Industrial Sector Longs For 'Boost Of Confidence' Amid High Vacancies, Sluggish Rental Growth

The formerly full-speed-ahead industrial market is struggling to hit its stride this year. 

Tenants for industrial buildings are taking longer to sign leases. Vacancy rates are climbing. The industrial development pipeline is at seven-year lows. And though executives at some of the nation's largest industrial REITs believe the slump will be short-lived, there is no sign yet that a turnaround is imminent.

“If you step back, there's really not been any positive economic news, whether it's global unrest, or interest rate cuts that were supposed to start in March of this year, or one of the most unusual elections I think any of us have seen,” said Marshall Loeb, president and CEO of EastGroup Properties, during the company’s Q3 earnings call last week. “There hasn't been a real boost of confidence.”

Top executives at publicly traded companies in the industrial sector hope that the current state of play represents the bottom of the market and that key metrics like vacancy rates, rent growth and new development will improve in 2025. The resolution of the election in the fourth quarter, coupled with additional interest rate cuts, should provide decision-makers with more clarity moving forward, executives said. 

But for now, the sector is feeling a slowdown after the blistering pace of the e-commerce-fueled pandemic boom.

Industrial vacancy rates in the U.S. reached 6.4% in the third quarter, far higher than the historically low 3% vacancy rates throughout 2022, though roughly in line with the long-term average of 7%, according to Cushman & Wakefield.

The average asking rental rate increased by 4.3% year-over-year to $10.08 per SF, passing the $10 per SF mark for the first time. But that was well off the double-digit gains of 2022 and 2023, according to the brokerage.

Tenants are taking more time to make decisions on leases, which executives linked to economic uncertainty and the “wait-and-see” approach tenants have taken in light of Tuesday's election. Some tenants are operating with more urgency, but most are not for those reasons and others, said Peter Schultz, executive vice president at First Industrial Realty Trust, on the company’s earnings call Oct. 17. 

“The level of prospects in the market today[is] probably better than it has been for most of the year, but the pace of that decision-making continues to be lumpy and somewhat deliberate,” Schultz said. 

First Industrial Realty Trust President and CEO Peter Baccile said the company believes there is pent-up demand for industrial space from larger tenants. Those tenants have investment dollars for growth ready to deploy, but they are waiting for the “fog to clear” on some of the uncertainty in the market, he said.

Loeb agreed, adding that this year on the leasing front has felt like “two steps forward, maybe one step back.” 

Tenants’ hesitancy to commit to space is leading to slower rent growth, said Prologis President Dan Letter on the company’s Q3 earnings call.

“We are near or in an inflection period right now. This is a time when forecasts have very high variability,” Letter said. “The near-term view on rents is pretty much in line with where we were 90 days ago. Customers are very engaged, but they are just not making decisions. So, we expect this softness in rents to continue throughout this period.”

Demand for industrial space has moderated, and it will take time for tenants to fill the existing inventory of properties, executives said. This comes as development pipelines sagged to their lowest point since 2017 at 215M SF under construction, according to Prologis’ Chris Caton, managing director of global strategy and analytics.

In the long-term, Prologis sees rent growth driven by the gap between market rents and replacement cost rents, Letter said. The company believes the market is at peak vacancy or close to it and plans to endure that for a portion of 2025, he said. Prologis expects a recovery to kick off late next year and accelerate afterward, Letter said. 

“We know the trend and we'll capture that rent growth in the longer term,” Letter said. “We just don't necessarily know the slope of that recovery and it's really hard to peg that. And honestly, when it comes down to it, guessing on the short term has never been one of our strong suits. We're running Prologis for the long term.”

The slowdown in construction hasn’t necessarily meant land purchases have become cheaper for investors. 

“We've seen land prices stay relatively flat throughout the year,” said William Crooker, president and CEO at STAG Industrial, on the company’s Oct. 30 earnings call. “With our development initiative, we're not buying raw land. We're really focused on sites that are permitted.”

And executives pointed to a new piece of California legislation that could increase the value of existing properties by restricting industrial development in the state. California Gov. Gavin Newsom in late September signed Assembly Bill 98 into law.

The legislation outlines requirements for locations of new warehouses. This includes setbacks of 300 feet from so-called sensitive uses, including homes and schools. In areas that aren't zoned for industrial use or where the zoning had to be changed to accommodate the property, setbacks are extended to 500 feet. 

“Our view is that there are going to be numerous sites that would be very difficult or nearly impossible [to develop] due to the constraints put by AB-98,” said Johannson Yap, First Industrial’s chief investment officer, on the earnings call.

“This has the effect of constraining development of land across the state and we all believe that anything that constrains the supply of developable land will increase the value of our existing sites and existing buildings.”

In setting the stage for next year, Caton said the industry is facing a relatively low level of supply and an opportunity for demand to improve as tenants hack their way through uncertainty.

Loeb said once things take a turn for the better, they will move fast.

“There's not much inventory out there,” Loeb said.  “All we need is a little bit of a lift in business confidence and things will turn pretty quickly. I think it will be more of a V than a U-shaped turn. It's just waiting for that turn, which has taken maybe a quarter or two longer than I would have told you I expected earlier in the year.”