Goods distribution

Industrial Development Responds to Cooling Debt Markets

At CRE.Converge 2022 this week, panelists Patti Miller, vice president at E.E. Reed Construction; Michael Anderson, senior project manager at DLR Group; Keith Largay, senior managing director and Chicago office co-head at JLL; and Carolyn Salzer, director and head of Americas logistics and industrial research at Cushman and Wakefield discussed current trends in goods distribution and the next generation of e-commerce fulfillment.

The panelists observed that conditions for new development have changed substantially over the past year due to rising interest rates. Largay noted that much of the 700 million square feet of industrial space that is currently under construction was initially financed when interest rates were about half of what they are now, with the cheapest debt currently available at interest rates in the 5.5% to 6.0% range. Developers are trying to identify what the residual cap rates for these projects will be. For those projects that secured construction loans at low interest rates but have not yet secured permanent financing, some investors will need to come up with additional equity before a lender will underwrite a permanent loan at current rates.

New projects are also affected by higher rates; Largay indicated that there is more equity currently available for deals than debt. As long as developers can obtain debt financing, they will continue to initiate new projects, but will focus on quality infill product with a higher ratio of build-to-suit than in recent years.

With higher interest rates and construction costs that remain elevated, developers must focus on the projects that can generate growth in rental income. Salzer projected that rent growth will remain above historical averages for the next three to five years, though slower than the recent boom. She is optimistic that the increase in interest rates and steadier growth in rental rates will gradually lead to greater balance between supply and demand for industrial space, rather than the volatility in each that the market has experienced over the last two years. Anderson expressed confidence that demand for e-commerce space is not going anywhere due to the convenience that it affords consumers.

Salzer expressed some concern for the potential for over-construction in some markets over the next year – should debt again become more available or construction costs ease – but observed that vacancies currently remain stable. Developers and investors continue to be drawn primarily to gateway markets where demand for industrial space is expected to remain robust. Development has been particularly strong in markets like Dallas and Houston where there is a much larger supply of developable land than in the major coastal markets.

Panelists also touched on emerging trends in industrial development, such as redevelopment of infill sites, multilevel warehouses, and electric vehicle charging stations. According to Salzer, new development is usually preferable to adaptive reuse, which tends to be more expensive. Older industrial buildings often require substantial structural changes to bring them up to current market standards. That is also true of retail to industrial conversions, which can come with additional resistance from municipalities that would prefer that the sites continue to support a retail use. Largay shared that some of the older infill industrial sites with 14- to 18-foot clear heights can be suitable for smaller local tenants but will not be attractive to credit tenants.

Salzer noted that multilevel warehouses are going up in a few markets in small numbers, and are largely confined to coastal, land-constrained markets like New York and Seattle. According to Largay, these sites need to be located in markets with “massive” population density where traffic is a major obstacle to delivery from traditional distribution centers outside the urban core.

Meeting the demand for electric vehicle charging stations from a growing number of tenants requires more advanced planning. Anderson observed that preparing for the additional demand for electricity generated by charging stations is similar to planning for a data center, in that the building’s power requirements may require the construction of an adjacent transformer. Transformers can take two to three years to build and require working closely with a local utility as well as a municipality’s planning committee.

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