Industrial Outlook

Outlook Summary

The industrial sector, which was the only asset class to see price increases within the last 12 months, according to MSCI Real Capital Analytics, is expected to face a slowdown in rent growth in H2 2024 because of a supply and demand imbalance.^15,17 Before the sector expands again, it will likely need to burn through vacancies, particularly for big-box spaces. However, smaller industrial facilities still generally have tighter vacancies, according to CoStar.¹⁸ After a temporary slowdown in H2 2024, CoStar expects rents to increase by roughly 4.6% in 2025 as the market adjusts to the excess vacancies for larger footprints, beginning a new cycle of overall growth for the sector.¹⁷ We expect e-commerce growth and friend-shoring trends to be among the main demand drivers for industrial space.

Figure 6: Industrial Market Fundamentals by Year with Forecast

Source: Industrial, United States, CoStar Data, July 2024.

Market Fundamentals

After record-breaking rent growth of 10.2% in 2022 according to CoStar, the industrial sector has seen a continued slowdown through the first half of 2024, with expectations of further declines in rent growth in H2 2024 due to a supply-demand imbalance. This is compounded by the fact that, following record deliveries in 2021, the overall vacancy rate has increased from 4.1% in 2021 to 6.6%, as reported by CoStar.¹⁷ According to CoStar, big-box tenants have a surplus of industrial space, overestimating their requirements after the pandemic’s e-commerce surge.

Despite this trend, smaller industrial units (less than 100,000 sq. ft.) remain scarce, with CoStar reporting vacancy rates roughly under 4% on average nationwide.¹⁸ Availability rates for some of the tightest industrial critical port markets for properties under 50,000 sq. ft. include Jacksonville, FL (1.6%), Louisville, KY (3.5%), and Tampa, FL (3.1%).¹⁸

CoStar’s data also shows that the construction of small industrial facilities is limited, constituting just 2% of recent developments. This is in stark contrast to the substantial growth of big-box properties, which expanded 8x faster over the past five years (See Figure 7).¹⁸ Thus, we see this scarcity of smaller properties may increase rental rates due to a supply shortage.

Figure 7: Industrial Development is Focused on Larger Properties, CoStar

Source: “Available Space for Smaller Industrial Properties Remains Near Record Low,” February 2024. *“Past Five Years” include 2019 - 2023.

Based on CoStar, while the demand plays catch up to supply, rent growth is expected to drop from 3.9% (as of 7/16/24) to 2.8% by the end of 2024.¹⁷ Still, we expect relief in the supply-demand imbalance, as fewer projects are expected to break ground in the next few months, generally attributable to a reduced appetite for construction loans, which are expensive due to high interest rates.¹⁹ With fewer expected projects in the pipeline, we anticipate an end to the surge in industrial development post-pandemic, which may lead to a new cycle of tightening vacancies as the space is absorbed.

Although the e-commerce trend has slowed overall since the pandemic's peak, we expect it will continue to drive significant demand for industrial space. E-commerce-related warehouse space requires roughly three times the logistics space of traditional retail, according to JLL.²⁰ JLL estimates an additional $900 billion in e-commerce sales will require more than one billion square feet of industrial real estate by 2025.²⁰

We also anticipate that the “friend-shoring” trend will continue in 2024, which involves moving industrial production to the shores of political allies and bringing more manufacturing to neighboring Mexico. Demand for distribution space in markets such as Texas may increase as more goods flow into the U.S. from Mexico.²¹

Transaction Activity

Industrial transaction activity decreased by 31% year over year, compared to 39% for the overall CRE market tracked by MSCI Real Capital Analytics.¹⁵

Despite a decline in sales, industrial was the only sector to see a price increase of 8.7% in the last 12 months, according to MSCI Real Capital Analytics.¹⁵ Commercial Edge also analyzed that overall industrial prices seem to be increasing despite a slowdown in transaction volume. Prices more than doubled between 2019 and 2023 in three of their top 30 markets - Nashville, the Inland Empire, and Philadelphia, with others including New Jersey, Charlotte, Dallas/Fort Worth, and the Bay Area.²² However, it's worth noting that Green Street reported a 10% decline in prices for the same period (as compared to a 5% decline for the overall CRE assets tracked by Green Street), highlighting differences in data tracking.²³

A combination of things could potentially increase the likelihood of more transaction activity for the industrial sector:

1) An overall relief in rate cuts could open the door for more positive leverage* on construction yields; 2) burn through vacancies to realize more rent growth, especially for big-box spaces; 3) more certainty on tenant demand that may come after some alleviation in vacancies and interest rates, and 4) an overall alleviation in construction and land costs.

CrowdStreet’s Strategy

Smaller Industrial Facilities

With oversupply in large distribution centers and tighter vacancies in smaller industrial facilities¹⁸, we will consider opportunities in two specific subsets of industrial: 1) Middle-market industrial properties ranging between 50,000 to 200,000 sq. ft. and 2) Light Industrial spaces under 50,000 sq. ft.

Strategies for middle-market industrial spaces can vary, but some examples include low-basis conversions of distressed offices or retail spaces to industrial spaces by taking advantage of market dislocation. Another strategy can consist of a sale-leaseback from non-institutional owners who sell their property while continuing their business operations on-site; this approach can benefit the user by enabling them to focus on their core business instead of property management.

For light industrial spaces, a general strategy would be to acquire a small space from a small, family-owned or, typically referred to as, mom-and-pop business owner and revamp it to be more efficient and functional to address any functional obsolescence in these properties. Light industrial facilities usually cater to tenants with specialized, often last-mile needs, like construction companies or auto repair shops, providing a logistical benefit for their daily operations closer to the point of sale. There is also an opportunity to aggregate multiple such investments by building a larger portfolio for the potential of cap rate compression.

Generally, middle-market and light industrial investments are considered too small for large institutional investors and too large for single high-net-worth investors from a capitalization standpoint, which can make them unique opportunities.²⁵

Build-to-suit Development

Because development is challenging today due to high overall construction costs, we are observing that many institutions are delaying or canceling projects. This situation is often exacerbated by skyrocketing land prices over the last three years, in many cases making sellers hesitant to offer land at reduced prices despite the need for more affordable development opportunities. However, there may be a silver lining as companies like Amazon start new developments, signaling a potential market rebound.²⁴

While strict lending standards are plaguing the CRE landscape, we have observed that local and regional banks are sometimes more willing to lend on industrial assets, especially smaller industrial facilities requiring smaller loans due to lower risk potential (higher loan amounts usually carry more risk).

If we identify a development deal with reasonable construction financing, we may consider build-to-suit projects, which by definition offer certainty of tenancy before construction which may prove helpful in today's uncertain market.

* Positive leverage occurs when the debt costs less to service than the cash flow received from the leveraged portion of the project (negative leverage is the opposite when the debt service exceeds the cash flow on the leveraged portion of the project). Another way to tell if leverage is positive is when a deal's operating cap rate is greater than its debt's interest rate.

Capital Trends, US Industrial, MSCI Real Capital Analytics, May 2024. Data as of 7/16/24.
“Industrial Property Deliveries Reach Record High in 2022,” Trepp, February 2023.
CoStar, Markets, Industrial, Data Export, July 2024. Data as of 7/16/24.
“Available Space for Smaller Industrial Properties Remains Near Record Low,” February 2024.
“The Money Has Stopped Flowing in Commercial Real Estate,” WSJ, October 2023.
“Industrial real estate demand on the rise in the U.S.,” JLL, 2024.
“Industrial Production Shifts to Mexico Drawn by Labor and Location Advantage,” Savills, December 2022.
“Industrial Pipeline Slows as Deliveries Continue to Outpace Construction Starts,” Commercial Edge, July 2024.
Commercial Property Price Index, Green Street, June 2024. Data as of 7/16/24.
“Amazon Gets Back To Doing What It Does Best, Signing Million-Square-Foot Leases,” CoStar, May 2024.
“Middle Market CRE Investment Is Ripe With Opportunity,” Globe Street, January 2022.