Recently coming off the effects of nearly two years of
rising interest rates by the Federal Reserve, the real estate market has been
in a state of constant change for the past 18 months. As this blog has extensively discussed, real estate is very
dependent on interest rates, as they influence property loans, cap rates and
ultimately, property prices. Despite the recent period of adjustment, the economy
seem to show signs of normalization, with mortgage rates, consumer
loan rates and even treasury
rates settling at levels much higher than those of the previous two years. By all indicators, it seems like our economy and we seem headed for a soft
landing. No market has internalized the current state of the economy
more than the Industrial Real Estate market.
For the past few years, industrial properties were the calm
in the storm—while other property classes were being hit by the effects of either
the pandemic, the economy, technology or changing sensibilities, the demand for
warehouse and tech spaces increased. This demand accounted for a large portion of the real estate growth over the past 3 years, leading the industry in new
construction, price increases and absorption. This recent strength of the industrial
real estate market is demonstrated in Avison Young’s Third Quarter Industry
Report, found here. Now industrial property finds itself in a differnt situation and in response to an economy that has settled around higher than normal interest
rates, it seem to be cooling off.
Though the term “cooling off” may at first seem to have a
negative connotation, in this context, it is merely an indication that
industrial properties are normalizing. For example Cushman
Wakefield predicts industrial property to trend to 5% vacancy nationwide,
which is up over 250 bps from the record low vacancy of 2.3% that was hit 18
months ago, but it is still significantly lower than the 15 year average of
6.8%. The same of can be said of the cooling of industrial property new
construction seen in the Avison Young and Cushman Wakefield reports and the resultant
lower net absorption of the properties happening in most metropolitan areas in
the country. After being real estate’s champion for so long, industrial property
is normalizing.
It’s interesting that normalcy makes the industrial market
interesting, but there are a few reasons for the recent slowdown in the market.
The first is that warehouse space has become overbuilt. The pandemic lead to an
increased demand for many items, which meant that more warehouse space was
needed to store these items. A resultant decrease in productivity led to supply
shortages immediately after the pandemic and the pent-up demand led to the
appearance of a need for more warehouse spaces. Builders have attempted to keep
pace with this demand, but the market has finally indicated that more space is
no longer necessary.
Another factor contributing to the normalizing of the industrial
property market is the very same interest rates that have been a topic many recent
posts on this blog. With lending restrictions tightening and capital more
expensive in the current high interest rate market, many
investors have checked out of the industrial property market, leaving owner-occupiers
as the primary purchasers. Typically owner-occupiers are known to pay a
premium for industrial properties, given their familiarity and dependence on
the property. While the increased percentage of owner occupiers purchasing properties
many be great news to landlords holding an industrial lease, this state
of affairs also means that there are less buyers in the market. Moreover, as
owner-occupiers realize their larger presence in the market, many of them have
begun to lower the premium that they would normally offer to purchase a
property. Realizing that they’re one of the few games in town, they are
beginning to flex their increased buying power.
Yet another factor contributing to a cooler industrial market
is the lower absorption rates. Consumer demand is shrinking for many reasons
and less secondary operators are needed for the retail chains of large companies
like Amazon and Walmart. As a result, less industrial properties are being
leased. Additionally, as the companies begin to settle their technology needs,
less new technology spaces are needed, reducing net absorption among all
industrial properties.
Like most markets today, the industrial property market is finding
a way to settle into the current economy. Where it goes from here is largely
dependent on whether
the economy has a soft landing or goes into a recession. One thing is for certain—it’s
no longer the lone outlier, propping-up the real estate industry. It’s also not
a tragic case of dramatic loss. It’s just normal, and that’s fine.
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