No Vacancy? Not Anymore: Industrial Tenants Have Leverage At Last

Industrial absorption in the U.S. declined by approximately 50% year-over-year, according to preliminary figures from Savills released this month.

While this plunge might seem alarming, analysts told Bisnow they are viewing the dip as a much-needed pause — especially considering the meteoric rise the industrial market witnessed in the pandemic era.

But with supply ticking up and rent growth slowing, tenants are finding relief from years of “no vacancy” signs.

“Normalized demand is meeting heightened supply for the near term,” Savills Senior Director and Head of Industrial Research Mark Russo said. “We think that over the next six to 12 months, tenants will have more power. They've had next to no leverage the last couple of years.”

An end user with a similar credit profile and space requirement now has considerably more options than even six months ago in any primary distribution market, said Newmark Executive Managing Director Adam Petrillo, an industrial specialist.

But at the same time, the relentless demand drivers that fed into the industrial space boom beginning in 2020 are showing some slack as well.

The surge in absorption was a direct result of consumer behavior, Russo said. E-commerce sales spiked in mid-2020, and by the end of that year, accounted for 17% of retail sales, up from about 12% at the beginning of the year, the U.S. Census Bureau reported.

Online sales hit a ceiling as the pandemic abated, leveling off at about 15% of total retail sales, where it remained in Q2 2023, the most recent quarter for which numbers are available.

“Consumers were spending their money on goods and services, then it was a lot of goods,” Russo said. “And now it's goods and services again, though of course there's some murkiness about the next year of the consumer economy, which remains the number-one driver of industrial demand.”

Besides the slowdown in e-commerce, Russo said, industrial users are just generally more cautious in leasing space now, considering 2023's economic and geopolitical uncertainties. 

These factors combined contributed to the drastically lower rate of absorption seen in Q3. The 64.5M SF taken down in the most recent quarter looks much more like third-quarter 2019 than 2021, with 58.6M SF and 148M SF, respectively.

Prologis, the world's biggest industrial owner, saw slowing in some metrics in Q3, with its net earnings per share dropping by about 41% to 80 cents per share. But rather than decreased demand, Prologis pointed to elevated interest rates eating into profits and still beat analysts' expectations for its revenue.

Development continues at an elevated pace, with some 607.9M SF of industrial space under construction in Q3, according to Savills, but starts took a nosedive to 64.7M SF.

Much of the industrial beginning this year is build-to-suit, rather than spec.

“The pipeline last year was mostly speculative, versus build-to-suit space,” Newmark Managing Director for national industrial research Lisa DeNight said. “We're already seeing that shift rapidly to the opposite. The shift to build-to-suit is palpable, and some markets aren't breaking ground on anything.”

There are still speculative projects kicking off, but as a whole, the volume is significantly quieter than even during the initial phase of the pandemic, DeNight said.

She doesn't expect that dynamic to last, however, as the pace of development drops after 2024.

“The supply pipeline will continue to deliver, outpacing demand all the way through 2024,” DeNight said. “But once you reach 2025, the amount of space currently breaking ground is so relatively low that some markets will very likely start to experience constraints again.”

Because much of the space now breaking ground is build-to-suit, that could further tighten at least some markets after 2024, especially if demand picks back up again, DeNight said.  

Eventually, supply will drop to meet demand, so the expansion of tenant leverage won't go on too long. Moreover, that probably means that rental gains landlords enjoyed during the pandemic probably won't be clawed back.

During Q3 2023, industrial asking rents came in at a nationwide average of $9.22 per SF, the highest they have ever been, Savills reports. In Q3 2019, asking rents were $5.61 per SF.

“We're still seeing rent growth throughout this year,” JLL Vice Chairman Leslie Lannie said. “We look at it from the perspective of not only new construction but existing product and renewals. "We don't think rents are going to grow at the same breakneck speed we've seen over the past three years, but we really don't see a massive deceleration in rents either.”

Petrillo said it takes a lot of pressure to move rents downward significantly, and only some markets are going to experience actual declines in rent. Even so, most markets will feel some kind of impact.

“If there is more supply than demand, users have some flexibility,” Petrillo said. “Then there's a natural downward push on net effects, meaning concessions are up, though base rents might not be down.