Doug Roberts: 2023 will bring new conditions to industrial markets (Voices)

Nationwide and globally, industrial development has experienced a historic rate of growth over the past few years. Although there has been a steady shift from brick and mortar store sales to online shopping for years, the pandemic accelerated this shift in consumer behavior and has amplified already strong demand for more logistics and fulfillment facilities in key markets.

However, real estate as an industry has undergone rapid changes in 2022 as interest rates climbed in combination with higher than typical construction costs and supply chain constraints. As we approach 2023, we will continue to see these changes, as well as challenges, play out in a market operating in a new set of conditions; chiefly the pullback in both debt and equity despite what appears to most observers to be a robust and healthy industrial market.

Rent Appreciation

Demand for industrial development will continue albeit at a slower pace due to instability in the capital and debt markets. Despite low single-digit vacancy, in some cases, record low vacancy rates, in the industrial markets across most U.S. cities, there has been a major pause in the deployment of both equity and debt and this has had a material effect on the ability of developers to proceed with projects going into 2023. Tenant activity remains at a very high level and this slowdown in developing new projects will only exacerbate the lack of available product for the number of tenants seeking space likely resulting in more rent appreciation especially in the coastal markets where the barriers to entry are high.

Continued ‘On-Shoring’

Providing additional pressure on the industrial sector is the growing trend of “on-shoring” or “near-shoring” into North American markets so as to avoid the supply chain issues that arose during the pandemic. More manufacturers — both based in Asia as well as the U.S. — have begun to build their production capabilities in the western hemisphere and then transport these goods into the U.S. via numerous ports of entry such as San Ysidro, Laredo, El Paso and Yuma. Like the rapid increase in online shopping during the pandemic, on-shoring and near-shoring is being necessitated by the issues with the supply chain that was negatively impacted by the pandemic.

E-Commerce Will Rein

The buying habits of U.S. consumers will continue to migrate to e-commerce, certainly at a slower pace in 2023 than during the pandemic, but there has been steady growth year over year since the mid-1990s. According to the U.S. Census Bureau, through the third quarter of 2022, the percentage of online shopping versus in-store was nearly 15 percent. Given this relatively low percentage, there is a great deal of runway ahead of e-commerce companies as well as conventional retailers with an online presence.

A New Type of Warehouse

The industrial sector has essentially seen a transformation of the prototypical warehouse from a plain box that services the retail stores to an actual store in and of itself. We will continue to see innovations on behalf of retailers who want to maintain market share and for most consumers, getting the product as soon as possible is a key reason to keep shopping online. These warehouses have a higher number of workers in the building, despite being highly automated, so this has required more parking spaces and employee amenities.

Time and Money

Although we have seen phenomenal growth in the industrial sector over the last few years, it has not been a time without challenges. Chief among them has been construction costs’ inflation and developers’ ability to anticipate inflationary pressures over the span of their development schedule. Rental rate increases and cap rate compression have both allowed developers to mitigate the inflation to a large degree but given the interest rate increases by the Fed and the dramatic slowdown in capital deployment, developers are now faced with some residual inflationary pressure coupled with an unclear forecast on rental rate appreciation and cap rates into 2023. This will naturally lead to a pause while all parties assess the overall market conditions as well as macro-economic factors at both a national and global level.

Next year will bring continued industrial development but the conditions will be different than what we have seen of late. By far the biggest factor effecting the industrial sector will be the willingness of equity to deploy capital in the new year. The chief reason for the pause in deployment is simply price discovery with respect to cap rates across the sector which is directly correlated to the interest rate increases during the last 6-9 months. In addition, we could see tenant activity slow if the country goes into a recession as consumer demand may slow. However, given the low vacancy rate across the industrial sector and the projected growth in e-commerce, the market remains a very healthy one from both a landlord and an investment perspective.

Doug Roberts is a partner with Panattoni Development. He is responsible for all aspects of development of office, industrial and retail projects as well as the supervision of staff personnel in two offices within the region. For more information, call 775-829-6112 or visit www.panattoni.com.