The hot streak? When it comes to industrial real estate it’s showing no signs of slowing. And that’s just as true in Minnesota as it is across the country.
CRE professionals working in the state say that Minnesota’s industrial sector is still booming, with demand soaring, rents rising and vacancy rates plummeting. This isn’t new: The industrial market was strong here long before the COVID-19 pandemic began making headlines.
But throughout the pandemic? Demand for industrial space has only grown stronger as the online shopping habits that consumers picked up during the pandemic have forced companies to open more warehouse and distribution space.
Industrial, then, remains the darling sector of the commercial real estate world.
“In my 36 years of working in this business, I have never seen rent growth the way it is now,” said Mark Kolsrud, senior executive vice president in the Minneapolis-St. Paul office of Colliers. “There is such a constraint on available industrial space. COVID showed people how much industrial space we really need. Now, two years later, demand for this space is still growing.”
Busy times for industrial
Kolsrud described the Minneapolis-St. Paul market as a kind of primary secondary market. The Twin Cities might be a secondary market for industrial real estate, but it is one of the best secondary markets out there, he said.
Because of this, plenty of capital has bounced from bigger markets, especially those on the coasts, to the Twin Cities as investors look for stability.
“We have never had the highs or lows that other markets have,” Kolsrud said. “We enjoy more of a stability here. That’s something that we can offer investors. We have always been able to monetize our real estate here. It is liquid. Investors can sell it if they need to.”
An influx of institutional capital has hit the Twin Cities market, Kolsrud said. That has provided yet another boost to the local industrial sector.
“The market keeps getting better and better,” Kolsrud said. “Developers are building more industrial space, and the space that they are building is better product. That is helpful to our market, too. We are seeing real quality product here.”
That doesn’t mean that there aren’t challenges in this sector. Interest rates, of course, are on the rise. That could impact investors’ returns. Inflation is rising, too, which could cool off the state’s economy.
But so far? Not even these headwinds are slowing demand for this sector in the Twin Cities and the rest of the state.
“The party is still going,” Kolsrud said. “We have basically had no bad news in the industrial market for 10 years. This is the first time some people in my industry have ever seen anything that could be considered something to worry about.”
An underserved market
Jacki Christopher, director of national build-to-suit development with the Minneapolis office of Ryan Companies, said that the demand for industrial space in the Twin Cities market is still outpacing the supply. This means that rising rents and falling vacancy rates aren’t going anywhere here anytime soon.
“Minneapolis is one of those markets that is underserved in terms of industrial product,” Christopher said. “We need more warehouse space here.”
And don’t expect the supply of industrial space here to catch up with demand anytime soon.
“We have a long way to go before we catch up to demand,” Christopher said. “There are a lot of reasons for that. We are still experiencing so many construction delays. The labor force is insufficient. There is a shortage of building materials. We will be catching up to demand for quite some time, a few years, at least.”
Because of this, developers will be busy adding new industrial space to the market throughout this year and 2022.
“There are so many tenants out there looking for industrial space,” Christopher said. “It’s not much different from what we are seeing in the housing market: They have a need and they can’t fulfill it. The need doesn’t go away.”
It doesn’t help that older industrial space doesn’t always meet the needs of tenants today.
“Users are looking for much more sophisticated space,” Christopher said. “That often means that existing industrial space needs to undergo a big retrofit. It can be hard to get the materials for that. We also have a land shortage that is hampering the development of new space. It is difficult to get materials for construction in a decent timeline. The end users are in a tough spot. There are not a lot of great options in this market right now.”
Changing habits
Peter Loehrer, senior associate with the St. Louis Park, Minnesota, office of Colliers, said that industrial remains the darling of the commercial real estate investing world. And because it’s easier today for investors to raise money, this equals historic levels of activity in the industrial market.
Combine that with the increase in online shopping, and suddenly you have a red-hot market that is showing no signs of a slowdown.
“The activity in industrial rose overnight to a level that we thought we would hit during the next five to 10 years,” Loehrer said. “We saw a huge amount of new demand from a new type of tenant in addition to the more traditional tenants who are trying to get online, too. Companies such as Amazon, Home Depot, Target and other ecommerce tenants starting circling Minneapolis as a place to be.”
Loehrer said that not too long ago Minneapolis and St. Paul didn’t rank as particularly strong ecommerce hubs. The cities aren’t really on the way to other parts of the country, which sets them apart from other Midwest cities such as Indianapolis, Columbus and Milwaukee.
This meant that the industrial buildings in Minneapolis typically served greater Minnesota, the Dakotas and maybe part of Wisconsin. The market was home to high-tech, manufacturing and healthcare companies that needed industrial space.
That is now changing, Loehrer said, with ecommerce companies gravitating to the Twin Cities market. These companies recognize that the Twin Cities market is a strong and growing one, and they want warehouses and distribution facilities near the rising number of customers in the area.
“I think this is a permanent change,” Loehrer said. “Once ecommerce companies have sunk their teeth in an area it’s hard to un-sink those teeth. They can’t increase delivery times. They can’t have lower inventory levels. It’s a one-way trip. I’m not saying we’ll have the unprecedented levels of increased demand every year. But ecommerce companies will continue seeking industrial space here.”
Consumers were shopping online, of course, before the COVID-19 pandemic hit. But consumers gravitated even more toward online shopping during the pandemic, with many wary of shopping in-person.
Even those who had never embraced online shopping before COVID-19 hit, began ordering groceries, restaurant meals, apparel, toys, shoes and electronics online. This put pressure on companies to open more warehouses and distribution facilities across the country, all to get these products to their customers in fewer days.
At the same time, companies realized that storing just enough products and materials doesn’t work well when demand soars. Many companies today, then, are boosting the amount of product they are storing in the United States so that they won’t be caught shorthanded when consumers demand more of a product. That has led to a need for more industrial space, too.
“Companies are still playing catch-up,” Christopher said. “Many companies embraced that model of having just-enough product stored onsite to decrease the amount of warehouse space they needed. Why pay rent to store toilet paper onsite if you can get it right before you need it?
“But companies are now realizing that this is not reliable. For a business, there is nothing worse than not being reliable. How many times will consumers keep going to Walmart and not be able to get what they want before they no longer go back?”
COVID exposed the weaknesses of this “just-enough” model, Christopher said. Now companies are looking to build in redundancy so that they will always have enough product available to meet demand.
Kolsrud said that he doesn’t expect these trends, especially the rise in online shopping, to disappear anytime soon.
“Our willingness to shop online? That will never change,” he said. “This is how we do it now. I don’t think we ever lose the ground we gained in ecommerce. If my 85-year-old parents are ordering products online, everybody is doing it. All the companies realize that they need to provide this product quickly to the consumers to be competitive.”
Food delivery has become important, too. Today, companies need more cold-storage space and freezer buildings. These spaces must be localized in different areas of different markets. As Kolsrud says, companies can’t just open “one big beast in the middle of a market.”
There are challenges in today’s industrial market, too. The biggest? The lack of enough labor and the months it now takes to get the construction materials needed to build more industrial space.
Loehrer said that this last challenge, especially, doesn’t look to be easing anytime soon, as materials shortages and construction delays continue to hamper new industrial construction.
“It is taking longer to get everything from the springs on the dock doors to the roofing materials,” Loehrer said. “It can take a full year to 18 months to get these products. And then your vendors are not giving you a set price. You can’t lock the price in.”
This makes it challenging for tenants to find industrial space in the Twin Cities market. As Loehrer says, finding the right space can sometimes seem like an impossible task.
“Part of our job today is being a therapist,” Loehrer said. “I have to remind my clients that this is a landlord-friendly market. It’s a tough situation they are in. The good news, though? Tenants are making more money than they have ever made, too.”
Why tenants are targeting the Twin Cities
What makes the Twin Cities and its suburbs such attractive destinations for industrial end users today? There are plenty of reasons.
Christopher points to the growing population in Minneapolis-St. Paul and its surrounding areas. The residents here, like consumers across the country, are shopping more frequently online, which drives the need for more warehouse and distribution space in the Twin Cities.
The Twin Cities area is also known for having a business-friendly environment. The lower cost of doing business here helps, too.
“While you won’t see the amount of activity that you see in Atlanta, Dallas or the Carolinas and Florida, there is plenty that Minneapolis offers industrial users,” Christopher said. “We have highly skilled workers here, workers that many of the more sophisticated industrial users need. We offer proximity to long-term established brands like 3M and General Mills. This is seen as a strong place for industrial users to be.”
Not all industrial facilities are created equal, of course. Companies looking to attract the best workers, and to retain them, need to offer industrial workspaces that come with a higher level of amenities, Christopher said.
This means nicer breakrooms and powerful air-conditioning systems. It also means landscaped outdoor spaces and walkways that workers can enjoy when on break.
“There was a time when you didn’t even need to have air-conditioning in a facility,” Christopher said. “Now that is changing. That is a shift. If you want to retain workers, you can’t ask them to work in a facility that doesn’t have air-conditioning in the middle of the summer. Workers will say, ‘Forget that.’ They’ll go down the street to the next employer.”
“Functionality in industrial is the key amenity,” Loehrer said.
This means that industrial spaces must feature high clear heights for ecommerce tenants that need to stock products higher. They need docks that are protected from cold air. And they need a lot of trailer parking.
That last bit is important, Loehrer said. Trailers often line the streets overnight around infill or urban industrial facilities in and around Minneapolis because these buildings don’t have enough parking spaces. It’s something that both the city and industrial tenants hate, Loehrer said.
“That’s an eyesore,” Loehrer said. “If a new industrial building is going up, the first thing investors look for is whether they have enough trailer drops.”
Loehrer said that developers are building as quickly as they can. They don’t want to overbuild, as that could eventually lead to lower demand and empty spaces. But there is little worry that the Twin Cities area will have too much industrial space anytime soon.
“If you are an industrial investor and you started in this business right after the Great Recession, you haven’t had a bad day yet,” Loehrer said. “Your value has only increased every single day. Cap rates are going down. Rental rates are increasing rapidly. And you are not doing anything special. You’re just owning the space. There is nothing that is going to touch the industrial market right now. There is too much demand by tenants and too much capital pouring into the sector.”