A massive race for space. That’s the most fitting way to describe the booming industrial market we’ve seen from coast to coast since the onset of the health crisis. Throughout 2021, strong e-commerce and retail sales—combined with supply chain challenges—fueled demand for space in the industrial sector, especially for warehouse and distribution centers.
And demand continues to outpace supply. The U.S. market absorbed a total of 140.7 million square feet in the third quarter, while overall absorption is predicted to reach 507.3 million square feet of space in 2021. Meanwhile, the national vacancy rate stood at 4.1 percent at the end of the third quarter, down 110 basis points year-over-year, according to Cushman & Wakefield research.
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With supply chain bottlenecks and rising transportation costs, there’s an increased push toward building resilience. As a result, companies are switching from a just-in-time inventory to a just-in-case supply chain strategy, pushing up the need for space.
At the same time, occupiers are also racing to improve their last-mile strategies by being closer to the end consumer. This approach, however, is predicted to disproportionately benefit gateway markets as they are the first step on the consumption end of supply chains, according to a Prologis report. Port markets generally record the tightest vacancy rates, with the Inland Empire having only 1 percent of vacant space at the end of the third quarter—the lowest in the country, according to CommercialEdge data. In other markets, such as Los Angeles and New Jersey, vacancy clocked in at 2.9 percent and 3.4 percent.
Indeed, location matters more than ever when it comes to logistics and distribution, and instead of real estate costs, it’s the speed and cost of transportation that drive decision making, Gregg Healy, executive vice president & head of industrial services at Savills, told Commercial Property Executive.
As higher transportation costs countervail low rents, secondary and tertiary industrial markets won’t benefit as much from this shift in supply chain strategies. However, Prologis predicts that the just-in-case inventory strategy will require around 800 million square feet of logistics space in the near term. Primary, gateway locations might not be able to support this growth, considering the high barriers these markets pose when it comes to new development. Therefore, this limited opportunity for ground-up projects might push some growth into neighboring locations.
The rise of on-demand warehousing
Although the logistics sector is working toward becoming resilient against supply chain disruptions, this is not yet reflected in leasing practices across the board, as companies focus on immediate inventory challenges, Prologis reported. Forced to reimagine how they think about and utilize space, businesses have often pivoted to on-demand warehousing to secure space to suit their needs and timelines, Chunker CEO Brad Wright told CPE.
Wright believes that despite the skyrocketing demand for industrial space, there’s still a significant amount of vacant, underutilized space in the market. “These are essentially hidden gems that can provide a lifeline to businesses in need of space quickly and on flexible terms, without the hassle and expense of long-term leases,” Wright said.
Short-term warehouse solutions can, without a doubt, fill a gap in the market, especially when businesses are trying to deal with the immediate effects of the pandemic and supply chain crisis. However, the need for new space will remain a challenge as businesses work out their long-term strategies.
Next year will be as intense as 2021. E-commerce will continue to drive growth, but there will be an uptick in demand for manufacturing facilities as well, leading to a continued shortage of industrial sites across all major markets, as the types of facilities in need versus the ones available is still not in balance, according to Healy.
Additionally, occupiers will continue to look for Class A space in premium locations.
“There will be a continued flight to quality across the different buildings, as well as many users will revisit their current locations to optimize transportation resources, especially as transportation costs soar,” Healy added.
Despite material and labor shortages and rising constructions costs, Cushman & Wakefield forecasts that deliveries will pick up significantly in the next two years, restoring some balance between supply and demand.
“New deliveries are projected to reach 932 million square feet from 2022 to 2023,” according to Cushman & Wakefield. Nonetheless, the vacancy rate will remain low—170 basis points below its 10-year average between 2012 and 2021 of 5.8 percent.
On the investment side, appetite is expected to remain high through 2022, following record sales in 2021. According to Colliers, industrial transactions totaled $94.8 billion in the first three quarters of the year—the highest number ever recorded compared to the same period in previous years. Cap rate compression should also continue next year, with 3 percent and lower deals becoming more frequent.
Despite a record-setting year and the positive outlook, the persistent backlog at some of the country’s largest seaports, labor shortages impacting every link in the supply chain and the lack of available land will continue to pressure the industrial sector in the coming year, Colliers noted. Nonetheless, industrial fundamentals are expected to stay robust in the next several years.