Key Findings:
1. A large speculative development pipeline is giving tenants greater options and flexibility
2. Pre-leasing is becoming less common with the rising availability of newly delivered space
3. Build-to-suits are expected to make up a larger share of construction activity in the near term
4. A drop-off in construction starts means the current tenant-favorable dynamics may not last long
5. Markets and submarkets with small construction pipelines are less influenced by these trends
Construction Starts vs. Secured Overnight Financing Rate
Developers broke ground on 1.3 billion square feet in 2021 and 2022 as they rushed to meet seemingly insatiable demand for industrial space in a severely undersupplied market. But, once the Fed began hiking rates in March 2022, construction starts began dropping as attractive financing dried up, and tenant demand returned to prepandemic norms. Quarterly construction starts in Q3 2023 were down 72% from the peak observed in Q2 2022. By late 2024, this is expected to translate into lower supply and possibly lower vacancy rates depending on demand levels amid continued economic uncertainty. However, despite this pullback, 602.1 million square feet (msf) of construction projects are still underway across the U.S.
Under-Construction Inventory by Development Type, Major Markets
The vast majority of the U.S. development pipeline consists of speculative (spec) product, the bulk of which has yet to secure a tenant. Dallas/Fort Worth has the highest under-construction pipeline, totaling 56.9 msf, 80% of which is speculative and available. Other markets with elevated supply include Phoenix, with 46.0 msf under construction (71% available), and Atlanta, with 27.4 msf under construction (78% available). In recent years, build-to-suits have become less prevalent due to market conditions of strong demand and low interest rates that favored spec, outside of manufacturing-driven markets like Detroit, where they make up nearly 50% of the construction pipeline. But the dominance of spec is expected to diminish in the near term due to a lending environment less conducive to the risk-taking of speculative development as well as the growing momentum of the reshoring trend and manufacturers’ need for specialized facilities.
Availability Rate for New Quarterly Deliveries
New deliveries are expected to remain historically high for the remainder of 2023 and most of 2024, given the size of the current pipeline. Before the interest rate hikes, pre-leasing had become the norm amid the tight conditions, evidenced by the availability rate for new deliveries reaching a low of 24% in Q1 2022. This meant that 76% of developments had tenant commitments upon completion. Since then, the availability rate for new completions climbed to 60% in Q3 2023, more than doubling in 18 months. Currently, tenants in most major markets have sufficient options for newly built space, so pre-leasing has become less common. To lease up new developments, landlords are offering greater flexibility, including a willingness to divide larger spaces and increased concessions. However, outside of Southern California, where inflated rates are beginning to slip, they have largely held the line on face rents.
A surplus of newly built and unleased space is expected to be a major feature of the industrial leasing market for most of 2024, which, combined with elevated sublease availability, gives tenants greater leverage. This is by no means a market in distress, with national vacancy still at a healthy 5.4% and long-term demand drivers intact. The market was sorely in need of new product up to modern specifications, and the new inventory is expected to be absorbed steadily. Additionally, pockets with less active construction pipelines are not seeing the same trends. However, in most locations in the near term, tenants can take advantage of these new dynamics to secure attractive terms for high-quality modern facilities.