Fissures Form For Big-Box Industrial As Tenants Delay Big-Money Moves

A nationwide slowdown in industrial real estate has been dubbed a normalization by every major player as the market cools from its searing state in the last few years. But third-quarter earnings reports from the country's top industrial REITs paint a more nuanced picture that shows where the soft spots are emerging.

Top-line occupancy rates remain historically high — around 97% or higher — but occupiers are piling on caution as they approach leasing decisions, according to earnings reports from Prologis, First Industrial Realty Trust and other top industrial REITs.

“Tenants are especially being deliberate about making large capex commitments, which at this point includes leasing any new warehouses in the current economic environment,” Green Street analyst Jessica Zheng told Bisnow.

That uncertainty is impacting some types of industrial properties more than others.

“The bigger box[es] are slowing, and that market rent growth is probably flat to maybe even negative,” Stag Industrial CEO Bill Crooker said on his company's third-quarter earnings call. “And the smaller suite size … less than 150K SF, are still holding up really well.”

That is a reversal from just a year ago.

By CBRE's definition, big-box industrial spaces are distribution centers or warehouses that span 200K SF or more. Last year, vacancies for this type of property were at record lows, according to a CBRE report from April. They brought in accordingly lucrative rents as third-party logistics providers and retailers gobbled up space in the wake of a pandemic-fueled e-commerce surge.

At the time of CBRE's report, a record 455M SF of big-box industrial was under construction in the U.S. Now, as tenants become harder to find and slower to sign, that record development pipeline is delivering spaces that could sit empty longer than they would have one year ago.

Big-box industrial space isn't evenly distributed across the U.S., making some more susceptible to the slowdown than others. 

“So where we're seeing some weakness in bigger boxes, it's the big-box distribution markets — Indianapolis, Columbus, South Dallas — those ones will struggle with that suite size,” Crooker said. “But when you get the smaller suite sizes, all those markets are still holding up really well.”

Prologis, the biggest industrial owner in the U.S. and a major developer and owner of big-box industrial space, reported Q3 net earnings of 80 cents per share, a 41% decrease from the $1.36 per share it notched in Q3 2022. Occupancy ticked down from 97.5% to 97.1% in the same period.

On the other hand, smaller markets with lower concentrations of big-box space — and the companies that invest in them — saw gains.

“EastGroup, because their property type really caters to the smaller, more local tenants, and [they are] also in the Sun Belt markets, they're actually seeing slightly stronger fundamentals because the supply deliveries in that property size and type has been pretty muted,” Zheng said. “It's not as elevated as the big-box type that we've seen.”

In its third-quarter call, EastGroup Properties reported a 22% increase in net earnings per share, from 87 cents to $1.07 year-over-year. Company leaders said they expect performance to continue improving into 2024.

“I feel good about our ability to push rents in the next year,” EastGroup President and CEO Marshall Loeb said on his company's call. “Our average building is about 95K SF, and our average tenant is 34K SF. Again, if you look, those vacancy rates haven’t moved. I really feel even better about our ability to push rents, assuming the economy — doesn’t have to get a lot better — just doesn’t get worse.”

Still, the overall picture for industrial REITs is a rosy one, even if they are no longer experiencing the incessant demand they enjoyed the last two years.

“As expected, we continue to see market rent growth normalizing from the unprecedented growth we experienced during the pandemic,” David Lanzer, Rexford Industrial general counsel, told investors on the company's earnings call.

Revenue from rental income at Rexford grew to $204.2M, up from $162.6M in the third quarter of 2022.

At First Industrial Realty, revenue from leases rose to $152.5M in Q3, up from $137.7M a year earlier, and Stag Industrial’s revenue from rental income rose to $177.9M in the third quarter, a 7.9% increase from $164.7M in the same period last year.

Although the market is developing the occasional crack, the rent gains made during the height of the pandemic continue to fuel the industrial landlords.

“The reason most REITs are doing just fine is because of the really robust rent growth all the markets experienced in the past two years,” Zheng said. “To the extent that you have a portfolio and leases are still rolling that are capturing those two years of really strong rent growth, your operations are doing just fine.”