Industrial sector settles into another new normal

Jessica Perry//March 20, 2023

Industrial sector settles into another new normal

Jessica Perry//March 20, 2023

The NAIOP Industrial Space Demand Forecast comes out twice a year. Based on a predictive model, the report projects national demand for industrial space on a quarterly basis for eight consecutive quarters. Out this month, the First Quarter 2023 report characterizes the outlook for the sector as “bright.” In New Jersey, while that assessment holds true, it’s worth noting that the forecast is tempered from what it had been in recent years.

According to NAI James E. Hanson Senior Vice President Scott Perkins, a broker who assists companies in the acquisition and disposition of industrial and office properties, activity in the sector has cooled, but it’s brought the market to a fine place.

“I would say the activity level is ratcheted back from frenzy to just healthy,” he told NJBIZ. With “several decades” in the space, Perkins is able to take a long view of the situation, incorporating historical context, to recognize that the boom in the industrial sector over the past two years couldn’t last.

“It was really a function of cheap money; that if you could borrow cheaply, you could pay higher rates,” he said.

That’s no longer the case, with the Federal Reserve raising interest rates seven times over the course of 2022 and once already this year—and poised to continue on that path in an ongoing effort to combat inflation.

NAI James E. Hanson Senior Vice President Scott Perkins

“So, there were all sorts of institutional investors in the market, say a year ago,” Perkins explained. “And there was a frenzy putting in offers on buildings, pumping up rates, sale prices, lease rates were also increasing at an unprecedented level. And then the Fed started ratcheting up interest rates and that threw a monkey wrench into the market because a lot of these investors are leveraged investors, so now they can no longer pay the same prices they were paying because their debt is now more costly.”

As a result, sale prices have started to drop. Leaving sellers wondering, what happened? Perkins says, the numbers simply aren’t there any longer.

According to the authors of the NAIOP report – Hany Guirguis, professor of Economics and Finance at Manhattan College, and Michael Seiler, J.E. Zollinger Professor of Real Estate & Finance at the College of William & Mary – industrial supply still lags demand, which has led to higher rents.

In New Jersey, Perkins said the status of the leasing market is something that institutional investors are interested in, “because their projections are based on what’s happening.” When investors were borrowing more cheaply, you could pay higher rates. “And then, because there was such a demand and prices were going up, lease rates were going up at the same time and tenants were paying those lease rates,” he said, adding that that hasn’t changed. Moving forward, Perkins anticipates that rents won’t increase as quickly as they had been, and that annual increases, in kind, will relax as well.

But instead of 10 offers competing for the space, now there’s perhaps two or three. Still not bad historically, but the leverage has shifted.

“You know, several years ago if you had one or two [offers], you make that deal,” Perkins explained. “A year or two ago, maybe you don’t; maybe you have one of 10 and you kind of push the envelope and see who will pay the most. [T]hat happened [with] several deals that I had a year, a year-and-a-half ago where the building was being built and we didn’t want to take an offer yet. … We felt like the market was still going to go up. So, we waited and waited and waited until the building was almost complete and then accepted a deal.

“That’s really not happening now,” he said.

With volume down, when deals are happening, Perkins said a lot comes down to where investors are getting their money from.

“Some investors are penciled down, so to speak, because they just can’t get a handle on their debt side … It’s like the stable investors who are at the forefront has shifted … So if we were going to XYZ giant company before, maybe we’re not, maybe we’re going to a smaller guy that’s going to a group of high-net-worth investors to do a smaller deal.”

On the ground

In the Garden State, rising interest rates isn’t the only factor shaping the sector.

Shipping containers
The Port of New York and New Jersey reported record levels of activity in 2022, making it the busiest container port during the peak holiday shopping season.

The NAIOP report indicated that markets here remain strong due to an influx in demand stemming from supply chain disruptions that continue to reroute goods to the East Coast instead of the West, which helped push the Port of New York and New Jersey to record levels of activity in 2022 and made it the busiest container port during the peak holiday shopping season. That, coupled with an expectation that e-commerce will continue to grow generally and as more traditional retailers turn to omnichannel distribution, “should continue to create demand for last-mile distribution facilities,” the authors said.

As consumer demands for home delivery persist and the need grows for distribution centers and warehouses, Perkins explained it’s becoming more difficult to develop these spaces. “So interest rates are one thing, developers would have to put more cash into a deal because that’s what banks are requiring. Banks aren’t really loaning on speculative development unless you have a developer with a pristine track record. And even then the rates that they’re getting are higher than they were,” he said.

Another issue to consider are new state Department of Environmental Protection stormwater management rules that, when they go into effect, which is expected this year, will effectively decrease the potential for a building’s footprint in order to accommodate larger – by approximately 20%-50% – stormwater basins. According to Perkins, then you’re getting less bang for your buck because you have to build something smaller than you previously would have on the same amount of property.

“[The] third thing is towns are starting to say, ‘Hey, I don’t want trucks. I want my stuff delivered, but I don’t want a warehouse with all those trucks.’ And they’re making it more difficult to put warehouses in,” Perkins added.

In a statement issued along with the NAIOP report, the organization’s president and CEO Marc Selvitelli said a more severe downturn in industrial had been anticipated. “We are pleased that the sector remains strong as supply chain issues are being resolved and the consumer trend toward online retailing shows no signs of returning to pre-pandemic levels,” he said.

In the Garden State, just how strong that outlook continues to be could depend on more localized considerations.