A dash of optimism. That’s what industrial brokers and developers say that the Federal Reserve Board’s September interest-rate cut brought to their commercial sector.
Yes, the industrial real estate sector had been holding steady, even with higher interest rates. But higher rates did slow investment sales and new development. Many markets also saw leasing activity dip from the highs of the COVID days.
CRE pros working industrial markets across the Midwest now hope that the cut in rates will provide a boost to the sales and development. It won’t happen overnight, these professionals agree, but if the Fed cuts rates even further? That could lead to more industrial sales and construction activity in 2025 and beyond.
An increase in inquiries in Kansas City
Zach Hubbard, senior vice president with Kansas City, Missouri-based Block Real Estate Services, said that he is already seeing some impact from the Fed’s rate cut: more inquiries from buyers considering purchasing industrial property.
Of course, inquiries don’t always translate to sales. But the rate cut, and the promise of future rate cuts, should be a positive for the Kansas City industrial sector.
“Inquiries are preliminary, of course,” Hubbard said. “Most of the people I speak with expected that half-point move from the Fed. It wasn’t a surprise. It’s hard to judge what the impact of the cut will be after such a short period, but the market expects more rate cuts. These cuts should help increase activity.”
The big question facing Kansas City’s industrial market: How can developers create more inventory for smaller users? Hubbard said that bulk and mid-bulk industrial product is overbuilt today in the Kansas City market. That’s because leasing volume has dropped in that slice of the industrial sector.
But tenants looking for smaller industrial space have fewer options in Kansas City and its surrounding communities.
Hubbard said that there is little industrial inventory under 50,000 square feet available in the Kansas City market. And for tenants seeking industrial spaces of 20,000 square feet or less? That’s even more difficult to find today.
“With a few exceptions, developers haven’t built much of what was the bread-and-butter product of this market just 15 years ago,” Hubbard said. “When the market moved to more of a bulk-distribution market, the developers were looking for a little more meat on the bone. They were looking to maximize the return on their efforts and gravitated to bulk and mid-bulk development projects.”
The hope is that if interest rates continue to fall, the cost to develop smaller industrial buildings will also fall. Developers and owners will then be able to charge lower rents, because their building costs would have fallen, for new smaller industrial space that tenants can afford.
“I don’t think that first half-point cut is going to get us there,” Hubbard said. “But it is a step in the right direction. If we get more cuts, what you’ll probably see is the developers behind smaller developments dust off their underwriting. Can we make this work? If we see another quarter-point cut and any future cuts, capital will become cheaper. If that happens, it’s more likely that developers will return to creating smaller industrial properties.”
The market could change quickly, though, Hubbard said. While it’s true that there is an oversupply of larger industrial product in the Kansas City market today, that might not be the case for too long.
Most new construction has been put on hold during the last two years, largely because of the increase in interest rates and construction costs. If the existing bulk buildings in the market that do have higher vacancy rates today get filled – which could happen next year – there might also be a shortage of bulk or mid-bulk space because of the shutdown of new construction.
Even if developers start building new product next year, the longer construction periods of today mean that tenants might struggle to find modern industrial space in the Kansas City market if lower interest rates encourage more companies to seek new warehouse, distribution and manufacturing space.
For now, though, the Kansas City industrial market is dealing with not only a slowdown in investment sales and new construction, but also in leasing activity.
“There has been a massive lull in bulk tenant demand that started in the third quarter of last year,” Hubbard said. “There has been a 9- to 12-month significant lull.”
Kansas City’s build-to-suit market is stronger, though. Hubbard said that the local market has seen the recent construction of build-to-suits focused on the food and beverage industries.
“It’s obviously a positive to have these build-to-suit projects. But we still aren’t seeing speculative industrial construction,” Hubbard said. “People read about these food-and-beverage developments, and they think the industrial market here is on fire. For those specific types of users, the market is strong. But most of our market isn’t booming today.”
Even with today’s challenges, though, Hubbard said that he isn’t worried about the long-term health of the Kansas City industrial market. The market’s fundamentals are too strong.
Hubbard points to the ongoing rise in ecommerce. This will help keep the industrial market strong, he said.
“That transition from brick-and-mortar to ecommerce is still in the first inning,” Hubbard said. “it has so much further to go.”
At the same time, the industrial market is benefitting today from reshoring, with a growing number of companies bringing more of their manufacturing work back to the United States.
And the growth of data centers and cold-storage – both niches of the industrial market – is only going to continue, another positive for the industrial market’s future.
Overall? Hubbard sees a positive future for industrial, both in Kansa City and across the country.
“My personal belief is that the Fed’s inflation-countering measures have been somewhat successful,” Hubbard said. “It’s never an exact science, but it seems like those measures are working. It’s never a smooth curve. There are always ups and downs. But the inflation-fighting measures have produced the desired effect so far. The rate cuts should provide some relief to commercial real estate.”
A return to a normal market in Des Moines
Adam Kaduce, president of R&R Real Estate Advisors in West Des Moines, Iowa, said that the Des Moines industrial market has returned to what feels like a normal market today following the boom times it saw during the COVID pandemic.
Kaduce said that consumer buying habits shifted so quickly during the pandemic that companies had to scramble for more distribution and warehouse space. Commercial real estate brokers knew that this demand wouldn’t last forever.
And it hasn’t. Today, companies aren’t seeking as much new warehouse space. That combined with higher interest rates and construction costs have slowed new leases, construction and sales in the Des Moines industrial sector.
That doesn’t mean that the Des Moines industrial market is struggling. Kaduce said that the sector remains solid, boasting strong fundamentals.
“We have returned now to what feels like a normal market in terms of demand,” Kaduce said. “During COVID, we saw 100,000-square-foot-plus deals. That is atypical for this market. Now we are seeing a return to 25,000-, 40,000- and 60,000-square-foot leases. We are seeing more of that activity now, which is more typical of Des Moines.”
And new industrial development? Kaduce said that the Des Moines market won’t see much new industrial construction until leasing activity picks up. There is simply too much available space now for tenants to spur new construction.
“We have second-generation availability in this market,” Kaduce said. “Tenants looking for a new-development product must be willing to take space at a higher lease rate. It takes a more institutional-grade customer to lease new product versus second-generation space. There are two different types of users: Some want that new product. They need the clear heights and the amenities. But in the Des Moines market, we are seeing more activity in that second-generation market.”
As Kaduce said, few developers want to develop 200,000-square-foot spaces and then divide them into 20,000- and 30,000-square-foot spaces. That helps explain why the construction of new bulk space has slowed here. With the market stronger for tenants seeking smaller spaces, it often doesn’t make economic sense for developers to add large spec spaces to the industrial supply.
It’s easier for owners to chop up second-generation product to fulfill the needs of tenants seeking a smaller amount of space, Kaduce said.
“This market has more of that second-gen product available,” Kaduce said. “We’ve seen some of those smaller deals. We’ve seen deals in which existing buildings have been broken up into smaller spaces.”
It gets more challenging for users seeking spaces of 7,000 to 12,000 square feet, Kaduce said. Those spaces are limited in the Des Moines market.
Kaduce says that if the Fed continues to cut its benchmark interest rate, it could provide a boost to development activity in the Des Moines market. But interest-rate cuts alone won’t be enough to unclog the new-construction pipeline, Kaduce said.
“The biggest driver for our market is going to be leasing activity,” Kaduce said. “We need to see our vacancy rates come down more before we see new development. There is enough existing product that has been delivered here. Developers are going to want to add new product in markets where there are more tenants seeking space. We must see some buildings get leased up before we see more new construction or sales.”
The industrial vacancy rate is somewhere near 10% to 8% in the Des Moines market, Kaduce said. That’s far from a terrible rate. In fact, Kaduce said, it is probably a healthy one.
Kaduce said that some developers have plans for new industrial product here. But they are waiting for the right time to start construction.
“If you start to see a couple of deals happen and that vacancy rate starts to drop down, then you’ll see some new development,” Kaduce said. “For right now, space is not coming off the market at a high enough rate to make new development make sense.”
The good news? Kaduce said that he is seeing an increase in the showings of industrial space. Kaduce says that he expects that first and second quarter of 2025 to see more industrial leasing activity in the Des Moines market.
“I’d love to say that we’ll see a big pick-up in leasing, but we are slow and steady market,” Kaduce said. “We are starting to see some good activity. But it will take a while to work through the pipeline before we kick off any construction.”
Developers are also watching construction prices, Kaduce said. If construction prices, which have mostly leveled off, start to fall, that, too, could help spur new development activity.
Like other CRE professionals across the Midwest, Kaduce is confident in the strength of Des Moines’ industrial market. Even with challenges, this local market remains a strong one, he said.
Part of the reason? Des Moines’ location in the center of the country. As the crossroads of Interstate-80 and -35, Des Moines remains a strong distribution market, Kaduce said. As he says, trucks can travel coast-to-coast and border-to-border on these interstates.
The second main positive of Des Moines? Its strong labor supply, Kaduce said.
“Whether drivers or warehouse employees, we have people available,” Kaduce said. “We also have that pro-business culture here. Companies find Des Moines to be an opportune place to locate businesses and distribution centers. It’s an attractive place to do business.”
Strong fundamentals in Detroit
John Boyd, executive vice president and principal with Signature Associates in Southfield, Michigan, said that the industrial market in the Detroit area remains active, even with higher interest rates.
This doesn’t mean, though, that investment sales and new construction are happening at the same pace as the Detroit market saw in 2020 through much of 2022. Boyd says that transactions and construction have slowed here as they have across the country thanks largely to higher interest rates. The impact of the coming presidential election has also slowed industrial transactions, as it does every four years, Boyd said.
But even with this slowdown, the fundamentals of the Detroit-area industrial market remain strong, Boyd said. Leases are still being completed in this sector. And tenants continue to seek out distribution and manufacturing space.
“Just look at the for-sale market,” Boyd said. “We are seeing a smaller number of transactions. But the prices of industrial properties that have sold are significantly higher than they were during the last several years. These increases are mostly mirroring the increase in construction costs.”
The biggest factor impacting the local industrial sector, Boyd said, is high construction costs.
These higher costs have contributed to the slowdown in new industrial construction throughout the Detroit market, Boyd said. When tenants move out of an existing building, they are finding fewer industrial buildings available to them. These tenants must often instead look at existing industrial space, even if it isn’t a perfect fit for their needs.
“The demand for existing industrial space is strong in our market,” Boyd said.
As in other markets, Boyd said that it’s more difficult for tenants to find space in smaller industrial properties, especially those offering from 10,000 to 15,000 square feet. This is especially true in Detroit’s suburban markets, Boyd said.
“That goes for buildings from the inner ring to the outer ring suburbs of our market,” Boyd said. “It’s not easy to find smaller industrial properties in an inner-ring area like Redford Township or Oak Park up to the far exurbs of Rochester Hills or Orion Township.”
When does Boyd think new industrial construction might pick up in the Detroit-area market? Not for a while.
Boyd said that new construction starts should pick up again once spring arrives in 2025. By then the weather will be warmer in Michigan and the presidential election will be settled. The Federal Reserve Board might also have enacted more rate cuts, all factors that could boost construction activity.
The most significant industrial construction project taking place in the Detroit-area market today is GM’s 700,000-square-foot facility in Auburn Hills. This facility will supply materials to an existing plant dedicated to building Chevrolet Silverado elective vehicles.
Spec development, though, has dwindled in the local industrial sector. This isn’t a surprise. The same thing is happening across the Midwest and the country.
Investment sales have slowed, too, thanks largely to higher interest rates. Boyd said that users are willing to pay more for industrial space than are investors.
Despite the temporary slowdown in new construction and investment sales, Boyd says that the Detroit-area industrial sector still boasts solid fundamentals. Boyd said that Southeast Michigan remains an attractive market, too. For one thing, it boasts one of the largest concentrations of engineering talent in the country. It also has many strong healthcare jobs.
“And that’s not even mentioning the billions of dollars that have been invested recently in downtown Detroit,” Boyd said. “There’s a strong technology base in this region that makes the area very attractive for end users.”
