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Industrial Development Slows Down in 2023, Signaling Market Normalization; Western Markets Continue to Dominate Industry

CommercialEdge, Los Angeles, Orange County, Inland Empire, Seattle, Bay Area, industrial report

By The Registry Staff

According to the latest U.S. industrial property market report by CommercialEdge, development in 2023 is expected to be more subdued compared to the previous year, despite record-breaking levels of new supply. From January to May 2023, approximately 109.6 million square feet of new industrial space broke ground, a significant decline from the 240.5 million square feet during the same period in the previous year.

The slowdown in development comes as no surprise, given the current high-interest-rate environment and the ongoing stabilization of demand for industrial space, according to the report. However, Phoenix and the Dallas-Fort Worth metroplex emerged as exceptions to this trend, with 13.5 million square feet and 13 million square feet of new construction starts, respectively. These two markets accounted for nearly 25 percent of all industrial space that broke ground this year.

Despite the construction slowdown, key industrial fundamentals remained robust in May. Average industrial in-place rents increased to $7.29 per square foot, marking an 11-cent increase from April. Additionally, new leases signed in the past 12 months averaged $9.50 per square foot, representing a $2.21 premium compared to existing contracts.

In May, the national industrial vacancy rate rose to 4.3 percent, a 20-basis-point increase from the previous month. This uptick can be attributed to the high levels of new supply in recent quarters, combined with a normalization of demand compared to the peak levels observed during the pandemic.

While a significant portion of the delivered industrial space has been absorbed, certain markets may experience higher vacancy rates in the coming quarters. The industrial market outlook suggests that markets with low barriers to entry for new development will face a higher risk of oversupply, while port markets are expected to maintain low vacancy rates.

The Inland Empire in the West boasted the second-largest supply pipeline, with approximately 33.1 million square feet in development, accounting for 5.3 percent of its existing inventory. On the other hand, Orange County had a smaller pipeline of 950,335 square feet, representing 0.5 percent of its current stock.

Despite a decline in industrial sales due to rising interest rates and slower e-commerce growth, prices have remained relatively stable. The national average price per square foot in the second quarter was $134, representing a minor decrease of 1.3 percent year-over-year.

Western markets dominated the national sales volumes, with the Inland Empire and Los Angeles leading the way at $1.9 billion and $1.1 billion in closed deals, respectively. The Bay Area and Phoenix followed closely with $1.08 billion and $836 million in industrial transactions.

In terms of average sale prices per square foot, the West claimed the top five positions. Los Angeles secured the first spot with properties trading at $417 per square foot, trailed by the Bay Area at $379 per square foot. Orange County followed at $323 per square foot, while the Inland Empire and Seattle recorded rates of $270 and $231 per square foot, respectively.

According to the Census Bureau, e-commerce sales in the first quarter of 2023 reached $272.6 billion, showing a 3 percent increase compared to the previous quarter. This marked the largest quarterly surge since the fourth quarter of 2021. Simultaneously, the share of e-commerce in core retail sales, excluding food, automobile, and gasoline, grew from 17.9 percent to 18.2 percent during the same period.

This is the first time since the second quarter of 2021 that e-commerce’s share of core retail sales surpassed the 18 percent mark. After experiencing a spike at the beginning of the pandemic, the share of e-commerce remained below 18 percent for several quarters. While this recent increase in sales volume and market share may not indicate a long-term trend, it is noteworthy for a sector that experienced significant growth in 2020 and 2021 but has since cooled down. Monitoring the data in the subsequent quarters will provide insights into whether this was a temporary blip or if the share of e-commerce will steadily rise once again, as it did over the last decade.

China’s implementation of a zero-COVID policy, characterized by periodic shutdowns in certain regions, played a significant role in exacerbating shipping backlogs and supply chain bottlenecks that continued throughout 2021 and 2022. However, the shift towards nearshoring is not solely a reaction to the challenges posed by COVID-19. It also reflects a response to the mounting tensions between the United States and China, the tariffs imposed during the Trump administration, and the fundamental need for expedited product delivery.

Nearshoring to Mexico has emerged as a solution for many companies looking to reduce risk and enhance supply chain resilience. The tensions between the U.S. and China, along with disruptions caused by the pandemic, have accelerated this trend. Mexico has become the most active importer to the U.S. this year, surpassing China, due to factors such as cheaper labor, available land, and proximity to major U.S. population centers.

The nearshoring movement is expected to continue as firms seek to address the vulnerabilities in global supply chains. Northern Mexico’s manufacturing sector is anticipated to become more diverse in the coming years, providing further opportunities for companies to establish operations in the region.