If anyone believes demand for industrial real estate is cooling, brokers, developers and investors in the sector would say they’re dead wrong.
With vacancy rates approaching zero percent in some markets, catapulting asking rents and sparking bidding wars for leases, the sector’s emergence as the hottest commercial asset class continues.
“This is not a market we’ve ever seen before,” said Jordan Kovalsky, who heads the Chicago division of the industrial-focused real estate investment firm Faropoint.
The demand has forced players in infill markets to get creative about bringing new space to the market.
“As brokers, we’ve started to look for redevelopment sites, for any industrial land to sell to developers,” said Newmark’s Kyle Eaton, who works across New Jersey.
Demand from e-commerce giants such as Amazon and manufacturers has developers focused on building big-box, single-tenant industrial warehouses — usually larger than 500,000 square feet. This leaves smaller tenants, who require less space, with less access to modern facilities.
Home to warehouse
Last April, Prologis and ML Realty Partners teamed up to spend $64 million on land in suburban Chicago to build 600,000 square feet of warehouses — only the land wasn’t vacant.
The investor duo purchased more than 100 homes, in some cases paying triple what the homeowners had, with plans to raze them and build two warehouses on the property.
“The Chicago market is so popular that developers are coming in and doing covered land plays,” Kovalsky said. Since the homes were located near O’Hare International Airport and surrounded by industrial properties, they’re in a prime distribution location.
Prologis’ deal is one of many examples of developers buying non-industrial properties to convert them to Class A warehouse space, even if it means waiting out existing leases.
In Los Angeles, Rexford Industrial Realty recently purchased about 100,000 square feet of land near LAX, where an aviation college holds a long-term lease.
“They can certainly operate out of there, but if they ever decide they don’t want to stay, we can redevelop the site into two industrial buildings,” said Patrick Schlehuber, Rexford’s head of acquisitions.
Across all markets, developers are more willing to make these deals happen if the property is already zoned for industrial use.
“The biggest key is having the entitlements, but also being well-located and near highways and distribution hubs,” said Tony Pricco, chief investment officer at Chicago-based real estate investor Bridge Industrial.
A tenant problem
Each of the 100 largest industrial leases signed last year were for more than 1 million square feet, according to CBRE. With tenants willing to take up such massive amounts of space, it’s no surprise investors are drawn to big-box properties. As rents eclipse $1 per square foot per month in some markets, including L.A., owners can reap at least $12 million per year on 1 million-square-foot properties.
But big-box warehouses only work for big firms. As a result, smaller tenants are often stuck with older industrial properties, which don’t have tall clearances or modern loading docks.
Approximately 75 percent of vacant industrial space across the U.S. is smaller than 300,000 square feet, according to Newmark.
Most of these properties are older and in urban infill markets, according to Anthony Amadeo, who leads industrial development for Woodmont Industrial Partners in New Jersey. Although there’s demand for space between 25,000 and 100,000 square feet in these markets, distributors often want them for last-mile uses, which require more modern specifications.
Spaced out
In Los Angeles, vacancy rates for distribution, warehouse and manufacturing space hit 1.3 percent in the fourth quarter of last year, according to JLL, down from 3 percent the year prior.
That’s not a unique situation. Chicago, New Jersey, South Florida and Las Vegas are all seeing vacancy levels between 1 and 4 percent, according to Newmark. “Tenants are facing a critical shortage of options for immediate requirements even as the pace of deliveries picks up,” the firm said in a November report.
Some developers have resorted to pre-leasing, which allows tenants to secure space months before a development project is finished, but pre-leasing can lock developers and investors into lower rents.
“Lock in a deal today and it could be up to 20 percent below market rates next year,” Woodmont’s Amadeo said. “It would have to be a sweetheart of a deal.”
Average asking rents for industrial real estate across the U.S. rose 12.4 percent last year, according to Newmark. In some core markets, including L.A. and Northern New Jersey, asking rents for higher-end properties have risen an astonishing 50 percent in the past year.
“Pre-leasing was always the holy grail,” said Bill Bumber at Advance Realty Investors, which has about 12 million square feet of industrial space in its pipeline. “But now, if you pre-lease too soon, it’s an opportunity to leave additional rent growth on the table.”
Advance Realty Investors did sign Target to a pre-lease deal on a 1.1 million-square-foot facility in Logan Township, New Jersey — several months before the development was finished.
That lease turned out to be a lucrative one. The firm, through a partnership with Greek Development, then sold the facility and a nearby parcel for $265 million.
“A shot of adrenaline”
Historically low vacancy rates and dramatic rent growth have led developers and investors to push forward with projects even as construction costs rise and supply chain issues cause delays.
“It’s uncharted waters,” Amadeo said. Estimates for construction costs are good for 30 days, he said, and firms are pre-ordering steel nine months in advance.
As long as rent growth keeps outpacing construction costs, which developers say it is, firms will continue to build.
“I don’t think anyone knows when a tenant is going to be unwilling to pay [industrial rents],” said Daniel Glaser, co-founder of New York-based investment firm Imperium Capital, which owns properties in 15 cities, including Miami, Denver and Dallas. “We haven’t reached that point yet.”
Until then, developers, brokers, investors and tenants will have to try and keep up with demand.
When asked how the pandemic changed demand for industrial real estate, three people gave the exact same analogy:
“It was a shot of adrenaline.”