By Ward Richmond
U.S. industrial market fundamentals softened in the first quarter of 2023. Higher interest rates and uncertainty about the economy led to more modest levels of net absorption, and steady completions outpaced demand. While the vacancy rate ticked up from a cyclical low in 2022, it remains well below historical average levels. Asking rents also continued to expand, given still-tight market conditions. However, after two years of exceptional growth driven by pent-up demand following the pandemic, industrial performance will moderate in 2023 as economic growth diminishes.
Following nine straight quarters in which net absorption exceeded 100 million square feet, demand for industrial space moderated in the first quarter of 2023 to 73.8 million square feet. While completions rose 34.9% year-over-year to 131.1 million square feet, deliveries declined modestly from peak levels reached in the prior two quarters. The vacancy rate increased 30 basis points from the end of 2022 to 4.0% but remained well below its historical average level of 6.2% since 2010.
U.S. GDP growth slowed to an annual rate of 1.1% in the first quarter, down from 2.6% in the fourth quarter of 2022. While inflation has come down from peak levels, it is still above the Fed’s target of 2%, suggesting interest rates will remain elevated in coming quarters. Tighter lending standards stemming from the recent weakness in the banking sector will also weigh on growth in 2023. While the probability of entering a recession later this year has grown, the relative strength of the consumer and the labor market may point toward a shorter, shallower downturn compared to previous cycles. Consumer spending, which accounts for over two-thirds of GDP, increased 3.7% in the first quarter, and while labor constraints are easing, unemployment remains below average.
The markets experiencing the strongest demand relative to their size (absorption as a percent of inventory) in the first quarter included the emerging metros of Charleston, Greenville/ Spartanburg, Richmond, Las Vegas, and Salt Lake City, along with a handful of more established markets including Phoenix, Indianapolis, and Dallas. A heavy development pipeline is also pushing vacancies in some of these markets above the national average, notably in the major metros of Dallas and Indianapolis, where 6.2% and 5.6% of inventory is underway, respectively.
Supply levels remain elevated, although ground-breakings have decelerated modestly amid higher interest rates. Just over 131 million square feet were delivered in the first quarter, down 7.2% from the record supply delivered in Q4 2022, but still well above the more typical pace of deliveries over the last five years. The development pipeline remains full, with a total of 621.8 million square feet under construction in the first quarter, equating to 3.6% of the market’s inventory. The automotive industry is driving many of the largest projects underway with the development of new semiconductor, EV battery, and microchip facilities across the U.S. Construction levels remain highest in the high-growth South and West regions, where 5% and 3.8% of the inventory was underway, respectively, in the first quarter.
After two years of record net absorption that totaled more than 100 million square feet per quarter, industrial demand decelerated to 73.8 million square feet in the first quarter of 2023. That reading was 37.6% lower than the first quarter of 2022 but still well above first-quarter totals in the years prior to the pandemic. Demand across most markets remained in expansion mode, although 28% of metros tracked by Colliers logged negative net absorption in the first quarter. Los Angeles experienced the largest decline in demand of 1.7 million square feet in the first quarter, although with little underway in the market, vacancy remained below 2%.
The overall vacancy rate increased30 basispoints quarter-over-quarterto 4.0%, although it remained well below its historical average rate of 6.2% since 2010. Major markets with the lowest vacancies include Savannah (1.0%), GreaterLos Angeles (1.2%), Miami (1.8%), InlandEmpire (1.9%), andReno/Sparks (2.3%), whilesome ofthehighestvacanciesare in Boston (7.2%), Denver (7.0%), Indianapolis (6.5%), Stockton (6.3%), andMemphis (6.3%). Averageasking rents for warehouse/distributionspaceremainedresilient, climbingto$8.76 per square foot per year in thefirstquarter, 8.2% higherthantheprior peakreachedattheendof2022. Rent growthisexpectedtomoderateover the comingquartersas supply begins to overtake demand in some markets.
Industrial demand growth cooled during the first quarter from the robust pace set in the last two years amid slower economic growth.
Construction activity remained elevated, with 621.8 million square feet underway, equating to 3.6% of total inventory.
The vacancy rate ticked up 30 basis points in the quarter to 4.0%, although it remains well below its historical average.
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Ward Richmond has over fifteen years of experience specializing in industrial real estate, and has negotiated over 500 transactions while working in over 100 cities across the USA, Canada, and Mexico. Several publications have featured Ward for his expertise in this field including the Wall Street Journal, Dallas Morning News, and Dallas Business Journal. He also serves on Colliers International Industrial Advisory Board, and is a member of the Logistics & Transportation Solutions Group.
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