The industrial sector has demonstrated remarkable resilience and strength in the face of various challenges in 2023, including rising interest rates, soaring labor costs, and mounting inflation.
The industrial sector has demonstrated remarkable resilience and strength in the face of various challenges in 2023, including rising interest rates, soaring labor costs, and mounting inflation. The surge in onshoring, coupled with the continued expansion of the e-commerce landscape, has further fueled the demand for industrial real estate in key cities across the U.S.
A recent report from CBRE underscores the robust performance of the U.S. industrial market, with expectations of double-digit rent growth in the current year. During the first half of 2023, the average first-year base rent soared by an impressive 16.6%. Notably, this growth has shifted from traditional gateway markets like Los Angeles and Northern New Jersey to regions experiencing substantial population growth, including South Florida and Atlanta. Projections suggest that these emerging markets may drive annual rent growth to nearly 15% by year-end.
Within the industrial real estate market, a sub-segment deserving attention is flex or light industrial. Flex properties represent a fusion of office and industrial spaces, often situated in suburban areas. These versatile structures can stand alone or be part of single-story industrial parks. The typical layout is office or retail space up front with storage/warehouse space in the back. The versatility of these spaces attracts a wide variety of businesses, from chiropractic providers to karate studios and manufacturing companies. The allure lies in having office, warehouse, and manufacturing facilities under one roof, a feature that has piqued considerable interest.
Diversity is another advantage of flex space, setting it apart from multi-tenant office buildings primarily catering to companies like law firms, insurance companies and financial institutions. In contrast, flex assets house a broad range of tenants, from construction companies to retail-style restaurants.
Another advantage of flex space is its inherent customizability. Tenants seeking to expand their office footprint can do so at a more cost-effective rate than with traditional Class A-B office buildings. Flex assets also offer affordable, short-term leasing options for new or small business owners.
The surge in flex or light industrial real estate was captured by the Wall Street Journal article “The Hottest Real-Estate Play Is in Your Neighborhood.” Businesses, including retailers, aim to remain close to where their customers now spend more of their time – at home. Data from Green Street reveals that strip center real estate investment trusts boasted occupancy rates of 95.3% in the most recent year. Pre-pandemic, physical occupancy was at 92.4%.
This movement is partly attributed to the widespread shift towards flexible working arrangements, resulting in consumers spending more time at home rather than in city centers. Office occupancy levels remain at approximately half of pre-pandemic levels in most metro areas, redirecting lunch demand from offices to strip centers located closer to people’s residences. This trend extends to personal care services and other activities.
Suburban and smaller cities with high population growth, diverse industries and robust infrastructure are benefitting most from the increase in demand for flex industrial space. In these MSAs, tenants prioritize nominal rent costs over per-square-foot rates, resulting in generally higher per-square-foot rents compared to large industrial properties. Additionally, the scarcity of flex office space further fuels this heightened demand, driving rents upward.
Despite the challenges of inflation, rising interest rates, and geopolitical tensions, certain real estate sectors are poised for growth. Areas characterized by high population growth, business-friendly environments, and robust infrastructure will continue to entice industries and companies as U.S. priorities evolve, heralding a resurgence in the industrial sector. Burgeoning MSAs will undoubtedly reap the benefits of these developments, offering opportunities for all stakeholders.