Hello, dear readers! I felt a bit like a professor today. So let me explain what we are witnessing in the Southern California industrial real estate market: lack of demand.
What is demand?
In this context, demand arises from needs created by external factors. Think for a moment about your home. If you suddenly find yourself out of coffee, the need for coffee was caused by an external factor: someone forgot to put coffee in the shopping list. As a result, you rush to the corner Starbucks or your local Albertsons to get your caffeine fix.
Demand for industrial real estate works in much the same way. This can occur due to changes in business activities, external economic factors, or changes in the market.
The last few days of 2020 and 2021 saw a surge in online shopping as many of us quarantined in our home offices. Retail giants such as Amazon, Walmart, Costco and Target have increased inventory to avoid stock shortages, leading to a massive demand boom for warehouse space.
Two things happened:
— On-hand inventory has ballooned to unprecedented levels.
— Increased inventory has led to historically low vacancy rates for industrial space, especially in logistics hubs. As a result, rents and sales prices for warehouse space have skyrocketed, and small retailers have begun to rely heavily on third-party logistics providers (3PLs) to manage their logistics. 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 environment has cooled, interest rates have risen, and once-strong demand for industrial space has slowed. The industry can no longer expect Amazon to absorb millions of square feet of space to fuel growth.
But today’s lack of demand feels different. It’s more systemic and driven not only by market corrections but also by deeper uncertainties. Businesses hesitate when the future is uncertain. They are less likely to acquire competitors, hire new employees, pursue new deals, or lease additional space. And this hesitation is exactly what we are witnessing now.
What is causing the uncertainty?
The lack of demand for industrial real estate can be attributed to several factors.
Upcoming elections: Political changes and elections often prompt companies to take a wait-and-see attitude. They want to know what policies will be implemented before making big promises.
Global tensions: From trade wars to geopolitical conflicts, global uncertainty is forcing companies to think twice before investing in new areas or expanding overseas.
Federal Reserve Actions: The central bank’s benchmark interest rate hike has increased borrowing costs, which in turn has increased the cost of financing real estate transactions. This has caused both tenants and investors to hit the pause button on deals that previously made economic sense.
Natural disasters: Natural disasters such as wildfires, hurricanes, and floods are becoming more frequent, making real estate decisions even more risky. Companies are increasingly aware of the potential impact of these events on their operations and are becoming cautious about long-term leases and purchases in areas vulnerable to climate change.
All-time high rents and sales prices: After years of rapid growth, industrial real estate prices have reached record highs, making it difficult for tenants to justify paying such a premium, especially in uncertain economic conditions. It is becoming difficult to convert.
What’s next for industrial real estate?
While this slowdown in demand is noticeable, it is not dooming the industrial real estate market. Instead, it signals a readjustment. It’s a moment for both owners and tenants to step back, assess and adjust their strategies.
For tenants, this cooling market could present an opportunity to negotiate more favorable lease terms, secure rent reductions, and lock in concessions such as tenant improvements or free rent periods. Meanwhile, for landlords, it’s time to consider flexibility such as shorter lease terms, more aggressive incentives, and even speculative development to align with future market changes.
As we move forward, it is important to remain focused on the macroeconomic factors that continue to shape demand: interest rates, geopolitical developments, and economic policy decisions. The industrial real estate market has proven its resilience over the years, and while it may be facing weak demand today, the situation could be very different tomorrow.
As we all navigate this uncertainty, one thing is clear. That means industrial real estate will continue to adapt, evolve and play an important role in the broader economy.
Allen C. Buchanan, SIOR, is president of Lee & Associates Commercial Real Estate Services in Orange. He can be reached at abuchanan@lee-associates.com or 714.564.7104.
