What’s causing the lack of demand for industrial real estate?
Good day, dear readers! Today I feel a bit professorial. Therefore, I’ll discuss a phenomenon we’re witnessing in the industrial real estate market in Southern California — the lack of demand.
What is demand, you may ask?
In this context, demand stems from a need created by external factors. Think for a moment about your own home. If you suddenly realize you’re out of coffee, you have a need created by an external factor — someone forgot to put coffee on the shopping list. Consequently, you rush to your corner Starbucks or neighborhood Albertsons to get your caffeine fix.
Demand in industrial real estate works in much the same way. It arises from changes in business activity, external economic factors, or shifts in the marketplace.
In the last days of 2020 and 2021, as many of us were quarantined in our home offices, a surge in online shopping occurred. Retail giants like Amazon, Walmart, Costco and Target ramped up their inventories to avoid stock shortages, leading to a massive boom in demand for warehouse space.
Two things happened:
— On-hand inventories swelled to unprecedented levels.
— The uptick in inventories led to historically low vacancy rates in industrial spaces, especially in logistics hubs. As a result, rents and sale prices for warehouse space soared, and smaller retailers began relying heavily on third-party logistics providers (3PLs) to manage distribution. These 3PLs also scrambled to lease more space to meet the growing needs of their customers.
But by the summer of 2022, everything changed. The business climate cooled, interest rates rose, and the once-voracious demand for industrial space slowed down. No longer could the industry count on Amazon absorbing millions of square feet of space to fuel growth.
However, today’s lack of demand feels different. It’s more systemic — driven not only by market corrections but by a deeper uncertainty. When businesses are uncertain about the future, they hesitate. They are less likely to acquire competitors, hire new employees, venture into new business deals, or lease additional space. And this hesitation is what we’re witnessing now.
What’s causing the uncertainty?
Several factors are contributing to the lack of demand in industrial real estate:
The upcoming election: Political transitions and elections often lead to a wait-and-see approach from businesses. They want to know which policies will be implemented before making large commitments.
Global tensions: From trade wars to geopolitical conflicts, uncertainty on the world stage makes companies think twice before investing in new space or expanding operations abroad.
Federal Reserve moves: The central bank’s benchmark interest rate hikes have made borrowing more expensive, which in turn raises the cost of financing real estate transactions. This has caused both tenants and investors to hit the pause button on deals that previously made sense financially.
Natural disasters: The growing frequency of natural disasters — wildfires, hurricanes and floods — has added a layer of risk to real estate decisions. Companies are increasingly aware of the potential impact of these events on their operations and are cautious about committing to long-term leases or purchases in areas vulnerable to climate change.
Record-high rents and sales prices: After years of rapid growth, industrial real estate prices have hit record highs, making it difficult for tenants to justify paying such premiums, especially in uncertain economic times.
What’s next for industrial real estate?
While this slowdown in demand is significant, it doesn’t spell doom for the industrial real estate market. Instead, it signals a recalibration — a moment to step back, assess and adjust strategies for both owners and tenants.
For tenants, this cooling market could present opportunities to negotiate more favorable lease terms, secure rent reductions, or lock in concessions like tenant improvements or free rent periods. Meanwhile, for landlords, this is a time to consider flexibility, offering shorter lease terms, more aggressive incentives or even speculative development that aligns with future market shifts.
As we move forward, it will be crucial to keep an eye on the macroeconomic factors — interest rates, geopolitical developments and economic policy decisions — that continue to shape demand. The industrial real estate market has proven its resilience over the years, and while today we may be facing a lull in demand, tomorrow’s landscape may very well be different.
As we all navigate through this uncertainty, one thing remains clear: industrial real estate will continue to adapt, evolve and play a critical role in the broader economy.
Allen C. Buchanan, SIOR, is a principal with Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.