By Randyl Drummer
CoStar News

October 25, 2021 | 9:51 P.M.
The holiday season is fast approaching, and the nation’s available warehouse space keeps shrinking.

The tight supply of space weeks before the busiest time of year for retailers is resulting in projected industrial rent increases of as much as 25% this year. It’s also prompting landlords to step up construction and even buy office parks to convert to industrial buildings in some markets.

That demand has further solidified the prime spot industrial real estate holds for investors, who have seen the sector become the strongest performer of the four major property types that also include office, retail and multifamily. A third-quarter industrial market report from Cushman & Wakefield found 340 million square feet had been leased and taken out of available inventory so far this year, and a CoStar analysis found that supply disruptions are now driving record demand.

As a result, a number of industrial landlords, including Prologis, the world’s largest warehouse owner with its portfolio of nearly 1 billion square feet across the globe, reported better-than-expected third-quarter earnings, fueled by record rent growth and near-complete occupancy as businesses race to lease a diminishing supply of warehouse space amid a global supply chain bottleneck.

“Space in our markets is effectively sold out,” Prologis CFO Thomas Olinger told analysts during the company’s recent earnings call. “In the last 90 days, supply chain dislocations have become even more pronounced, with customers acting with a sense of urgency to secure the space they need.”

A variety of factors, including spikes in e-commerce demand during the pandemic, production problems overseas and a shortage of truck drivers serving the nation’s ports, have caused cargoes to languish on ships and docks. The result has been shortages of products ranging from consumer electronics to automobiles several weeks before the holiday shopping season kicks off the day after Thanksgiving.

The disruptions have caused logistics companies and other tenants to grab space as soon as it becomes available, especially near the nation’s largest seaports, driving national warehouse leasing and rent growth to all-time highs, according to CoStar.

Prologis, a real estate investment trust based in San Francisco, reported that its portfolio was 98% leased in the third quarter and projected that rents in the United States would increase 19% for the year, after jumping 7% in the third quarter alone. The company said its net income more than doubled in the quarter ended Sept. 30 to $722 million from $298.7 million for the same time a year earlier.

The situation is expected to change at some point. Tangled supply chains that can follow global disruptions such as wars have eventually smoothed out in the past, while the addition of warehouse space now underway will increase that supply and could lead to more space than needed in the next strong economic downturn.

Demand at Ports
Even so, for now logistics demand is surging, driving warehouse vacancy to below 1% near the ports of Los Angeles and Long Beach, the nation’s largest port complex, points to continued strength in the coming year for Rexford Industrial Realty Inc., which owns 280 Southern California properties totaling 35 million square feet.

Rexford’s porfolio was 96.6% leased and logged 24% year-over-year rent growth in the third quarter, co-CEO Michael Frankel told analysts during the real estate investment trust’s third-quarter earnings call.

“There’s a dearth of any space, let alone quality space,” said Howard Schwimmer, co-CEO for the Los Angeles-based landlord. “It’s really just an all-on fight on the tenant side to get occupancy on anything that’s available.”

The industrial land shortage in Southern California, paired with soft demand for older offices as more people work at home during the pandemic, has prompted Rexford, Prologis and other industrial developers to come up with creative solutions.

Rexford recently paid $70 million for Volt Corporate Park, a four-building Orange County, California, low-rise office complex on 12.5 acres built in 1984, with plans to convert the property to industrial space when current leases expire.

This type of conversion underscores the rising value of industrial buildings near neighborhoods that can serve as logistics hubs for the final mile of delivery to online shoppers. Large industrial users such as Amazon have also looked to convert obsolete shopping malls and even golf courses to fulfillment centers.

All the while, rents are on the rise.

First Industrial Realty Trust Inc., a Chicago-based REIT, said nearly one-third of its tenants with leases up for renewal in 2022 have already extended their contracts at rental rates averaging 23% higher than current rates.

“A lot of the tenants who need imported products are having a hard time getting product and they cannot ascertain the availability nor the timing, so the net effect is that they order more inventory,” First Industrial Chief Investment Officer Johannson Yap told analysts during the company’s earnings call. “We now have less space than at the start of the year and rents have been rising because of that.”

While he hopes for the sake of customers that rents will level off next year, he sees the conditions leading to the shortage continuing, and therefore, worsening space availability: “The reality is that I don’t think it will level off. It looks like the supply chain issues will continue and the rent pressure will continue because of the lack of space and increased demand.”

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