A panel of executives at leading industrial development firms shared their outlooks for the future of industrial real estate at NAIOP’s I.CON West: The Industrial Conference this week in Long Beach, California. The COVID-19 pandemic has accelerated the adoption of e-commerce and demand for industrial real estate over the last two years, creating new opportunities for developers, but also presenting them with new challenges as space becomes scarce, tenant operating costs increase, localities impose more regulations on development and environmental sustainability becomes increasingly important to tenants and local communities.
Fran Inman, senior vice president at Majestic Realty Co., observed that while industrial real estate has “been front and center since the Great Recession… the last two years have been absolutely crazy” as demand has taken off. According to Tom Bak, senior managing director at Trammell Crow Company, industrial developers have had to balance a slackening of demand for properties that serve brick-and-mortar retail with rapidly growing demand for e-commerce distribution. Consumers are flush with cash and continue to spend it on goods, producing insatiable demand for industrial space. Kim Snyder, president of Prologis’ West region, noted that there has been a psychological shift among consumers during the pandemic as people who had relied primarily on in-store retail became comfortable ordering goods online.
Dayton Conklin, managing director at Clarion Partners, observed that the acceleration of demand related to e-commerce distribution has expanded the number of metropolitan markets that attract new industrial development. Where 10 to 20 years ago, most activity was concentrated in five major markets, secondary markets now attract substantial levels of new development and tertiary markets have also grown more important as retailers move distribution closer to population centers. Dwight Merriman, head of industrial development at Ares Management Corporation, noted that while demand has pushed up industrial rents across the U.S. by an average of 17%, coastal markets have seen higher rent increases with key markets near major logistics hubs seeing the strongest growth in demand. For example, rents for one property in California’s Inland Empire increased 53% in the space of just one year.
Panelists have seen the improvement in market fundamentals and scarcity in the supply of undeveloped land driving a growing number of redevelopment projects in California. Merriman shared that Ares has even acquired several office buildings and is tearing them down to build industrial buildings. Conklin observed that developers are also actively redeveloping regional malls into distribution space.
Inman noted how the dimensions of industrial buildings have also been growing over the last two decades, with an increasing number of distribution centers exceeding a million square feet in size. According to Snyder, much as design shifted from 26-foot clear heights to 40-foot clear as the new standard for larger buildings in California, conversations with tenants are increasingly shifting from square feet to cubic feet and racking capacity. Both Merriman and Conklin noted that trailer storage and circulation are more important than they were in previous years, leading to lower coverage ratios.
Environmental sustainability is also a growing concern for both tenants and the communities they serve. Snyder shared that developers increasingly have to plan for electric vehicle (EV) charging stations and the additional infrastructural and power requirements they entail. EV charging stations and automated racking systems now require that developers install capacity for between 12,000 and 20,000 amps of electricity in many distribution facilities. Prologis is also adding more structural support for roofs in new buildings so that they can accommodate future solar panel installation.
Local jurisdictions in the Inland Empire are also imposing new regulations related to environmental sustainability that increase costs for industrial tenants. Snyder described how the Indirect Source Rule assesses fees on industrial tenants based on the estimated environmental impact of trucks servicing a building. This presents a challenge for warehouse operators, who usually do not operate their own truck fleets and don’t have direct control over truck emissions. Prologis is encouraging tenants to make capital investments to reduce emissions on the trucks that service their buildings by installing EV charging stations, and expects that tenants will soon start to ask trucking companies to increase their use of zero-emission vehicles to reduce costs associated with the rule.
Panelists noted that in addition to environmental regulations, local jurisdictions in California have made obtaining entitlements increasingly difficult over the years. Many jurisdictions view industrial buildings less favorably than other commercial uses: they don’t generate sales tax and nearby residents may not appreciate additional truck traffic on adjacent streets. Longer and more challenging entitlement processes and outright opposition to industrial development in some jurisdictions is contributing to the shortage of industrial space in Southern California.
A range of other concerns are also on developers’ minds as they anticipate where the industry is headed. Panelists shared that they are prioritizing recruitment and retention to foster the talent needed to grow their firms, including by participating in diversity, equity and inclusion initiatives such as those offered by NAIOP. According to Conklin, rising interest rates have slowed the pace of capital flows, even as demand for industrial space remains robust. Merriman, Bak and Inman shared their concerns that inflation and rising operating costs for tenants, such as those associated with port fees and shipping rates, are affecting tenant budgets and may affect their locational decisions. Bak is also concerned about rising land costs and growing risk-taking behavior by developers. Merriman echoed this view, noting that although conditions now favor new development, developers need to keep an eye on risk: “It’s so perfect you have to pinch yourself.”
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