Industrial REITs are facing challenging fundamentals today, including slower leasing demand and elevated supply. At the same time, analysts also point to encouraging developments for the sector that include increased leasing activity by Amazon, a drop in new construction starts, and an uptick in localized manufacturing.
Meanwhile, first quarter data from the Nareit Total REIT Industry Tracker Series (T-Tracker®) report highlights ongoing strength for the industrial sector, with average occupancy during the first quarter at 96.1%, compared with average occupancy for all equity REITs of 93.2%.
REIT.com spoke to Camille Bonnel, REIT analyst at Bank of America Global Research, and Vince Tibone, head of U.S. industrial and mall research at Green Street, to gauge their views on developments in the industrial sector.
Broadly speaking, how do fundamentals in the industrial and logistics real estate sector look today?
Camille Bonnel: Leasing activity has slowed across all regions over the last few quarters, reflecting an environment where businesses have been recalibrating inventory levels. Consumers have shifted away from spending only on goods and higher interest rates have put a greater focus on optimizing costs for businesses. In addition, the combination of new construction deliveries has added to vacancy. Throughout this, net absorption has remained on par with pre-pandemic averages, which were considered normal growth years during an extended expansionary cycle. We continue to expect demand to remain slow during the first half of the year but are starting to see early signs demand is returning.
Vince Tibone: Industrial demand negatively surprised in the first quarter with net absorption only totaling 14 million square feet, down from a 70 million square feet quarterly pace in 2023. Supply completions remain elevated. Supply exceeded demand by 100 million square feet in the first quarter, which is one of the worst quarters in history, rivaling only the depths of the GFC and the burst of the dot-com bubble. In those prior periods, supply was lower while net absorption was negative.
How does the outlook for leasing volume look for the rest of 2024 and into 2025?
Tibone: In a recent Green Street research report, demand forecasts for 2024 and 2025 were reduced by 50% and 30% respectively, driven by tepid first quarter demand, increased concerns around excess supply chain capacity and inventory trends, and lower real retail sales estimates. We are now expecting 150 and 225 million square feet of industrial net absorption nationally in 2024 and 2025, respectively.
Bonnel: We believe the outlook for industrial is quite encouraging with several key markets with new supply pressures seeing higher leasing volumes already in the first five months of the year. Amazon’s expansion this year suggests early resurgence in demand as competition picks up from Walmart and overseas e-commerce players. There are a sizeable number of tenants active in the market, with leasing volumes expected to pick up in the latter half of the year.
What variations in geographic markets are you seeing?
Tibone: Demand is currently weakest in markets where vacancy rates were the lowest, generally coastal markets. Many tenants appear to have over-leased space at the peak in these metros given that there was fierce competition to secure warehouse space, rents were spiking, and goods consumption was booming. Tenants erred on the side of leasing more space than less in that environment to ensure there was capacity for future growth, leading to excess supply chain capacity today. Demand is holding up better in markets with favorable demographic trends. Our near-term fundamental outlook is strongest in Atlanta, Miami, and Tampa.
Bonnel: Market fundamentals vary from submarket to building size. Most U.S. markets have experienced flat to slightly positive rent growth year to date. Southern California remains a key outlier as it led the U..S in growth during the pandemic but has since moderated more sharply from peak occupancy and rent levels.
Southern California was also impacted from a prolonged port labor strike in 2023. Within markets, fundamentals remain strongest for smaller (less than 100,000 square feet) infill buildings where availability remains well below historic levels. On the opposite end, vacancy for 500,000-1 million-plus SF buildings is more volatile but has tightened with Amazon becoming more active this year. Mid-sized buildings (around 250,000 SF) have had the softest fundamentals recently, driven by elevated speculative deliveries over the past few years.
Are you seeing differences in terms of demand across tenant type and building size?
Bonnel: The slowdown in new leasing has been largely attributed to slower decision making around the big box format, which has been a key driver of the robust activity over the last several years. Smaller tenant activity has remained relatively stable at a similar pace to its long-term averages and resilient even through the past cycle. E-commerce, manufacturing, and food and beverage tenants have been most active this year compared to lower demand from retailers.
Tibone: Yes, demand varies by tenant type and building size. Ecommerce and large retail players such as Amazon have been more active, a positive development of late, while smaller, less capitalized tenants and 3PLs (third-party logistics) are seeing slower leasing activities. Broadly, demand for smaller suites remains healthier than demand for larger boxes.
To what extent is supply responding to market fundamentals?
Tibone: New development starts have been down significantly from peak levels over the past several quarters. This should translate into lower supply deliveries in the back half of 2024 and extending deeper into 2025.
Bonnel: New construction starts have continued to fall over the past 18 months, down over 70% since the peak as demand slowed and interest rates moved higher. Meanwhile, 55% of the current pipeline is expected to deliver during the first half of this year, leaving one of the smallest pipelines over the past decade. This will create a new space gap that will last for at least 18 months.
Have near-shoring and on-shoring trends been fully felt by the industry at this point?
Bonnel: BofA strategists see the next cycle being driven by capex investments into infrastructure driven by significant federal funding (IRA and CHIPs Act) across a wide range of sectors (e.g. energy, manufacturing, environment, transport, etc). We are still in the early phase of seeing these trends play out as many large manufacturers are in the process of building their facilities. There has been over $350 billion and $145 billion respectively invested into semiconductors and EV / battery related sites since 2020. As these facilities come into production, it will create spillover demand as suppliers move to meet the demand.
Tibone: Near-shoring is fueling strong industrial demand in Mexico and border markets such as Laredo and El Paso. The impact on most other U.S. markets is still in early innings, but metros such as Dallas and Phoenix seem like logical regional hubs for good produced in Mexico. U.S. on-shoring initiatives are gathering momentum but most projects are not yet operational. The benefits of onshoring to industrial comes in the form of upstream suppliers and downstream distributors that seek commodity warehouse space near these mega, custom-built facilities. Select Midwest and Sun Belt markets are likely hubs and should benefit from incremental demand over time.
Is there anything else you’re watching in terms of a potential impact on the industrial and logistics real estate sector?
Bonnel: Delivery speed to consumers has been a key driver of demand over the past decade and is an increasing focus for retailers to improve inventory management as bricks and mortar shops have shifted more toward experiential and hold less inventory. However, infill development close to the consumer is becoming increasingly difficult driven by lack of available land and local zoning regulations.
We see REITs with stronger platforms and higher quality/well-located existing portfolios best positioned in a world with higher barriers to entry. Additionally, data centers are beginning to compete for land that otherwise might be suitable for industrial development. Geographically, we continue to hear “nearshoring is real” and are starting to see more evidence of localized manufacturing. Companies are focused on efficient distribution, such as Amazon’s recent shift to a regionalized model. The majority of these factors are supportive towards favorable longer term demand/supply dynamics for landlords and we see many REITs as beneficiaries.
Tibone: The evolution and trends of goods versus services spending bear watching. Goods as a percentage of total personal consumption expenditures has been on a steady decline for decades, partially due to higher inflation for services than goods. The pandemic understandably reversed this long-term trend but those gains in goods consumption are proving temporary. The reversion in spending habits back to pre-Covid norms is unfolding faster than previously expected, which is a drag on near-term retail sales and logistics demand.