The demand for industrial real estate remains high throughout the Minneapolis-St. Paul market. So why does it feel like the industrial sector here is going through a slowdown?
Could it be that people got a bit spoiled during the industrial boom years of 2020 and 2021?
We spoke about the Twin Cities industrial market with Dan Larew, executive vice president of the Minneapolis industrial and tenant representation team with JLL. He agreed that industrial sales and leasing activity in 2020 and 2021 was an aberration. But what does he expect to see in this sector in 2024? Larew says that he expects sales and leasing activity to be more in line with what the Minneapolis-St. Paul industrial market saw in the years leading up to the COVID-19 pandemic.
Here is some of what Larew had to say about the Minneapolis-St. Paul industrial market.
Did anything in JLL’s 2023 fourth quarter industrial report, released last month, surprise you?
Dan Larew: I don’t think there was anything unexpected. Industrial demand in the Twin Cities peaked in the first quarter of 2022. The primary demand drivers here were the same things we saw across the country: a rise in ecommerce sales, a slight benefit from onshoring and more companies increasing their inventory levels. Just-in-time worked prior to the pandemic. But it no longer works in today’s environment.
In the first quarter of 2022, we were tracking tenants that were looking for about 17 million square feet of industrial space across the Twin Cities metro area. Pre-pandemic, that activity was closer to 5 million to 6 million square feet in our market. That high demand drove vacancy rates down and inspired many developers to build new industrial space on a spec basis. We saw about 4.5 million square feet of spec industrial projects delivered in the Twin Cities market in 2022 and about 7 million square feet in 2023.
Those projects were built to satisfy that record-setting demand. But then the interest rate movement we started to see at the end of 2022 and throughout 2023 impacted tenant demand. It made companies act more conservatively. We saw it with Amazon. Amazon significantly halted warehouse expansion across the country.
In the Twin Cities, the tenant demand dropped closer to 9 million to 12 million square feet. At the same time, we had record-setting new spec space delivered. That’s why we saw a slightly tempered 2023 compared to 2022 in our industrial market.
Is this good news for tenants? Can they find a good deal in the Twin Cities’ industrial market today?
Larew: If you were an occupier in the Twin Cities, you probably thought, ‘Hey. They delivered 7 million square feet in spec space last year. Vacancy rates were over 5% for the first time in two years. I should be able to find a good deal.’ Unfortunately for occupiers, that really isn’t happening.
If you look at that 7 million square feet, just over 30% of it was in four buildings that were 300,000 square feet in space each. That kind of space doesn’t work for most occupiers. So that leaves about 5 million square feet of spec industrial space that will work for most of our occupiers. That’s only slightly above the amount of spec space delivered in 2022.
Even with tenant demand for industrial space dropping, we are still tracking tenants in our market who are looking for about 10 million square feet of industrial space. That is still higher than pre-pandemic levels. That is a healthy level of demand. A vacancy rate of 5% to 6% is still a healthy market. Because of that, occupiers aren’t landing any great deals on industrial space here.
Do you expect to see more spec development in the second half of 2024 in the Twin Cities market?
Larew: New speculative developments don’t pencil now. Developers would love to build more, but they can’t make the math work. I don’t think we are going to see much new spec industrial development in our market this year. Maybe we will see one or two new spec developments in 2024.
I think we’d have to see two interest-rate cuts in the next six months for the numbers to get closer to making sense for spec industrial development. If I were to guess, the type of project that could go spec would be an infill conversion or redevelopment in the Interstate-694 loop. Those are the only projects that could achieve premium rental rates.
Do you think the demand for industrial space that we saw during the COVID years was an aberration that we aren’t likely to see again?
Larew: I’m not sure we will ever see a flurry of demand like what we saw in late 2021 and early 2022. We are talking about a hopefully once-in-a-generation event like COVID. That climbed on top of the demands that were already trending, such as the rise of ecommerce.
What about investment sales? Will we see more industrial sales transactions in the second half of 2024?
Larew: If you see one or two rate cuts, you will potentially see more groups putting packages and portfolios on the market for sale. There is not a lack of interest in acquiring industrial properties. Plenty of groups want to buy. The challenge is that sellers’ expectations on pricing have not adjusted to the new reality.
Sellers are evaluating whether they should make a sale today or wait 12, 16 or 18 months to see if they can get a better price. However, we are starting to see some clarity on what the rest of 2024 will look like. That might help increase the number of industrial sales in the second half of the year.
We already spoke about spec construction. But what about build-to-suit activity? Do you think we’ll see any increases in the number of build-to-suit properties that are built this year in the Twin Cities?
Larew: I do see a slight uptick in build-to-suit projects. You can make those projects work because you can go to the lender with a lease in hand. You know what your costs are, what your rents are and the credit profiles of the tenants. You have all the factors you need to put together a total-project cost summary.
You talked briefly about reshoring. Will reshoring efforts have any impact on the Twin Cities industrial market?
Larew: Reshoring will have a very limited impact in our Twin Cities market. Reshoring was a buzzword that was hot during COVID. It’s easy to say that we are going to move everything out of Asia and South America. The reality is, that is a lot more challenging that it sounds on paper. You have contracts. You have heavy investment in capital and equipment.
That doesn’t mean that reshoring isn’t happening in the United States in some markets. But it is more industry driven. It’s happening with electric vehicle and battery production. But the reshoring isn’t going to be evenly distributed across the United States. You see that in Detroit and Michigan. There is a flurry of onshoring happening there in the electric vehicle industry. Companies are going to go where the employees and industry are drawing them.
Do you think 2024 will be a strong year for the Twin Cities industrial market?
Larew: There is a lot of pent-up capital that wants to buy industrial. Investors just need to make the numbers work. We probably need to see some seller corrections, but I do think we could see an uptick in sales activity at the end of 2024. Hopefully that picks up even more in 2025. We do need capital flowing through the system for the industry to keep moving.
From the tenant side, I expect a very solid year, one that is comparable to last year as far as the amount of absorption. We still have roughly 10 million square feet of active requirements. Those groups have to go somewhere. There is still a need for additional industrial space to accommodate that demand. As we move into the third or fourth quarter of 2024, the available options will grow smaller and vacancy rates will probably push back down to 3% or 4%. I think that will lead in 2025 to a larger percentage of new spec industrial development.