It’s long been one of the most consistent commercial real estate sectors. But the industrial market across the country is seeing a slowdown in leasing activity, investment sales and new construction.
Blame high interest rates and construction costs. But throughout the country – including in Minnesota – the industrial sector’s boom days appear over for now.
The good news? The fundamentals of this real estate sector remain strong. And commercial real estate professionals working the Twin Cities region predict that leases, sales and new development will again trend up, especially now that the Federal Reserve Board has cut its benchmark interest rate and is poised to enact future cuts.
Peter Mork, founding partner with Edina-based Capital Partners, said that leasing activity has slowed, especially for industrial spaces with larger square footage. Those properties of 100,000 square feet or more? Owners are taking longer to fill them with tenants.
“The market has slowed,” Mork said. “My rationale for it is that we are in an indecisive time with interest rates, inflation and the presidential election. Those three things make larger publicly held companies pause before making major decisions.”
As Mork says, it’s more difficult for larger companies, those that need more expansive industrial space, to ask for board approval today to expand their plant, shop or warehouse space. Doing so requires borrowing money at interest rates that are still high.
Many of these large companies? They are waiting until the next presidential administration takes office before making expansion plans, Mork said.
Tenants looking for smaller spaces of 20,000 to 40,000 square feet, though, are still active in the Minneapolis-St. Paul market, Mork said.
These companies are simply nimbler and able to make decisions faster, he said.
“It comes down to the company approval process,” Mork said. “The smaller companies are not publicly traded. If they have a need, they fill it. This might not be an ideal market, but if they need another 30,000 square feet, they’ll make the move. They can react faster than the bigger companies.”
Mork said that he doesn’t expect the demand from these smaller, often regional, companies to lessen any time soon. The fundamentals of the Twin Cities market remain strong, he said.
“The nice thing about the Twin Cities is that it’s not overbuilt,” Mork said. “There is not a ton of new industrial construction right now. It’s difficult to get financing for new developments. Land prices are not in line with the market. We are not seeing much new product being added to the market.”
Mork said that he expects industrial vacancies to fall. Demand for industrial space will rise, he said. And when it does, there won’t be enough space to meet it because of the current slowdown in new industrial construction.
“We will see a tighter market,” Mork said. “There will be fewer options for tenants. There will be a chance for landlords to push rents and annual escalations. I think we’ll see vacancies start coming down soon.”
This isn’t to say that the Twin Cities industrial market doesn’t face challenges. Mork pointed to the Minnesota legislature and the city councils in Minneapolis and St. Paul. These government bodies continue to send large sums of money, Mork said. To help fund that? Mork predicts that they will fund it partly by increasing taxes on industrial real estate and residential homeowners.
“Values are only going to go up in industrial real estate,” he said. “Every other commercial segment is flat or going down. Industrial real estate has a target on its back. I’m worried that higher taxes will drive corporations out of Minnesota. That will be unfortunate.”
When will new industrial development begin rising again? No one knows for sure, but does predict that industrial construction activity will pick up soon, thanks in part to the lower interest rates resulting from the Fed’s decision to cut its benchmark interest rate.
At the same time, the cost of construction is also coming down, Mork said.
And when construction starts up again? Certain Twin Cities submarkets will likely see more activity than others. Mork said that the southeast submarket of the Twin Cities remains strong. The northwest quadrant has long been solid and will continue to be so, he added.
Mork also pointed to the Dayton and Rogers markets, which he said are strong today and will only grow stronger as sales and construction activity increase. Mork said that the Interstate-94 corridor in the Woodbury market is seeing a jump in industrial leasing activity, too.
“Minnesota is a very conservative state when it comes to new development and pushing rents,” Mork said. “The market is not overbuilt. We have a great education system here with a highly educated workforce. We always attract new companies and talent. It’s a great place to live. The qualify of life is high. If our local and state government don’t tax people out of the state, this is a great place to do business.”
Ready for a brighter industrial future
Paul Hyde, chief executive officer of Minneapolis’ Hyde Development, said that the industrial sector in the Twin Cities region is now going through a correction.
Leasing demand for industrial space soared during the COVID pandemic.
“There was a sense that all commerce would be ecommerce,” Hyde said. “People were gobbling up space left and right, especially large users. Large industrial deals became common.”
To meet this demand, developers added larger industrial spaces to the Twin Cities market, including properties of 500,000 to 1 million square feet.
And when demand inevitably slowed after this boom period? It’s led to a slight increase in vacancies and far less industrial leasing activity today.
“Some of those larger industrial spaces were a result of that over-enthusiastic COVID reaction to demand,” Hyde said. “That led to a rise in construction costs and significant impacts on the supply chain for building materials. Your typical four months of lead time for precast panels or steel got pushed out to 12, 14 months or longer.”
The slowdown in leasing activity, spurred in large part by rising interest rates, has resulted an equally dramatic slowdown in new industrial construction, Hyde said.
This slowdown was necessary, correcting the oversupply of industrial product in the Minneapolis-St. Paul market. It also slowed the acceleration of construction cost increases and normalized the lead times for building materials such as precast panels and steel, Hyde said.
Hyde says that this is setting the local industrial market up for its next growth cycle, one that this industry veteran says should start in 2025.
“Everything that needed to happen to correct the market has happened,” Hyde said. “This points toward a promising future for industrial during the next several years. As long as interest rates keep coming down, we’ll be in really good shape.”
Hyde said that as interest rates fall, construction activity in the industrial sector will begin to rise. That’s largely because as tenants look for space in the Minneapolis-St. Paul market, they’ll see that there isn’t much available because of the recent slowdown in new deliveries.
As leasing demand increases, companies such as Hyde Development will begin building new industrial properties.
Hyde is predicting that new construction activity will begin in 2025 and only grow stronger in 2026.
“The last thing we are all hoping to see and are counting on is that interest rates will keep ticking down,” Hyde said. “With commercial real estate, 60% or sometimes more of the capital to build these buildings comes from loans. If interest rates are high, it is more expensive to build. Then owners need to charge higher rents, and you run up against how much tenants are willing to pay. If interest rates come down, so will the cost of building and rents. That will spur new construction.”
Hyde Development is already seeing positive signs. Hyde completed construction on a 200,000-square-foot industrial property in Fargo, North Dakota, in February. The company signed a lease in October that filled the last remaining vacant space in that property.
A tenant signed a million-square-foot lease to fill Hyde Development’s 76 Commerce Center development in Brighton, Colorado. And at Hyde’s The Waters in Eagan, Minnesota, occupancy has jumped from 80% leased to 96%.
Hyde said that tenants are smart to lease industrial space today. When new construction activity ramps up again, industrial rents will rise. Tenants today, though, can still land a solid deal when leasing industrial space.
“It takes a bit of courage, but companies that see what is coming are acting now,” Hyde said. “They are jumping in the water and leasing space now while they can get a better deal.”
What makes these Hyde developments so attractive to tenants? Hyde says that these buildings are Class-A quality and are either newly built or recently renovated. They are also located on infill sites close to urban cores. They are near quality labor and large customer bases.
“In a slower market, the best buildings get leased first,” Hyde said.
