Amazon sign pointing to a warehouse, where workers are voting on unionizing

The hairline fractures in logistics warehousing transaction activity, which surfaced over the summer, have widened into the fall as the rapid and fierce rise in borrowing costs puts the red-hot segment in what could be called “recalibration” mode.

Deals are still getting done. However, they are taking longer to complete. Debt is harder to secure as cautious lenders tighten their underwriting criteria. Investors have stepped back somewhat as higher borrowing costs lead to an increase in “compression rates,” an unfavorable trend that implies falling prices for the same projected stream of income.

Tenants and lessees, meanwhile, have been reevaluating their strategies as consumer spending on hard goods level off and Americans order more from stores and less on online platforms. Some have put projects on hold as they search for clarity in an increasingly clouded environment for both interest rates and tenant demand. 

Other occupiers are taking the plunge now, looking to lock in space at current prices before they go any higher, said John Balestra, principal in the Los Angeles office of Trammell Crow Co., the developer arm of CBRE Group Inc. (NYSE: CBRE). Part of the reasoning could be that any reduction in supply could actually fuel higher rents in certain markets.

Some investors and landlords are pushing deals with shorter lease durations in the belief that rents will continue to rise, experts said. Tenants want 10-year leases, but landlords won’t give it to them, said Jack Rosenberg, the head of the national logistics practice at Colliers’ International Group (NASDAQ: CIGI), a real estate advisory.

Landlords don’t want to commit to such long durations and potentially miss out on rent escalation opportunities in the interim, Rosenberg said.

None of this means that the raging 12-year bull market for industrial real estate — mostly logistics but also some manufacturing — is coming to an end. The three primary trends driving industrial demand — a growing population, elevated e-commerce activity and the need to maintain higher levels of buffer stock to ensure product availability — remain very much in place.

“The market fundamentals have never been better,” Balestra said. The spike in interest rates is “creating a clear disconnect between industry fundamentals and the capital markets,” he said.

Amanda Ortiz, Colliers’ national industrial research director, said the average purchase price of a facility in May hit a record of $145 per square foot, despite a slowdown in sales volume. 

The strong rent levels reflect positive secular trends that are likely to survive the current bouts with more expensive money and macro uncertainty, according to Ortiz. The “outlook for net operating income growth remains strong, which should drive more capital to real estate,” she said.

Third-quarter data reflects a continued robust industrial market, said Carolyn Salzer, head of logistics and industrial research at real estate advisory Cushman & Wakefield plc (NYSE: CWK), a real estate services firm. Vacancy rates continued to hover around 3.2%, slightly higher than the second quarter but still hovering at all-time lows, according to Cushman data.

Third-quarter asking rents nationwide were projected to hit $8.70 per square foot, which would be a 22% year-on-year increase, according to Cushman data. In the West, which includes areas of California where logistics warehouse space is virtually nonexistent, rents hit $12.99 per square foot. In the equally space-constrained Northeast, rents hit $11.33 per square foot. 

Net absorption, which calculates the amount of square feet occupied during a specific period minus the amount of square feet vacated, came in at 108 million square feet, according to Cushman data. That’s below the 132 million square feet of net absorption in the second quarter, but still a solid number, Salzer said. 

The data marks the eighth consecutive quarter of more than 100 million square feet of positive net absorption. Prior to the pandemic, there had never been a quarter of more than 100 million square feet of net absorption, Salzer said.

The industrial construction pipeline hit an all-time high in the quarter of 716.9 million square feet, up 2.6% from the previous record set in the second quarter. The gains came despite a historically high number of project completions in the quarter, Salzer said.

Much of the pent-up supply caused by supply chain issues, port congestion and materials shortages has begun to unwind, she said.

Tight conditions and healthy demand will keep near-term overbuilding concerns at bay, Salzer said. However, should more projects break ground, some markets could experience overcapacity, especially should tenant demand slow, she said.

Markets such as Dallas/Fort Worth that already have a lot of available capacity may see vacancy rates rise and asking rents fall in the months to come, said Balestra of Trammell Crow. Ultratight markets like the Southern California sea and airport region, the Inland Empire about 80 miles east, and the New York, New Jersey and central Pennsylvania corridors will be less affected, he said.