A new era for the fundamentals of Industrial

December 2, 2022 3 Minute Listen

Resilient demand will power market in 2023

U.S. industrial leasing activity is expected to moderate in 2023 as occupiers delay expansion plans and the post-pandemic need to hold additional inventory dissipates. Despite the slowdown, demand will keep up with supply in 2023, with a 13th consecutive year of positive net absorption, a near record-low vacancy rate and solid rent growth.

Digital economy stimulating demand near growing MSAs

E-commerce growth, supply chain transformation and location optimization will continue to drive demand for industrial space in 2023. Leading occupiers will focus on markets with strong population growth and modern distribution space to ensure quick delivery of online orders.

The digital economy’s growth will lead to an increase in online purchases from more sources, including smartphones and the metaverse. Younger shoppers are driving this trend, which will prompt companies to increase their warehouse presence in markets with young and growing population demographics, including Nashville, Salt Lake City, Las Vegas, Phoenix and Central Florida.

Figure 14: E-Commerce as a % of Total Retail Sales Forecast

Note: non-auto-related retail sales.
Source: CBRE Research Q2 2022.

Supply chain diversification key to protect inventories

Global supply chains remain in flux despite fewer seaport backlogs and lower international shipping costs. Companies will look to diversify their product sourcing as they try to mitigate a host of possible disruptions, including shutdowns at Chinese ports, labor issues at U.S. ports, inclement weather and the ongoing war in Ukraine. Many U.S. companies seeking less reliance on China for product supply and labor are adopting a “China Plus One” approach to add other countries. Some companies will fully shift manufacturing to other Asian countries, while others will onshore manufacturing to the U.S. or nearshore to Mexico.

Imports will flow through more U.S. ports, stimulating demand for nearby industrial space and along direct transportation routes to and from Mexico. Shifts in imports away from crowded West Coast ports will benefit markets like Savannah, Charleston, Houston and Baltimore, while onshoring of manufacturing will benefit Phoenix, the major Texas industrial markets, Atlanta, Cincinnati, Greenville-Spartanburg and Northern Florida. El Paso will be a major beneficiary of increased manufacturing in Mexico.

Location and labor driving occupier decisions

Location optimization will be key to controlling supply chain costs in 2023. While ocean rates plummeted in 2022, they remained higher than in 2019. Domestic freight costs are still increasing due to higher fuel costs and labor shortages. Taking rents increased nearly 20% in 2022, putting additional cost pressure on occupiers. As a result, occupiers will seek locations near domestic transportation hubs with high-quality infrastructure, and markets with strong labor dynamics and more affordable rents. Louisville, Memphis, Indianapolis and Kansas City will all benefit.

Larger retailers, occupiers and third-party logistics (3PL) companies will continue to expand despite the economic slowdown as they look to shore up their distribution capabilities. However, smaller businesses don’t have the capital reserves to do the same. Small businesses are the top occupier of light-industrial facilities (under 25,000 sq. ft.), demand for which fell by 20% year-over-year as of Q3 2022. A similar slowdown will occur in 2023 amid economic uncertainty and higher supply chain costs.

Figure 15: Year-to-date Leasing Activity by Size Range

Note: includes new lease and renewal transactions signed 1/1 to 9/30.
Source: CBRE Research, Q3 2022

Record-breaking construction completions but plummeting starts

A record 661 million sq. ft. of industrial space was under construction as of Q3 2022, nearly double the amount since 2020 amid demand for high-quality facilities and a backlog of projects delayed by a shortage of construction materials. The shortage seems to be waning and completions will break records in 2023, likely increasing the U.S. industrial vacancy rate by 30 to 60 bps. Groundbreakings will decline by more than 50% in early 2023 due to construction financing challenges and economic uncertainty. The reduction in construction starts will lead to completions dropping to around 250 million sq. ft. in 2024, leading to a shortage of first-generation space.

3PLs will lead leasing activity

Leasing activity is expected to decline by 10% to 15% in 2023, finishing in the 725 million- to 750 million- sq.- ft. range. Demand will be led by 3PLs, as companies outsource at a greater clip to avoid a lack of inventory, labor shortages, rising transportation costs and other supply chain challenges. 3PLs’ leasing market share will reach 40% by midyear 2023. Solid leasing activity will keep vacancy rates low, resulting in rental rate growth of approximately 15%. However, in markets with an excess of construction deliveries, there could be an increase in concessions, including free rent and higher tenant improvement allowances.

Figure 16: 3PL Leasing Market Share Outlook

Source: CBRE Research, Q3 2022.

Trends to Watch

Solid Fundamentals Despite Slowing Activity

U.S. industrial leasing activity is expected to decline in 2023 as occupiers delay expansion plans and the post-pandemic need to hold additional inventory dissipates. Despite the slowdown, vacancy rates will remain well below the 10-year average. Low available supply will create another year of double-digit rent growth.

Record Breaking Completions and Plummeting Construction Starts

Groundbreakings will fall by more than half in early 2023 due to construction financing challenges and economic uncertainty. The reduction in construction starts will lead to completions dropping to around 250 million sq. ft. in 2024, leading to a shortage of first-generation space and a return to record-low vacancy rates at a time when many companies will reenter the market.

Resilient demand will power market in 2023

U.S. industrial leasing activity is expected to moderate in 2023 as occupiers delay expansion plans and the post-pandemic need to hold additional inventory dissipates. Despite the slowdown, demand will keep up with supply in 2023, with a 13th consecutive year of positive net absorption, a near record-low vacancy rate and solid rent growth.

Digital economy stimulating demand near growing MSAs

E-commerce growth, supply chain transformation and location optimization will continue to drive demand for industrial space in 2023. Leading occupiers will focus on markets with strong population growth and modern distribution space to ensure quick delivery of online orders.

The digital economy’s growth will lead to an increase in online purchases from more sources, including smartphones and the metaverse. Younger shoppers are driving this trend, which will prompt companies to increase their warehouse presence in markets with young and growing population demographics, including Nashville, Salt Lake City, Las Vegas, Phoenix and Central Florida.

Figure 14: E-Commerce as a % of Total Retail Sales Forecast

Note: non-auto-related retail sales.
Source: CBRE Research Q2 2022.

Supply chain diversification key to protect inventories

Global supply chains remain in flux despite fewer seaport backlogs and lower international shipping costs. Companies will look to diversify their product sourcing as they try to mitigate a host of possible disruptions, including shutdowns at Chinese ports, labor issues at U.S. ports, inclement weather and the ongoing war in Ukraine. Many U.S. companies seeking less reliance on China for product supply and labor are adopting a “China Plus One” approach to add other countries. Some companies will fully shift manufacturing to other Asian countries, while others will onshore manufacturing to the U.S. or nearshore to Mexico.

Imports will flow through more U.S. ports, stimulating demand for nearby industrial space and along direct transportation routes to and from Mexico. Shifts in imports away from crowded West Coast ports will benefit markets like Savannah, Charleston, Houston and Baltimore, while onshoring of manufacturing will benefit Phoenix, the major Texas industrial markets, Atlanta, Cincinnati, Greenville-Spartanburg and Northern Florida. El Paso will be a major beneficiary of increased manufacturing in Mexico.

Location and labor driving occupier decisions

Location optimization will be key to controlling supply chain costs in 2023. While ocean rates plummeted in 2022, they remained higher than in 2019. Domestic freight costs are still increasing due to higher fuel costs and labor shortages. Taking rents increased nearly 20% in 2022, putting additional cost pressure on occupiers. As a result, occupiers will seek locations near domestic transportation hubs with high-quality infrastructure, and markets with strong labor dynamics and more affordable rents. Louisville, Memphis, Indianapolis and Kansas City will all benefit.

Larger retailers, occupiers and third-party logistics (3PL) companies will continue to expand despite the economic slowdown as they look to shore up their distribution capabilities. However, smaller businesses don’t have the capital reserves to do the same. Small businesses are the top occupier of light-industrial facilities (under 25,000 sq. ft.), demand for which fell by 20% year-over-year as of Q3 2022. A similar slowdown will occur in 2023 amid economic uncertainty and higher supply chain costs.

Figure 15: Year-to-date Leasing Activity by Size Range

Note: includes new lease and renewal transactions signed 1/1 to 9/30.
Source: CBRE Research, Q3 2022

Record-breaking construction completions but plummeting starts

A record 661 million sq. ft. of industrial space was under construction as of Q3 2022, nearly double the amount since 2020 amid demand for high-quality facilities and a backlog of projects delayed by a shortage of construction materials. The shortage seems to be waning and completions will break records in 2023, likely increasing the U.S. industrial vacancy rate by 30 to 60 bps. Groundbreakings will decline by more than 50% in early 2023 due to construction financing challenges and economic uncertainty. The reduction in construction starts will lead to completions dropping to around 250 million sq. ft. in 2024, leading to a shortage of first-generation space.

3PLs will lead leasing activity

Leasing activity is expected to decline by 10% to 15% in 2023, finishing in the 725 million- to 750 million- sq.- ft. range. Demand will be led by 3PLs, as companies outsource at a greater clip to avoid a lack of inventory, labor shortages, rising transportation costs and other supply chain challenges. 3PLs’ leasing market share will reach 40% by midyear 2023. Solid leasing activity will keep vacancy rates low, resulting in rental rate growth of approximately 15%. However, in markets with an excess of construction deliveries, there could be an increase in concessions, including free rent and higher tenant improvement allowances.

Figure 16: 3PL Leasing Market Share Outlook

Source: CBRE Research, Q3 2022.

Trends to Watch

Solid Fundamentals Despite Slowing Activity

U.S. industrial leasing activity is expected to decline in 2023 as occupiers delay expansion plans and the post-pandemic need to hold additional inventory dissipates. Despite the slowdown, vacancy rates will remain well below the 10-year average. Low available supply will create another year of double-digit rent growth.

Record Breaking Completions and Plummeting Construction Starts

Groundbreakings will fall by more than half in early 2023 due to construction financing challenges and economic uncertainty. The reduction in construction starts will lead to completions dropping to around 250 million sq. ft. in 2024, leading to a shortage of first-generation space and a return to record-low vacancy rates at a time when many companies will reenter the market.

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