Rising Prices, Tariffs, Low Cap Rates: Nothing Bothers Philly Industrial

The cycle may be nearing its end for multifamily and office real estate in the Philadelphia area, but industrial is poised to keep going strong for the foreseeable future.

Positioned between New York and Washington, D.C., Greater Philadelphia has experienced not just steady demand after a few busy years, but continued growth, CBRE Capital Markets Vice Chair Michael Hines said at Bisnow's 8th Annual Philadelphia Industrial & Logistics event last week. The Lehigh Valley and Central Pennsylvania especially remain white-hot.

"[The I-78/81 corridor] has become the Inland Empire of the East," Hines said.

Panelists at the event, held at the Ritz-Carlton Philadelphia in Center City, debated topics such as the up-and-coming market within Philly city limits, the most popular uses for distribution center space and ideal clearance heights for new warehouses. The answer to the latter question depends on who you ask and who you build for, but it is among the most-discussed selling points of new distribution centers.

Smaller warehouses have popped up everywhere from suburban Philly to right along the big-boxes of Central Pennsylvania, and STAG Industrial Vice President of Northeast Asset Management Mike McCarthy said facilities with 1M SF or more continue to be an area of need.

“You’d think that you’d run out of 1M SF sites, but in this cycle we keep finding ways to build these large sites,” McCarthy said.

Equus Capital Partners Head of Dispositions Chris Locatell said that while Amazon continues to be the biggest player for larger distribution centers, other companies that once were happy with smaller facilities spread out across their network have turned toward larger boxes to boost efficiency.

“The demand has been relatively insatiable, and the whole e-commerce deal means that [users] don’t know that they want a 1M SF building, but they’re all trying to compete with the Amazon model," Locatell said. "So that means consolidating into larger spaces.”

The need for proximity to population centers has led users to take less-than-ideal buildings in exchange for ideal location, which has driven rents up to dizzying heights in areas like South Jersey.

“Rents were at $3.50, now they’re at $5/SF, which is growth that rivals Los Angeles and Seattle," Exeter Property Group principal Matt Brodnik said. "What was a sleepy market 20 years ago has shifted so dramatically that it’s now the last-mile hub for Philadelphia.”

Though CBRE's Hines is more bearish than some on the prospects of distribution space within Philadelphia due to the price of land and construction, he acknowledged that South Jersey's rent spike has changed the value equation somewhat.

“I had been sort of negative on last-mile in Philadelphia ... That being said, the prices are getting so high — one person I know got $6.50/SF on a 300K SF warehouse [in close South Jersey] — that I’m looking at Philadelphia differently," Hines said. "I do think there will be more opportunity for last-mile in Philadelphia because you can do better on rent than in some surrounding areas.”

Much ink has been spilled on the revolutionary nature of e-commerce, and how retailers' need to keep up has driven the ravenous demand for new distribution centers. But one part of e-commerce remains something of a sleeping giant, at least for now: online grocery delivery.

Hines said that 6% to 7% of grocery shopping in the U.S. is done online today, compared to 20% in Europe, and he sees it as inevitable that the gap will close. To that end, The Kroger Co. is in the early stages of a massive deal with British online distributor Ocado for 20 automated centers across the country.

Due to its long history of food production, South Jersey is well-positioned for this trend with a sizable portion of its facilities already equipped with some cold storage. Dietz & Watson and the Tasty Baking Co. have built facilities to process and distribute food within Philadelphia in the past few years as well, according to PIDC Senior Vice President Tom Dalfo.

Though this development cycle has gone on for longer than most expected coming out of the Great Recession, and President Donald Trump's tariff policy has driven up the cost of materials, all panelists agreed that industrial real estate will keep chugging along in the area.

“We’re somewhat insulated given our location and relative proximity to the population of the Northeast, so even if there was a slowdown, we wouldn’t feel it as strongly as the tertiary markets,” JLL Managing Director Kim Jacobsen said.

Nationally, the industrial market still has room to grow thanks to the continued increase in the diversity of users. From food to e-commerce-adjacent uses such as packaging and returns, the industry is far beyond depending on warehouses full of boxes on shelves.

“Our industrial sector is not just warehouse distribution," Jacobsen said. "There is a significant amount of manufacturing and value-add that goes on within these boxes, so what may look like pure industrial is really more of a cross-section of our economy. We have manufacturing, R&D, production and distribution. So it really runs more of the gamut, which is more insulation there.”

The range of potential uses only promises to grow wider, as Pennsylvania slowly opens itself up to medical marijuana. Vintage Law principal Sean Whalen said that before production licenses were awarded, the entire state held its collective breath and industrial space in anticipation.

“Just last year, literally every industrial property that I knew of got tied up for some time while people tried to get their medical marijuana licenses," Whalen said. "As soon as a lot of people lost their bid, they started turning around and wondering what the heck to do with their property.”

As legalization for recreational cannabis use spreads across the country, its adoption in Pennsylvania and at the federal level "is a matter of when, not if," Whalen said. When it does happen, the impact could be seismic.

"I’m not sure we can undersell what an explosion that’s going to be, both in the industrial side and the commercial side attached to it," Whalen said. "Denver said it balanced its budget for the next 20 years in one year, so there’s no reference point for the industry coming into this real estate market.”

Whalen also mentioned breweries and distilleries as a growing section of tenants, as growth in sales requires more than a large retail box. Alcohol, as Whalen pointed out, is always in demand regardless of the economy's health.

All the potential uses for industrial space provide optimism that demand will continue to meet the frenzied pace of construction, but McCarthy and Locatell both emphasized that some sources of demand are still as yet unknown. As consumer needs change, so does the industrial market — and both are changing at light speed.

“You can’t imagine what everybody does [with industrial space],” McCarthy said.