Navigating industrial: Stay agile in uncertain times

As developers, it’s our job to create road maps for our partners, investors and properties. As we enter a new year, uncertainty seems to remain the constant. Interest rate hikes, supply chain disruption and increasing construction costs, as well as shifting post-pandemic consumer behavior, all require us to stay agile.

Despite these challenges, there are pockets of optimism across the industry. According to PwC’s Emerging Trends in Real Estate 2023, aspects of the industry are “normalizing.” JLL has reported in its Q3 2022 United States Industrial Outlook that “despite a loss of momentum in the macroeconomic environment, industrial market fundamentals remained sound.”

While investors await clarity in the market, spreads have continued to compress, and consequently capital market assumptions are increasing, yet tenant demand for industrial space has remained steadfast. According to CBRE’s U.S. Industrial Report for Q3 2022, supply is catching up with demand, but available space remains tight. In Denver, the total leasing volume transacted in the third quarter climbed to over 3.9 million square feet, the third highest quarterly total in the last five years. As a result, quarterly achieved rental rates in Denver increased 13.6% year over year.

Strategies for Success

  • Build to suit. Continued tenant demand for industrial space in Denver has created an uptick in build-to-suit opportunities, which elevated preleasing activity to 36.3% of all industrial space under development at the end of the third quarter. While investors may exhibit hesitancies in moving forward on speculative projects, build-to-suit opportunities offer predictability in a time of uncertainty. Cap rate expansion puts pressure on developer yield spreads, but rising rental rates and the elimination of downtime between construction completion and rent commencement can help maintain the necessary margin.
  • Build to meet the market. While Denver has experienced larger tenant leasing activity (users over 150,000 rentable sf), specifically in the airport submarket over the last five years, the bulk of tenant leasing activity has remained 25,000- to 40,000-rsf users. Front-park, rear-load, 180-foot to 240-foot-deep buildings provide investors with the potential to capture the larger user, but the building design allows for demising that can accommodate the bulk of the demand. Designing buildings for long-term flexibility and adaptability, with increased clear heights, optimizing loading and improved interior lighting, help set your project apart. While the industrial demand remains strong, when it does slow, we typically see a flight to quality from both investors and users. Ensuring your project is designed to be recession resistant will be a key consideration moving forward.
  • Integrated team approach. Having in-house entitlements and construction teams can be the difference-maker. Entitlements are a critical component to any successful development, and sites with no entitlement challenges are largely nonexistent. Being able to navigate projects that need to be rezoned, lifted from flood plains, or mitigated for flammable gas conditions require longer due diligence periods and experienced entitlements expertise. Construction management experts can work in conjunction with entitlements teams to craft phasing solutions, project designs and material selections to usher projects to fruition. Many municipalities are understaffed and, as a result, need developer cooperation from both entitlements and construction perspectives to streamline the project approval process.

Embrace the Future
Now is not the time to sit idle, especially when it comes to the industrial asset class. Consumer behavior is shifting to a culture of immediacy, which doesn’t appear to be reverting backward anytime soon. As gas prices rise, logistics and distribution companies will continue to focus on more last-mile locations vs. larger, centralized spoke and hub systems. Population growth is chasing affordable housing, and, as a result, markets like Denver will experience suburban sprawl, creating more last-mile opportunities.
Investors and developers need to remain focused on positioning themselves to capitalize on a dynamic market through recession resistant strategies. Building projects that appeal to tenants focused on future growth, adaptability and sustainability will position the investment to outperform the competition. Don’t build for today, build for tomorrow.

Article originally found in CREJ Industrial Quarterly - December 2022