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Expert Roundup: The Future of Industrial Real Estate

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We already know that the industrial real estate sector has been one of the strongest commercial real estate performers as of late. However, with deliveries already slowing down, CommercialCafe gathered industry experts’ opinions on what the market might look like in the next few years.

Specifically, we asked them about the biggest challenge facing the market, the effect of e-commerce on industrial real estate development, the future of manufacturing in the sector and other trends to watch out for in the upcoming year. Keep reading for their valuable insights.

Meet our Experts

Michael Glimcher

CEO, Retail Strategies at BGO

What is the biggest challenge that the industrial real estate sector is facing this year?

Michael Glimcher

The rising and relatively high cost of capital is probably the most significant factor impacting the industrial sector. Rising rates have impacted business growth expectations for industrial space users and made it more costly for those users to make investments into their facilities. This combination has led to a modest softening of demand in many markets.

Another big challenge is supplying these spaces with the energy they need to run properly. There is only a finite amount of energy and, in some cases, it can be difficult to supply the spaces with power. I believe developers who are able to provide modern properties in desirable locations that can handle today’s robust power needs will have a significant advantage.

Jared Riemer

The Fed’s changing interest rate policy has really increased the cost of capital, disrupting the capital markets and the value of industrial real estate. Cap rates have expanded significantly, and it’s been more challenging to get capital for industrial investments, especially debt.

Brett Turner

This year’s greatest challenge for CRE has inarguably been stubborn interest rates. While we now have more clarity on where rates will ultimately rise, the rate cuts that were expected by the end of 2023 now seem unlikely. With at least one more uptick expected by the end of the year, the pressure on lending institutions — primarily lenders of loans over $100 million — will continue into 2024.

David Tully

[1] Increased sublease space due to oversupply: The builders were able to deliver industrial space of 143 million square feet (73% of those completions were speculative, yet there was a 37% yearly growth). The industrial real estate sector faces a significant challenge this year due to a 46% increase in industrial sublease space since early 2022. This surge began in the middle of last year when recession fears led to reduced online purchases, resulting in excess warehouse inventory for many retailers. Amazon’s move to sublease 10 million square feet of industrial real estate added to this trend. As a consequence, net absorption rates dropped by 15% year-over-year in Q4 2022, and quarterly rent growth fell from 4% in Q3 to 0.9% in Q4. The sector is also grappling with a surge in speculative completions, which may raise nationwide vacancy rates from the 3.3% recorded in Q4. Despite these challenges, analysts remain optimistic about the industrial real estate market’s long-term prospects, driven by sustained demand from online retailers and logistics companies. Property owners are advised to consider short-term leases and increased build-out allowances to attract tenants in the current market.

[2] Insufficient greenfield space: A shortage of suitable greenfield space for new projects is another dynamic challenge in the current market climate of industrial real estate. Balancing land acquisition costs against workforce accessibility has traditionally been a key consideration. Purchasing expensive greenfield sites may lead to high rents for tenants, while remote locations can deter cost-conscious companies due to employee commuting costs. Additionally, fees associated with transporting goods from seaports or freight depots to warehouses pose challenges. Developing brownfield land is a potential solution, but it can face opposition, causing delays. However, it offers faster construction timelines, addressing the demand for same-day delivery.

Do you think that e-commerce will continue driving industrial real estate development?

Michael Glimcher

Yes, I do believe that e-commerce will continue to be an important factor driving industrial real estate development, but it is only one of many drivers. Other categories — such as distribution, third-party logistics and transportation, to name a few — also all play important roles. So, yes, I believe the e-commerce trend will continue, but other factors will also be vital in industrial development.

Jared Riemer

E-commerce expanded very rapidly during the pandemic to adjust to changing consumer needs as brick-and-mortar retail shut down. Many tenants expected that e-commerce would continue to grow above previous trends and they expanded their real estate footprint accordingly. Now, consumers are shifting their spending to services, and e-commerce has returned to its pre-pandemic trend line and many tenants are still growing into their industrial real estate footprints. E-commerce will continue to be a long-term demand driver for industrial real estate, but it seems like it may have over-expanded in the short-term in response to the pandemic.

Brett Turner

E-commerce will certainly continue to expand since it’s such a critical component of the multi-channel retail network. In the past couple [of] years, however, we’ve also seen tremendous growth in other innovative uses, such as advanced manufacturing. The reshoring phenomenon in the wake of the pandemic — combined with technological advancements and massive federal initiatives to promote U.S. manufacturing — has reinvigorated the industry, and this will continue for some time.

David Tully

Yes, e-commerce is expected to remain a driving force in industrial real estate development due to the ongoing consumer demand for online shopping and the need for efficient warehousing and distribution to meet this demand. The convenience and selection offered by online shopping have become ingrained in consumer behavior, making it a sustainable driver for the industrial real estate sector’s growth.

In your opinion, where is the future of manufacturing in industrial real estate heading?

Michael Glimcher

It’s always difficult to predict the future, but one area that I believe is going to be very significant in the future of manufacturing in industrial real estate is onshoring. As we saw through the COVID-19 pandemic and the recent political landscape, having the ability to supply manufacturing operations in the U.S. can provide significant advantages. As companies seek to simplify supply chains and avoid any possible political headaches, onshoring will contribute to an increased demand in industrial properties.

Jared Riemer

Manufacturing is diversifying its footprint both globally and locally. It’s tough to say where it’s heading, but we are seeing more manufacturing uses return to the United States in order to create supply chain resiliency.

Brett Turner

The use of artificial intelligence and automation is becoming a greater contributor to manufacturing, which is accelerating the evolution of industrial real estate. We’re seeing this particularly in the semiconductor space, where AI is fueling greater productivity and innovation. Accordingly, our tenants that produce components for these manufacturers also have a continued need for expansion.

David Tully

[1] Technology integration: In New York alone, the global industrial robotics market was valued [at] $48.5 billion at the start of the year. Automation and technology adoption are becoming integral to manufacturing within industrial real estate. The use of industrial robots and advanced technologies in factories and warehouses is expected to increase, making manufacturing more efficient and less space-intensive. In industrial real estate manufacturing, the integration of technology like robotics and automation is projected to increase by 11.4% in 2032 ($142.8 billion).
[2] Demand for flexibility: Small industrial properties — often referred to as flex space — will remain in high demand due to their affordability and adaptability. These properties cater to a variety of business needs and are expected to continue being sought after. Although adoption rates will vary by industry, still the anticipation is that 30% of the market will be made up of flexible space by 2030.

Will innovations such as multi-level warehousing be slowed down?

Michael Glimcher

Overall, I believe that, as the industrial sector continues to evolve, innovations in development will also continue. Multi-level warehousing is an important trend in urban areas where land development can be difficult and expensive, and, in general, buildings are getting taller as they must now support new automation technologies. With the growth of these technologies, buildings must also adapt, as well.

Jared Riemer

As capital supply to industrial real estate development has slowed, we’ve seen less interest in risk-taking generally, which will likely affect investment into new and innovative designs for warehousing, such as multi-level warehousing. Cap rate expansion and rent stagnation will also make densification less economical in the short term.

Brett Turner

The spike in interest rates and general uncertainty about the direction of the market is going to make development tough for a period. With developers pressing the brakes on traditional warehouses, experimental designs — such as multi-level warehouses — will likely be put on hold until the cost of capital comes back in line and construction pencils out.

David Tully

Infrastructure investment: Governments and private entities are investing in improving urban infrastructure, including transportation and logistics. Multi-level warehouses can play a vital role in supporting these efforts by providing storage and distribution hubs in urban centers.

What are your predictions regarding industrial real estate trends in 2024?

Michael Glimcher

The combination of a modest reduction in demand and some as-yet unabsorbed new industrial supply has curtailed the rate of rental growth in many markets during 2023, but the construction pipeline has significantly diminished, and we expect to see stronger rent growth return in 2024. Historically, U.S. industrial rent growth has shown impressive momentum, while the rent costs are normally a small portion of the total logistics costs for the tenant. Hypothetically, even a 25% rent increase would only increase the overall cost burden by about 1% in many cases. Developers who are able to supply modern properties may be able to take advantage of these increases.

Jared Riemer

We’ll be keeping a tight focus on the health of the consumer, and we’ll look to see whether consumer spending patterns shift back to goods-sector spending and away from service-sector spending. If strong consumer spending comes back to the goods sector, then we would expect to see an increase in tenant demand. We’re not expecting interest rates to come down materially in 2024, so we expect the cost of capital and cap rates to remain elevated.

Brett Turner

If the Fed ceases its interest rate hikes like many expect, the market will go through a period of adjustment next year. Still, cap rates will likely hold steady through 2024 and rents will continue to climb — albeit at a slower pace than the unprecedented growth we saw in the post-COVID period.

David Tully

Smaller, but better offices in corporate real estate. In 2024, industrial real estate trends are expected to align with the changing dynamics of work. Companies are likely to adopt smaller, more efficient office spaces, with reductions of 20% to 50% in office footprints observed. Premium-grade offices will focus on providing an exceptional employee experience, featuring flexible workspaces, fitness centers, and eco-friendly designs. Some office spaces may be repurposed for mixed-use developments, addressing community needs. Sustainability will remain a priority, with a move towards green-certified buildings, zero-carbon emissions, and eco-conscious practices, driven by both environmental concerns and upcoming regulations.

What will the industrial market look like in the next three to five years

Michael Glimcher

The industrial market is strong, and I don’t see that changing any time soon. Manufacturing, e-commerce, onshoring — these are just some of the drivers that will continue to push people into industrial properties. Even if one of these drivers is to slow down, the others will continue to drive demand, especially for modern industrial properties that are able to meet the evolving needs of the sector. Groups that focus on developing or acquiring buildings that can keep up with (and stay ahead of) this industrial revolution have the potential to be very profitable.

Jared Riemer

In the longer term, we expect industrial real estate demand to be supported by longer-term drivers, like e-commerce. The lack of availability of construction lending starting in 2022 helped moderate supply in many markets. In SoCal, supply has also been inhibited by a challenging entitlement process and the lack of large land sites, especially for larger logistics product. These supply challenges should help those markets return to a healthy vacancy level that should support long-term rent growth again. These dynamics will continue to make industrial real estate a preferred asset class for institutional investors.

Brett Turner

COVID brought attention to the need for reliable logistics and manufacturing. Tenants will continue to see their real estate as a larger part of their overall operating expense than before. This reframe has created a fundamental demand shift that will put upward pressure on rents.

David Tully

Over the next three to five years, the industrial market will see ongoing growth and transformation. Industrial and apartment rents which will peak by the end of 2023 — will maintain strength, but at a slightly lower pace in the following years, with yearly increases averaging 5.9% and 4.5%, respectively. Retail rents are predicted to grow annually at an average rate of 1.7% with a dip expected in 2023. Office rents will experience minimal growth, with the most significant gains anticipated in 2024. Total returns will temporarily moderate to 3.8% by the end of 2023 and are projected to strengthen to 7.0% in 2024, although still below the long-term average. Property-wise, 2024 returns are expected to range from industrial properties at 9.6% to office properties at 4.1%

If you found this article useful and informative, please feel free to check out our Expert Insights & Roundup Series.

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