Sublease inventory in the national industrial market grew more than 50% in the first quarter of 2023 from Q1 2022.
That’s according to research by Savills PLC, which also found less than 0.5% of the entire industrial market is up for sublease right now. Still, growth in sublease space tends to be a leading indicator of a changing market and is extremely notable, given how hot the industrial market has been in the past couple of years, said Mark Russo, senior director and head of industrial research at Savills.
“It’s not (that) the sublease availability in itself is going to upset the market,” Russo continued. “I look at it more as a barometer as for what’s coming in the next six months. It’s a signal that businesses don’t need as much warehouse space anymore. More concerning, it’s going to trickle into new leasing activity.”
Between direct vacancy and sublet space, the Dallas-Fort Worth, Texas, market has the most, at 112.8 million square feet, Savills found. With 4.4 million square feet of that total inventory sublease space, it makes up less than 4% of the entire market.
Chicago, meanwhile, has about 6.9% of its available inventory as sublease space, or 5.2 million square feet — and the second-most available warehouse space currently, among markets tracked by Savills.
Atlanta, at No. 3, has 5.3 million square feet of sublease space on the market, or about 7.6% of its available industrial space.
But the most competitive industrial markets across the U.S. tend to have the biggest share of sublease space among vacant warehouse real estate, Russo said. The Inland Empire in southern California, for example, has 11.2% of its available warehouse space as sublet inventory.
“In these very tight markets like southern California and New Jersey, you’re more likely to look at a sublease option … where it’s been very difficult to get a nice, quality, functional warehouse space in recent years,” Russo said.
Companies that have put their industrial spaces on the market are facing a tougher economy and are looking to cut costs, including on their real estate. Some tenants are putting spaces they’ve never occupied on the sublease market these days, Russo said.
Boston-based Wayfair Inc. (NYSE: W), for example, canceled plans to open a distribution center in the Houston market, citing changes to its business. The company last year took other cost-cutting measures, including layoffs, because demand for e-commerce furniture slowed compared to pandemic years.
New industrial warehouse construction
One potential point of concern is how much new construction certain industrial markets are underway on right now.
The first quarter ended with 663.3 million square feet of warehouse space under construction nationally, according to Cushman & Wakefield PLC (NYSE: CWK). While that’s a decline from the previous two quarters, it’s still high on a historical basis.
It’s widely anticipated construction starts in industrial will pull back this year, which could eventually balance the supply issues some markets will temporary face with slowing tenant demand.
Jon Pharris, co-founder and president at Newport Beach, California-based industrial real estate firm CapRock Partners LLC, said it’s felt like the industrial market has gotten ahead of itself during the past two years. E-commerce sales exploded at the start of the Covid-19 pandemic but consumer spending, including online, is beginning to pull back, and companies are tightening their belts ahead of a widely predicted recession.
While CapRock pulled back earlier than others on buying because of where pricing has been in the past couple of years, Pharris said there will be opportunities in 2023, as land values have softened and capitalization rates are up. CapRock has about 7 million square feet of industrial development underway right now, in western and central U.S. logistics markets.
“The bar has been raised for the entire industry, meaning the economics need to be attractive, the location needs to be attractive, competing supply needs to be limited,” Pharris said. “As construction financing has slowed down, that will naturally limit the amount of construction coming online.”
Cushman found 84% of the space under construction at the end of Q1 was speculative. Pharris said his firm continues to do a mix of spec and build-to-suit construction projects but has gotten pickier on location — similar to the office market, a flight-to-quality trend is being observed now in the warehouse market, he said
Nearly half — 46.4% — of all leases tracked by Cushman in Q1 were in Class A industrial buildings built since 2020. Leasing activity in Class A properties accounted for 46.2% of all deal volume in 2022 and 40% in 2021.
It may take until 2024 for supply and demand dynamics to catch up, Russo said, as a lot of new product will continue to hit the market in the next six to 12 months.