Prologis report highlights myriad challenges for industrial real estate market occupiers

The most recent edition of the Industrial Business Indicator (IBI), which was issued by San Francisco-based real estate investment trust company Prologis continued to highlight ongoing trends in the industrial real estate sector, relating to vacancy, rents, and space utilization, among other factors.

Prologis defines the IBI as a quarterly survey of customer sentiment focused on customer activity in warehousing. The fourth quarter IBI reading came in at 66.8 (a reading of 50 or higher indicates growth is occurring), continuing a strong run of readings, with the first, second, and third quarter readings, coming in at 66, 71, and 66, respectively.

Key data points in the IBI included:

• United States vacancy, at 3.4%, dropped to an all-time low and is expected to remain at historic lows through 2022, with market rents pegged to increase by another 10%;
• rents increased 6.5%, from the third quarter to the fourth quarter, and were up 20.4% annually;
• 70% of the 390 million square-feet (MSF) currently now in the pipeline is pre-leased, and with 270 million SF of new supply, vacancies dropped 160 basis points to 3.4%; and
• logistics customers absorbed 120 MSF of logistics space in the fourth quarter, with a record-setting 410 MSF absorbed for all of 2021, marking an 85% annual gain over 2020;

Prologis also said that the utilization rate hit the mid 85% range in November and December, and with utilization below its historic high of 87%, Prologis said that the inventory-to-sales ratio is more than 10% below pre-pandemic levels, with no “shadow space” (technically occupied but marketed for lease) to absorb inventory right-sizing. And Prologis added that it believes supply chains need to expand by 15% or more “to accommodate normal inventory levels and foster resilience against future disruptions.”

In order for supply chains to expand by 15% or more, as the report observes, Prologis Head of U.S. Research Heather Belfor said in an interview that a few different things would need to happen.

“First, production and distribution bottlenecks need to correct so that goods may flow through supply chains in a more predictable manner,” she said. “Then, customers will need to build up storage and distribution capabilities to meet resilient inventory growth. We estimate that to restore the inventory-to-sales ratio to pre-pandemic norms and build in just 5% inventory growth on top of that would generate the need for 800 million square feet of space in the U.S.”

When asked how long these current market conditions—comprised of low vacancy, rising rents, and tight vacancy—are expected to remain intact, Belfor said that under the company’s base case, these conditions will last at least through the next two-to-three years.

“The pandemic has forever altered the logistics real estate landscape, and we expect that increasing e-commerce penetration rates combined with the move to more resilient, ‘just-in-case’ inventory models will have a lasting impact on the demand for industrial and warehousing space,” explained Belfor. “At the same time, barriers to new supply have been rising in a structural way. It is becoming increasingly difficult to build prime logistics space in the locations users need the most. As a result, most of the construction pipeline is focused in lower-barrier locations, which could see some easing of market conditions and rent growth in the latter part of this forecast horizon. However, for the majority of the top logistics locations, demand should continue to outstrip new supply, putting upward pressure on rents.”

With the IBI pointing out how 70% of new supply is pre-leased, Belfor said that presents challenges for occupiers and developers alike, noting that in many markets, developers can’t build fast enough to meet demand, materials and labor are in short supply, and industrial land is becoming increasingly scarce.

“As a result, demand has flowed into under-construction projects, and there will be less speculative supply available to lease in the future,” she said. “For occupiers, this means that competition for prime logistics space will likely remain elevated, and there may not be enough options for lease when they need to grow their distribution networks.”

Late last year, Prologis CEO Hamid Moghadam said at the company’s “Groundbreakers 2021: Breaking New Ground” conference that “logistics space in the U.S. is effectively sold out.”

Belfor said that speaks to how Prologis’s customers not only need to move quickly to secure their logistics space in a tight market—they also need to plan ahead to ensure they have the space they need.