Industrial fundamentals softened in Q2 as occupiers continue to take a “wait and see” approach in their decision-making process. Absorption was even with the previous quarter, bringing the year-to-date absorption figure to 55.4 million s.f. For context, absorption through H1 2023 was 120.3 million s.f. Absorption figures were strongest in the primary markets of Houston, Phoenix, Dallas-Fort Worth, Chicago, and Atlanta, which tallied 18.4 million s.f. of positive net absorption. However, some markets posted negative absorption figures for reasons including consolidation of operations and lease expirations. Of the 113.3 million s.f. delivered, nearly 70% was vacant, causing the vacancy rate to increase to 6.6%. Rental rate growth was positive, passing the $10.00 per s.f. threshold for the first time and landing at $10.03 per s.f., a 5.8% year-over-year increase. Furthermore, eight markets saw their asking rates contract by at least 3% this quarter. Sublease availability slowed significantly, with only 10 million s.f. of new sublease space being brought online, while vacant sublease space saw only 2 million s.f. of space vacated. Sublease space is most concentrated in the major metro markets, including the Inland Empire, Dallas-Fort Worth, Atlanta, Los Angeles, and Eastern & Central Pennsylvania. Despite sublease availability space being elevated by 75.1% year-over-year, it is important to note that this figure accounts for only 1.1% of all availability, and the majority of sublease space is being marketed for short-term use.
Businesses exercise caution amid economic uncertainty and consumer spending fluctuations
Overall leasing activity was down in Q2 as businesses remained cautious due to economic uncertainty and fluctuating consumer spending. In Q2, 112.6 million s.f. of industrial space was leased, with 59.1% of that figure attributed to new leases. Furthermore, of those new leases, 45% were in Class A assets, demonstrating the ongoing flight to quality and demand for newer facilities. However, users up for renewals are largely opting to stay in place as industrial rents continue to climb. Moving forward into H2 2024, leasing momentum is expected to fluctuate, though evolving supply chain requirements from manufacturers, e-commerce, and other users will continue to drive demand for 3PL companies. Many companies are drawn to 3PLs for their scalability, flexibility, expertise, and global network to streamline extensive logistical operations. The top industries for leasing in Q2 were 3PL, construction materials and building fixtures, logistics and distribution, food and beverage, and auto parts & tires. The communications and tech sector has sustained a 117.2% year-over-year increase in average lease size, in part from the boom of data center construction, in which large tech companies have begun leasing industrial space to support those operations. Economic uncertainty and shaky retail sales have translated to the average lease size of a traditional retailer shrinking by 57% year-over-year. As consumer and occupier needs continue to evolve, activities related to sustainable solutions, government support, advancing technology, reshoring, and consumer demands will help fuel growth in the manufacturing, automotive and, energy and utilities sectors in the long-term.
Development pipeline wanes as 77% of all industrial assets under construction set to deliver by end of year
The pace of new deliveries ticked up slightly from Q1, with 113.3 million s.f. being delivered. This brought the year-to-date total to 222.6 million s.f., marking a 35% decrease from the previous quarter. Phoenix, The Inland Empire, Dallas-Fort Worth, Atlanta, and New Jersey combined accounted for 37.1% of all new deliveries. Phoenix and Savannah both topped Dallas-Fort Worth for the largest development pipelines in Q2, with Phoenix boasting 32.5 million s.f. under construction and Savannah having 30.3 million s.f. under construction. Nationally, the total amount of industrial product under construction has decreased 46.7% year-over-year, with 312.9 million s.f. being underway. Additionally, we estimate that 77% of this total figure will be deliver by the end of 2024, while 2025 deliveries are currently estimated at roughly 85 million s.f. Preleasing of under-construction assets has increased by 36.7% year-over-year. Of the 43.1% of preleased buildings under construction, mega-box sites measuring over 1 million s.f. have the strongest preleasing rates at 75.4%. For context, there are currently 49 buildings under construction in this size tranche. The 100,000 s.f. to 250,000 s.f. size segment has the most buildings under construction at nearly 400, so while a preleasing rate of 22.7% might seem sluggish, demand and leasing activity within this size segment indicates otherwise. It is also worth noting that owner-user and build-to-suit projects make up nearly one-third of all products under construction. With many occupiers experiencing sticker shock at current renewal rates, some have opted to purchase the speculative-built building they occupy. The Chicago market has seen four notable such transactions, with buyers representing varied industries, including a food and beverage distributor and a filter and injection molding distributor, as well as a national logistics and distribution user. In New Jersey, Abaline, a supply distributor, purchased its 311,040 s.f. speculative warehouse for $65.3 million.
Diverse geographies for markets with remaining mega-box availabilities
With mega-box buildings having the strongest preleasing rates in both newly delivered assets and current buildings under construction, users seeking a large swath of space have options in differing geographies. Leasing of spaces over 1 million s.f. in the first half of 2024 has outpaced that in the second half of 2023 by over 6 million s.f. Furthermore, six of these mega-box transactions were in The Inland Empire market. While these large transactions certainly help bolster leasing figures, the majority of industrial occupiers are concentrated on “rightsizing” their spaces leased. Of all space leased in Q2, 58.2% of that figure were leases measuring less than 250,000 s.f. Users currently have more options available and thus don’t feel as rushed to lease too much space too quickly, rather opting to grow into additional space as needed. As it relates to new construction, many developers are opting to have large buildings be easily demised instead of building for one tenant.
Industrial transactions volume declines level off; investor conviction rises since start of 2024
Transaction volume declines across commercial real estate are leveling off, and YTD 2024 has seen considerable green shoots as it relates to investment sentiment and depth of bidder pools. In addition, the appetite for larger transactions has been improving. The CMBS SASB market has been very active; industrial issuance in the first half of 2024 is up fourfold compared to full-year 2023. Cap rates for in-favor property sectors like industrial have marked some compression versus late last year. Investor interest continues to be strong for shallow bay and value-add assets, and there is also an increase in activity around core and core-plus transactions. Furthermore, there’s an increase in interest in land sites for developers to position themselves for when development economics improve.
Power capacity top concern for industrial occupiers over long-term
Absorption will continue to fluctuate for the duration of the year; however, due to several large-scale deliveries and leases commencing, industrial absorption figures could see a slight push at the end of 2024. With the ongoing flight to quality, owners of Class B and C products will likely work to update older facilities as the complex needs of automation and technology advance. New groundbreakings have slowed 49% year-over-year but did increase by 17.3 million s.f. from the previous quarter. Power capacity remains the top consideration of tenants looking at new developments. To help draw tenants to speculative sites, some proactive speculative warehouse developers are taking on the task of upgrading the power supply and capacity at the onset of construction. Given that power capacity is one of the core pillars of the manufacturing industry, markets with readily available power will benefit the most. Furthermore, as manufacturing projects are expected to ramp up in the coming years, proximity to mega-sites will draw suppliers, helping to sustain demand.