To say that industrial real estate experienced a boom from 2021 to 2022 is an understatement. It seemed demand for buildings that could be used for warehouse space, fulfillment centers, distribution centers, and manufacturing space would never end. Special purpose space commanded the highest price, with average rents rising from $8.47 per square foot in Q4 2020 to $11.48 per square foot by the end of 2022; however, rents rose across the board for all industrial space during the same time period. However, demand slowed in 2023 and early data for this year indicates that the market will grow at the slowest pace since 2012.
There are several factors driving the slowdown. It appears demand has been satisfied to a certain extent, which means that many companies are reassessing business operations before purchasing more space. Eric Zahniser, the managing principal at Cresa, recently explained that third-party logistics providers, which are the most active players in the industrial sector, have more space than they need. Other experts point out that economic uncertainty has caused many companies to reassess industrial space purchase and lease agreement decisions. It’s a wise move considering the fact that J.P. Morgan expects the economy to decelerate this year as consumer spending slows. The market is beginning to feel the impact of an increase in credit card delinquencies, low savings, diminished savings, and the restart of student loan payments. Wages aren’t rising even as inflation remains a concern, which is another factor that will likely put a damper on spending for the foreseeable future.
At the same time, one of the main reasons why demand for industrial space is slowing this year is that companies are putting priority on using AI and the latest tech to make the most of the spaces they already have. Zak Mirkowski, the executive managing director at Savills in Chicago, says that he has seen many industrial tenants using tools and technology to optimize current space. Zahniser points out that businesses are prioritizing automation as they seek to either optimize space or cautiously expand their operations. “Every week another large company announced plans to optimize their distribution network by focusing on automated facilities while closing older ones,” he notes. The trend will likely affect the industrial CRE market permanently. Buildings with the right specifications will be in demand as companies look to get the greatest value from their purchases or leases.
At the same time, automated facilities aren’t the only ones in demand. The cost of setting up a logistics operation at an industrial facility has risen significantly in the last few years. While rents will likely rise at a slower pace than they did a few years ago, they will most likely continue rising. Thus, many companies have shown an interest in purchasing facilities from their landlords in order to save money long-term. Naturally, not all CRE investors will find a sale to be in their best interests. However, there are good reasons to consider selling the space now that demand is slowing and many firms are consolidating operations rather than expanding them.
The industrial CRE market is facing headwinds. Some firms feel they have as much space or even more space than they need. Automation is leading many companies to explore ways to do more with existing space rather than expand to new facilities. Businesses wary of current economic uncertainty are either pausing expansion or expanding cautiously, leading to a slowdown in demand for industrial facilities. However, there are still opportunities for investors in the CRE market, as the sector is still growing even though the growth speed is far slower than it has been in the past few years. Research is vital, however, to ensure that any space purchased has the right specs for full automation. The right facilities will likely not only command the highest prices but also see steady demand.
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