The scarcity of US industrial property continues to be at odds with readily available office buildings, as the commercial real estate sector faces significant risks amid rising interest rates.
In the third quarter of 2022, average office vacancy rates in the US rose for the 12th consecutive quarter to reach 17.8%, according to Cushman & Wakefield, a commercial real estate services firm. By comparison, US average industrial vacancy rates stood at 3.2% — up slightly from an all-time low of 3% in the second quarter. This was the first increase in two years and remains well below the 5% average national vacancy rate recorded in 2020.
This dichotomy between the office and the industrial property market is perhaps unprecedented
“This dichotomy between the office and the industrial property market is perhaps unprecedented,” said Gregg Wassmansdorf, the chair of the Site Selectors Guild, a global association of site selection consultants.
The level of activity in different segments of commercial property partially reflect trends across the economy, such as physical investments made by companies. For instance, the boom in US industrial real estate has followed a pick up in US manufacturing activity. The Covid-19 pandemic also triggered massive demand for warehouses from retailers that had to manage supply chain disruption and increasing e-commerce activity.
Meanwhile, demand for offices has been negatively impacted by remote work and companies reconsidering their physical footprints. Despite worries about an oncoming US recession in 2023, industrial developers delivered a record 148.2 million square feet (msf) of industrial facilities throughout the country in Q3 2022, according to Cushman & Wakefield.
While there has been a slight cooling, demand for industrial space in the US remains high. Tenants occupied 108.2msf more industrial space at the end of the third quarter of 2022 than at the beginning, according to Cushman & Wakefield’s ‘net absorption’ figures. The opposite is true of the national office market, where tenants occupied 18.47 msf less space over the same period.
Despite there being a difference between metro markets, high occupancy rates and elevated demand for industrial space has also pushed rents to new heights. The US overall industrial asking rental rate finished the third quarter at $8.7 per square foot, an increase of 22% on the previous year. For warehouse and distribution space the rate surpassed %8 for the first time.
Mr Wassmansdorf said that the dynamics in commercial real estate are “a real challenge” for economic developers and companies, who are finding project schedules being much longer than expected.
“We have heard of a lot of economic developers that can’t keep up with the velocity of industrial projects. And at the same time, they struggle to figure out what the office market will look like in their locality,” he said.
Amid a surge in foreign direct investment (FDI) in the US since 2021, new and existing investors are facing delays in their expansion plans due to shortages of labour, industrial land and supply chain issues.
Between January and August 2022, foreign investors pledged more than $48bn to manufacturing projects in the US, according to the latest figures from fDi Markets. This is on track to exceed the record $50bn of manufacturing FDI tracked in the US during the whole of 2021.
Industrial developers remain bullish in line with this high investment activity. More than 716msf of industrial facilities were under construction across the country in the third quarter of 2022, which was 2.6% higher than the previous peak seen in the second quarter.
“Supply is expected to exceed demand over the next few quarters as demand cools off due to the economic slowdown as well as the construction pipeline, which is anticipated to deliver robust totals,” read the Cushman & Wakefield third-quarter 2022 US national industrial MarketBeat report.
But there remain concerns about the prices of commercial real estate and future investment due to rising interest rates. An IMF blog published in September 2022 stated that “tighter financial conditions tend to have a direct impact on commercial property prices by making it more expensive for investors to finance new deals or refinance existing loans, thereby lowering investment in the sector”.