How much do investors really need to re-examine, re-define or re-think long-term investment strategies in U.S. industrial

A mid-year review of industrial & logistics capital markets activity shows many positive market indicators, along with plenty of complex economic headwinds that are influencing investor sentiment and near-term decision-making. While rent growth, occupier demand and general leasing fundamentals remain strong and even robust in some markets, there is notable caution, trepidation and concern about persistent inflation, supply chain disruption and rising interest rates. As the Fed pushes to control overheating economic conditions, many other geo-political and socio-economic factors continue to offset themselves against others. In this issue we take the backdrop of key U.S. industrial markets at the mid-point of 2022 and discuss the importance of re-examining capital strategies, re-defining investment risk tolerance and re-thinking the long-term about market positioning.

Erik Foster

Principal
Head of Industrial Capital Markets
[email protected]
+1 312.273.9486

Complex economy driving investors' decisions

As the second half of the year gets under way, there are many complex economic issues driving capital markets decision making. While the industrial sector continues to experience strong rental growth and tenant demand, the impact of high inflation, geo-political issues, supply chain disruption, and rising interest rates cannot be overstated.

Industrial remains a top investment asset class, given its multi-faceted linkages to e-commerce growth, from large-scale distribution to the flurry of recent micro-fulfillment start-up activity – as well as the overall outlook for tenant space utilization across many other business segments and industries. Current indicators reflect a strong yet cautious capital markets environment for the near future. In this environment, many investors are re-examining their go-forward strategies and risk tolerance to ensure they are property positioned to navigate potential challenging and volatile economic times over the near-term.

Prime-grade industrial & logistics assets continue to generate significant asking rent growth in many markets, with double digit increases being the norm in markets from Los Angeles, which has experienced a 60% increase since the pandemic began, to New Jersey, where rents were up 24% over the past 12 months alone. Tight, in-demand markets are not yet at a stage of pricing equilibrium, with rents constantly being adjusted to reflect continued occupier competition in the midst of overall space scarcity.  Construction activity also remains at a solid pace across the U.S., with a balanced flow that is in line with tenant demand in most markets, but still managing timelines for delivery and occupancy.

However, while core fundamentals point to a positive outlook for the next 12 to 18 months, there is a steady undercurrent of uncertainty around the broader economic trajectory. Among the concerns on investors' minds are the potential for a recession; questions about how quickly and how high interest rates will rise; and whether the latest COVID-19 variant will impact supply chains and consumer spending.

Overall sales moderate in mid-year 2022

Industrial sales activity in the first two quarters of 2022 averaged about $25 billion per quarter, in line with activity from late 2018 through early 2020 before the pandemic-induced slowdown and subsequent spike that pushed volume to an all-time high of $61.4 billion in the last quarter of 2021, according to MSCI Real Capital Analytics.

Yet every market has its own unique supply, demand and pricing dynamics to contend with, as global, national, regional and local continue to influence mostly otherwise robust real estate markets. According to Avison Young research, here's a look at second quarter activity across a few select U.S. industrial markets:

Inland Empire

This venerable West Coast market remains a top choice for investors, yet there are limited options. This dynamic helped boost average sale prices in the second quarter by 58.9% to $295.84 psf year-over-year.  

Current trends indicate rental rates ranging from $1.25 psf to $1.50 psf triple-net (on a monthly basis), with growth forecasted to continue to increase between 10% to 15% in 2022. Those rates could be higher as newer state-of-the-art construction projects reach completion. Tenants with expiring leases, which typically span five years, are in for sticker shock as leases that were signed at $0.65 psf have doubled to around $1.30 psf.  The range for industrial land is $50 to $70 psf and as high as $100 psf or more.

Market-wide vacancies reached 1.2% in the second quarter, with leasing volume slowing to just over 4.0 msf due to the lack of available space.  There remains 37.5 msf under construction, with all eyes on Bill AB2840, which could hinder future development by banning most new industrial construction within 1,000 feet of non-industrial areas.

Los Angeles

The market-wide vacancy rate was 1.7% in the second quarter, up 30 basis points from the prior quarter. Over 2.2 msf of industrial space was delivered in Q2 2022, with 6.0 msf currently under construction. According to MSCI Real Capital Analytics, the Los Angeles metro market has recorded nearly $7 billion in sales to date in 2022, compared with $16.6 billion for all of 2021.

Industrial rents remain at record highs and have increased nearly 60% since the start of the pandemic to finish the quarter at $1.44 psf triple-net.  Average sale price for industrial space in 2Q 2022 was $335.08 psf, a new all-time high.  Rental growth is expected to be between 10%-15% in 2022.

Houston

The Houston industrial market experienced increased levels of absorption and leasing activity in the quarter, with e-commerce and other retailers filling about 38.2 msf of space in the last 12 months. As population increases help drive consumer brands’ expansion, this activity has pushed the vacancy and availability rates to record lows during the last several years.

This activity, along with increased traffic at the Port of Houston, have contributed to the non-stop development pipeline, which has totaled about 20 msf for the last two quarters.  Asking rental rates have slowly risen each quarter during the last 18 months, increasing 13.5% year-over-year to break last quarter’s record rate. Sales volume tracked by MSCI Real Capital Analytics totaled $1.29 billion in the first half of 2022.

New Jersey

Despite more than 20 msf of industrial space under construction in this prime East Coast market, occupier demand is outpacing the increase in supply. Due to land constraints, overly competitive pricing, and labor shortages in select areas, industrial developers are getting more creative in order to service the increasing demand for warehouse and distribution space. This is resulting in more ground-up and conversions projects along the northern NJ/NY border where land is less expensive and there is ample labor. This activity has placed even more pressure on rents, which have increased by 24% overall over the last twelve months.

Atlanta

The Atlanta industrial market is at a 2.0% vacancy rate and landlords have begun to push escalations to a new standard of 4%. As existing available space remains limited, average asking rental rates continue to rise, moving up by14% year-over-year in the second quarter and showing no sign of slowing down. Landlords are also starting to limit concessions or remove them all together.

There is a record breaking 50.5 msf of new space underway, which is helping to ease the burden of larger tenants looking for space. Investment sales totaled $2.24 billion so far in 2022.

Miami

Miami’s industrial market is shattering records, with the overall average rental rate rising to $13.93 per sf, a hike of 12.5% in just one quarter. Record low vacancy and new construction have been driving rent growth with some landlord asking as high as $14.95 NNN for new industrial product.

With more than 7.0 MSF of industrial space currently underway, Miami is on track to have the strongest year on record for construction deliveries. Mid-way through 2022, just over 3.2 MSF of industrial space has delivered in Miami-Dade County, which is already 72.4% of total deliveries recorded in 2021. Additionally, an impressive 4.3 MSF is still expected to deliver by the end of this year.

South Florida has been hit by Amazon's recent decision to pull back on its space utilization. The company announced plans to sublease 10 MSF of warehouse space throughout the US, with some of those transactions expected to hit the market in South Florida over the next few quarters.

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