there are very few modern facilities within urban centers. Demand for Class A space is at its peak, with almost 70% of the newly modernized inventory already preleased upon 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. With Class A industrial space only accounting for a small portion of total U.S. inventory, markets with a higher industrial building stock of second-generation facilities have an opportunity to repurpose and modernize them to fit the current needs of industrial users. By doing so, they will be able to facilitate future industrial occupiers and potentially absorb the increasing demand this property sector has been experiencing.
The competitive leasing environment is accelerating rent growth
From an occupier perspective, warehouse rents are a small part of the overall operating cost formula, relative to transportation and labor costs. However, as rents continue to increase, occupiers are seeing this operating expense grow notably and become an important factor when making executive decisions. Demand from industrial uses, coupled with rising demand from traffic-clogged ports, has resulted in near-zero vacancy rates in many urban logistics markets. 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. In essence, there isn’t enough availability in the market for industrial tenants or developers, which has resulted in heightened competition and above-average rents. Over the last five years, a competitive leasing environment has accelerated U.S. industrial rent growth by 37%. Amid the competition for space, landlords have a greater ability to command a premium for rents. We’ve seen a few isolated and unique situations where rents have increased by more than 50% year-over-year. Markets with the highest asking rents in the U.S. include New York City, Mid-Peninsula, Silicon Valley, Long Island and Los Angeles. This trending environment with escalated rents is expected to continue over the next 24 months as deliveries continue to get pushed out and demand outpaces space availability. 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.
Adaptive reuse and replacement conversion projects
JLL Research has identified nearly 100 proposed, under-construction and existing conversions across a dozen of the nation’s top urban logistics markets. Each conversion falls into one of two broad categories: adaptive reuse and replacement. Candidates for adaptive reuse typically include distressed malls and big-box stores. Their large floorplates, high ceilings and massive parking lots are beneficial features, and location allows for multiple points of access to major thoroughfares. While several adaptive reuse projects have been initiated in the U.S., barriers to entry such as zoning changes and expensive alterations typically render these conversions infeasible to developers. In contrast, the demolition and replacement of existing structures is far more common. Unlike adaptive reuse, replacement projects originate from many different types of former use, with site size, proximity to major highways and zoning being the most important aspects of the properties. Unsurprisingly, we have seen strong replacement conversion activity in some of the highest rent markets in the country, including Los Angeles and New York City, where demand is strong enough to justify the development costs.
Another popular concept taking shape in the densely populated areas are multistory warehouse projects. These buildings feature multiple levels of warehouse space, each with loading docks and truck courts connected by ramps. For users who need to move goods through their facilities quickly, the multistory design offers greater utilization than mezzanine structures. While development costs tend to be greater for these well-located and innovative structures, occupiers who value proximity to customers are willing to pay top-of-market rents.
Shifts in demand spark new trends in the construction pipeline
Given that industrial users want to be near high-density urban cores to quickly access their customer base, small-box developments have been the most popular size segment to build. To date, this size segment accounts for 60% of projects currently under construction. While small-box properties account for the majority of the pipeline, developers have faced economic, physical and political dynamic challenges in densely populated areas when taking on these projects. That said, in the last 18 months, the number of mega-box developments being added to the construction pipeline has outpaced all other size segments. While demand for facilities in close-in locations have increased the number of developments currently in the pipeline, the high cost of land and the economies of scale from building larger structures makes big-box facilities an easier fit.
Sun Belt markets have been leading in new development
Population growth and migration patterns have played a factor in which cities are seeing the highest number of new deliveries hit their market. Cities such as Dallas/Fort Worth, Atlanta, Inland Empire, Phoenix, Houston and Memphis are seeing the highest volume of new deliveries hit their market. Amid favorable market and demographic trends, Sun Belt markets have seen some of the largest year-over-year increases in project cost. As migration patterns continue to favor Sun Belt cities with strong affordability and job opportunities, we anticipate demand for industrial space to continue. Demand and commodity pricing show no signs of slowing down in the near term. This will enable general contractors to justify passing their increased costs to the investors and end-users. However, as other sectors continue to recover and new development becomes feasible, construction costs are expected to stabilize and have the potential to alleviate costs passed down to tenants and investors.
The total cost to build a new warehouse, including labor, is up 21% over the last year
The industrial construction pipeline was considerably robust pre-pandemic, with material costs already locked in and a steady flow of demand. Following the initial onset of the pandemic, projects across all property sectors experienced significant delays and cancellations. 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. Going into 2021, as restrictions eased and the economy picked up, occupiers and developers alike rushed to expand their logistics portfolio. As the industrial construction pipeline began to replenish, higher material prices and rising labor costs started to have a more significant impact on final project costs. The increasing costs to build have also added pressure to end-users, with tenants absorbing these added expenses in the form of higher rents. Over the last 12 months, the cost to build a new industrial asset, including labor, increased 13.6%. For warehouses specifically, those costs are up 21% during the same period. 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. Since most industrial buildings delivered in 2021 broke ground pre-pandemic or very close to pandemic shutdowns, all new projects entering the development pipeline will continue to be pushed out. 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.
Source: “The Race for Industrial Space“