Sustained Demand and Insufficient New Supply Drive Lease Premiums to New Highs in Port Markets

Key Takeaways:

• High demand continues to push prices up in the industrial sector, with September in-place rents nearly 6% over year-ago figures
• National vacancy rate rests at 4.1% for second consecutive month with occupier demand unlikely to weaken
• With shrinking amounts of available industrial space nationally, 703 million square feet of new supply was under construction at the end of September
• Although sale prices cooled in some markets during Q3, industrial assets are still trading for 54% more than in 2020
• Under construction and planned projects to increase Phoenix industrial footprint by 32% due to unrelenting overflow from Southern California
• Despite rivaling So-Cal vacancies, Indianapolis and Columbus keep industrial rent growth at 3% with sustained deliveries
• Under construction industrial projects reach 62 million square feet in Dallas-Fort Worth as market leverages lack of geographic limitations to satisfy demand

Industrial space remains in high demand, leading tenants to pay increasingly higher prices for a shrinking amount of available space. The national average rent for in-place leases stood at $6.88 per square foot, growing 5.8% over the last year. While rents are climbing and vacancies falling virtually everywhere, markets adjacent to ports with a lack of land to build new supply are seeing the most extreme trends.

“Especially in Southern California and around the port in New Jersey, very low vacancy, a limited new supply pipeline and steady demand are justifying the premiums new leases are garnering. Less so in the Midwest where supply pipelines represent a greater percentage of existing inventory.”

Peter Kolaczynski, Operations Senior Manager

Geographical constraints are preventing many of the hottest markets from adding sufficient new space. But markets unhindered by such limitations are taking advantage of unmet demand with impressive new supply pipelines, such as the 62 million square feet of industrial space currently being built in Dallas – Fort Worth.

Rents, Occupancy & Supply: New Supply Keeps Rent Growth Down in Non-Port Markets

Although some markets have managed to keep rent growth at more modest levels with large pipelines of new deliveries, nationwide demand continues to outstrip supply, leading to continued rent growth. Thus, while national in-place rents for industrial space reached $6.88 per square foot, new leases cost $1.38 more per square foot than in-place contracts, averaging $8.26 per square foot.

Average Rent by Metro

Although most markets saw tenants pay premiums for new space, in some locations the difference between all leases and new leases was negligible. Most of these markets were far removed from busy ports and have large supply pipelines as a percentage of existing stock. Denver, St. Louis, Kansas City, Houston and Memphis all had an average rate for new leases slightly below the market average for in-place leases, influenced by above-average vacancy rates, high levels of new supply delivered recently or in the pipeline.

Industrial Space Under Construction (Million Sq. Ft)

The national vacancy rate in September was 4.1%, unchanged from the previous month. Despite economic uncertainty, industrial space continues to be in high demand and no letup from occupiers appears to be in sight, continuing to fuel the nationwide boom in industrial development, although some industry experts are concerned about the possibility of overbuilding.

National Industrial Pipeline

Specifically, a total of 703.0 million square feet of industrial stock was under construction nationally, representing 4.0% of stock, with an additional 650.3 million square feet in the planning stages.

Across the 50 most important industrial markets in the U.S., none have more industrial supply under construction on a percentage-of-stock basis than Phoenix, and only Dallas has more square feet being built on an absolute basis.

Transactions: Pricing Cools Slightly in Third Quarter Bringing Year-to-Date Rate to $128/ Sq. Ft

Although pricing cooled in some markets during Q3, it also must be noted that given the current economic climate and considering the record transaction volume year of 2021, a Y-o-Y pullback in total volume was to be expected.

Year-to-Date Sale Price Per Square Foot

Thus, after seven straight quarters of increases in the average sale price of an industrial property, prices slightly decreased in the third quarter, falling to $127 per square foot from $136 in the second quarter. Rising interest rates, inflation and other economic headwinds have dampened the transactions market. Despite the decrease in the quarter, prices have increased 15.5% over the last year and 53.9% over the last two years. As a result, the average sale price of an industrial building year-to-date stands at $128 per square foot, with the national sales volume for the first three quarters of the year at $65.4 billion.

Quarterly Transactions (Billions)

Of the top 30 markets covered by CommercialEdge, half saw prices slip in the third quarter from the second. For example, the average sale price in Baltimore fell 40% in the third quarter and Tampa had a 30% quarterly decline. But not every market saw declines in sale prices in the third quarter: Atlanta, for instance, underwent an increase of 41% in the third quarter.

Western Markets: Under Construction and Planned Industrial Projects Could Increase Phoenix Local Stock by 32%

Southern California continues its unshakeable leadership of industrial rent growth, with both the Inland Empire and Los Angeles appreciating more than 9% year-over-year and Orange County rents rising 7.1%. But it’s not just Southern California that continues to see a rapid pace of rent growth — Western markets in general continue to post some of the highest industrial rent increases. Specifically, Phoenix in-place rents appreciated 7.5% over year-ago figures, while the Bay Area and Seattle gained 6.3%.

Consequently, industrial markets in the Western U.S. remain the priciest nationwide, with many seeing new leases inked at rates over $10 per square foot. At $12.65 per square foot and $11.49 per square foot, Orange County and Los Angeles in-place rents were among the three highest nationwide. Combined with the rapid pace of rent growth, new leases are now averaging $17.36 per square foot in Orange County and $17.39 per square foot in Los Angeles, for the widest lease spreads among the top 30 industrial markets in the country.

These markets also have some of the lowest vacancy rates in the U.S., with the Inland Empire at just 1.1%, Central Valley at 1.9% and Los Angeles at 2.0%. Moreover, the expectation for these markets is that vacancy rates will remain tight for the foreseeable future due to demand far outstripping supply, compounded by the lack of land for significant industrial developments.

For instance, Los Angeles had a mere 2 million square feet of industrial space under construction at the end of Q3, accounting for 0.3% of its existing stock. Even when taking into account planned projects, L.A. is expected to increase its footprint by just 2.2%, resulting in a supply pipeline far below what the market continues to demand. Similarly, Orange County had an under-construction pipeline of just 1.8% of its existing inventory. And while deliveries and new starts are significantly larger in the Inland Empire, they still far short of market needs.

West Regional Highlights

On the other hand, Phoenix currently has the largest supply pipeline on a stock basis and the second largest in terms of square footage, as it continues to attract an increasing number of industrial players squeezed out of Southern California. To be precise, Phoenix had nearly 45 million square feet of new industrial space under construction as of late September, the equivalent of 15.1% of its existing stock. Moreover, the market’s planned projects could more than double that pipeline for a full increase of 31.7%.

However, the industrial sector overall cooled somewhat in Q3, with sale prices lower than Q2 levels in about half of the country’s leading markets. Among them was Central Valley where Q3 sale prices were 30% lower than Q2 figures. On the other hand, the Bay Area’s industrial sector saw sales average 40% higher rates quarter-over-quarter.

Southern California claimed the highest sale prices, with Orange County industrial properties trading at $362.06 per square foot, Los Angeles at $305.54 per square foot and the Inland Empire at $303.42 per square foot. The two latter markets also remained in the lead in terms of sales volumes. Specifically, the Inland Empire closed $3.89 billion in industrial sales, followed by Los Angeles with a sales volume of $3.82 billion. Additionally, Phoenix closed $2.1 billion in industrial transactions.

Midwestern Markets: Robust New Construction Pipeline Keeps Midwest Rent Growth Down Despite Tight Vacancies

Although several Midwestern markets are also facing tight vacancy rates, rent growth has been more muted than on the West Coast or in port markets like New Jersey. Columbus and Indianapolis both experienced a 3.0% year-over-year increase in industrial rents, despite low vacancy rates that rival Californian markets. Specifically, Columbus had a 1.9% vacancy rate, the same as Central Valley, while Indianapolis vacancies stood at 2.3%, just over Los Angeles’ 2.0% rate.  By comparison, Central Valley leases rose 4.8% year-over-year, while Los Angeles shot up 9.1%.

In terms of rent growth, the attention Detroit has been receiving of late resulted in a 7.0% year-over-year lease rate increase, nearly equaling Orange County’s 7.1% gains. Thus, Detroit was at the lead of rent growth in the Midwest, and posted the widest lease spread in the region, with in-place rents averaging $6.10 per square foot and new leases signed at average rate of $6.97 per square foot.

As a result, Detroit posted the second-highest lease rate in the Midwest, surpassing Chicago’s $5.51 rate. Moreover, Detroit came close to equaling the Twin Cities’ $6.14 per square foot rate, the Midwest’s highest. But while Detroit and the Twin Cities had under-construction pipelines of 0.8% and 1.8%, respectively, Columbus and Indianapolis kept rent growth at a much lower level than West Coast markets with similar vacancy rates thanks to large new development deliveries and pipelines.

To be precise, Columbus had close to 18 million square feet of industrial space under construction, the equivalent of 6.4% of its existing footprint. When taking into account planned projects as well, Columbus is looking at a stock increase of 9.6%. Indianapolis had an even more robust construction pipeline at nearly 25 million square feet, the equivalent of 7.6% of local stock. When considering planned projects as well, the Indianapolis industrial sector is set to expand its footprint by 13.4%.

And although Kansas City was building 12 million square feet of new space for a 4.6% increase of its industrial square footage, planned projects are set to lift that figure to 17.9% of existing stock.

Midwest Regional Highlights

Chicago’s industrial market stood out when it came to sales, ranking as the only Midwestern market with a sales volume larger than $1 billion, closing $2.73 billion in industrial sales over the course of the first three quarters of the year. Additionally, Chicago had the highest number of industrial transactions among the country’s 30 leading markets, closing 275 deals by the end of September, surpassing Los Angeles’ 151 deals.

However, Chicago’s $84.59 per square foot average sale price was only the second highest in the Midwest, surpassed by the Twin Cities at $105.74 per square foot. Columbus also stood out regionally in terms of transactional activity with the second-highest sales volume at $908 million, suggesting it may very well go north of $1 billion before the year is out. The market also posted the region’s third-highest sales price at $81.45 per square foot.

Southern Markets: Dallas – Fort Worth on Track to Add 62 Million Square Feet of New Industrial Space

Among leading Southern markets, Nashville posted the lowest vacancy rate at the end of Q3 with just 1.6%. It was followed by Atlanta at 2.3% and Miami at 3.3%, with all three markets comfortably below the 4.1% national average. Conversely, Houston had one of the highest vacancy rates at 7.8%, both in the South, and nationwide.

In line with these markets’ higher vacancies, rent growth has been slower than in other markets in this region. Specifically, Houston and Memphis saw lease rates gain 2.0% over year-ago figures, while Tampa rents inched up 2.2% year-over-year. Rent growth was more robust in Miami, Atlanta and Dallas – Fort Worth, where rates increased 5.2%, 5.5% and 5.7%, respectively.

These gains resulted in some of the widest lease spreads in the region as well, with Miami in the lead: While in-place rents averaged $9.43 per square foot here, leases signed over the past 12 months averaged $11.30. Tampa’s in-place rents clocked in at an average $6.62 per square foot, while new leases came in at $7.87 per square foot. The Dallas - Fort Worth industrial sector was next, as in-place rents stood at an average $5.15 per square foot and new leases signed at $6.11 per square foot.

Conversely, some industrial markets in the South saw new leases average lower rates than in-place rents. Among them was Charlotte, where in-place industrial leases stood at $6.37 per square foot, while leases signed over the past 12 months averaged $6.09 per square foot. Houston’s high vacancy rate was also evidenced in its lease spread, with new rents averaging $5.74 per square foot while in-place contracts stood at $6.01 per square foot.

South Regional Highlights

Construction activity was fairly modest in Tampa and Atlanta on a percentage-of-stock basis: Tampa’s under-construction projects totaled 2.6% of its existing stock, while Atlanta’s industrial developments with shovel in the ground were set to increase the local stock by 2.7%.

On the other end of the spectrum stood Dallas - Fort Worth with 62 million square feet of industrial space under construction as of late September, accounting for 7.3% of the market’s stock. As a result, the Dallas market was at the forefront of industrial development in terms of square footage, with Phoenix’s 45 million-square-foot pipeline the next largest. When considering planned projects as well, Dallas is set to increase its footprint by 11.9%, the same rate as Charlotte under-construction and planned industrial pipeline.

Among Southern markets, Houston and Atlanta had the most robust sales volumes, closing $1.42 billion and $1.33 billion in sales year-to-date, respectively. Atlanta also had the most active transactional market, closing 111 deals in the first nine months of the year, ranking fifth nationwide.

In terms of pricing, Houston led the South at $164 per square foot year-to-date, followed by Nashville at $157 per square foot and Atlanta’s $113 per square foot. Atlanta was also among markets where Q3 sales prices were significantly higher than Q2 figures, coming in 40% higher.

Northeastern Markets: East Coast Construction Pipeline Struggles to Meet Demand

As has been the case across port markets, New Jersey’s vacancy rate remained tight a 2.5%, placing it between Los Angeles’ 2.0% and Orange County’s 2.7% rate. Considering the market’s high occupancy rate and demand, industrial rents in New Jersey have continued to rise, coming in 7.6% over year-ago figures, for the fourth-fastest pace of increase nationwide. That also meant that New Jersey had one of the widest industrial lease spreads nationwide, with in-place rents averaging $8.97 per square foot, while leases inked over the past 12 months averaged $11.60 per square foot.

While some leading markets in the South saw new leases signed at lower rates than in-place contracts, in the Northeast’s most important industrial markets rates for new leases were higher than in-place ones. In Boston, for example, in-place contracts averaged $9.25 per square foot, while new leases stood at $10.36 per square foot. Baltimore’s spread was also north of $1 per square foot, with the average in-place rent at $7.06 per square foot and new leases at $8.38. This trend held true even in Philadelphia, where both existing and new leases stood below the national average.

Northeast Regional Highlights

As remains the case in California’s leading industrial markets, new supply simply cannot keep up with demand in New Jersey either. The East Coast’s tightest industrial market had close to 16 million square feet of new space under construction, the equivalent of 2.9% of existing stock, and even with planned developments that have yet to break ground, New Jersey is set to increase its industrial footprint by just 5.0%, nowhere near enough to meet the demands placed on this market.

In fact, the East Coast’s most important industrial markets all had construction pipelines lower than the national average of 4.0%, with Philadelphia’s the highest on a percentage-of-stock basis at 3.4% and the Bridgeport – New Haven market the lowest at just 1.1%. Even when considering planned projects, the only market to go over the national average of 7.7% was Philadelphia, where developments that have yet to break ground and those already underway are set to increase the market’s footprint by 12.1%, for the third-highest share nationally.

In terms of sales, New Jersey remained in the lead with a year-to-date rate of $174.76 per square foot, closely followed by Boston’s $174.08 per square foot rate. New Jersey also had the third most active sales market across the country’s top 30 markets, closing 136 deals year-to-date, with Philadelphia right on its heels with 127 closed transactions. New Jersey and Philadelphia also posted the fourth- and fifth-largest industrial sales volumes, closing $2.44 billion and $2.14 billion in industrial sales year-to-date.

Economic Indicators: E-commerce Deceleration Continues

The Producer Price Index (PPI), which measures supply-side inflation faced by the producers of both goods and services, grew at a monthly rate of 0.4% and 8.5% on a 12-month basis. Core PPI, which excludes volatile food and energy prices increased 0.4% on the month and 5.6% over the last twelve months. Goods prices, driven by a 1.2% increase in the cost of food, rose 0.4% on the month and 11.3% year-over-year. Services grew at a monthly rate of 0.4% and an annual rate of 6.8%.

Economic Indicators

Inflationary pressures have eased in the second half of the year, but inflation remains well above the Federal Reserve’s target. The Fed has increased interest rates 75 basis points on two separate occasions in 2022 and recent inflation readings suggest a third such hike in November is likely. We are already seeing the impact of higher interest rates on the transactions market, with average prices and total sales volume slowing in the third quarter. A higher cost of capital may also constrain the new supply pipeline, despite continued demand for space.

Producer Price Index:

Download the complete October 2022 report for a full picture of how U.S. industrial markets fared in the first eight months of the year, including insights on industry and economic recovery fundamentals.

You can also see our previous industrial reports.

Methodology

The monthly CommercialEdge national industrial real estate report considers data recorded throughout the course of 12 months and tracks top U.S. industrial markets with a focus on average rents; vacancies (including subleases but excluding owner-occupied properties); deals closed; pipeline yield; and forecasts, as well as the economic indicators most relevant to the performance of the industrial sector. For a detailed methodology, download the full report above.