“It was inevitable,” Neal Driscoll, Midwest Region Partner at Dermody Properties, said about the slowdown in industrial absorption in southeast Wisconsin at the end of 2023.
A historically strong market strategically located between major metropolitan areas like Chicago and Milwaukee, southeast Wisconsin’s industrial slowdown followed several quarters of robust net absorption, reflecting a complex interplay of factors. Driscoll, in part, blamed the aftermath of the COVID-19 pandemic, which triggered a surge in demand for industrial space as companies rushed to adjust their logistics networks to meet heightened demand and mitigate global supply chain disruptions.
“It shifted the model from ‘just in time’ inventory management to ‘just in case’ inventory,” Driscoll explained. “Directly and indirectly, through third party logistics partners, tenants leased millions of square feet of warehouse and distribution space.”
As the economy began to normalize and the Fed responded to inflationary pressures by raising interest rates, the cost of capital increased, dampening expansion plans and cooling the industrial real estate market.
“These elevated rates contributed to economic uncertainty that caused a slowdown to the incredible e-commerce growth that southeast Wisconsin experienced,” said Ned Frank, executive vice president with Colliers.
He also noted the trend of occupiers seeking to own their own real estate contributed to a reduced pool of potential tenants leasing large blocks of warehouse space. Notably, Uline’s purchase of more than 100 acres of land in Kenosha for a new 1.4 million-square-foot facility exemplifies this shift towards ownership. It’s also an example of a trend Driscoll pointed out: that much of the industrial growth in southeast Wisconsin has been organic, spurred by the success of local companies.
“Over the past 10 years, however, it has become a very attractive submarket of the greater Chicago market because the state and local governments are very business friendly, it has a great labor force and from a real estate cost perspective is significantly lower than many of the Chicago submarkets,” Driscoll said.
The region’s robust growth has also been driven by the increasing demand for specialized infrastructure from tenants, according to Frank, who said it’s particularly notable among users with significant infrastructure needs, such as heavy power requirements, temperature-controlled warehouses or large office space build-outs.
“Due to this trend of requiring infrastructure, landlords are experiencing high upfront costs by providing costly improvement needs,” Frank said.
He added that landlords are proactively addressing tenants’ significant infrastructure needs by incorporating these requirements into their speculative pricing strategies.
“For example, landlords may increase power to their building before securing a tenant because the lead time on that upgrade can be lengthy,” said Frank. “If a tenant has to wait for certain upgrades they will focus on different spaces to lease.”
Recent data from the market shows the total inventory stands at 82,630,208 square feet with a vacancy rate of 11.82 percent. Year-to-date sales amount to 19,600 square feet, while new leases encompass 1,059,865 square feet. Notably, net absorption stands at 1,022,799 square feet, indicating healthy demand for industrial space in the region. Additionally, there have been 1,152,984 square feet of completions year-to-date, with 1,582,560 square feet currently under construction, suggesting ongoing development activity to meet growing demand.
The surge of speculative construction has significantly impacted vacancy rates and market dynamics in the region, particularly in Kenosha and Racine counties, where Frank shared that there are currently six available buildings over 500,000 square feet.
“In the short term, this certainly affects tenant behavior because a tenant who needs a large amount of space will have numerous options to lease from,” Frank said. “This also influences their decisions on how much space to lease within a building. Landlords are willing to lease a portion of a space to a tenant and give the option to grow into the entire building over the length of their lease.”
“It will take some time to work through this inventory, most of which is commodity real estate, meaning there is little differentiation between buildings,” echoed Driscoll. “Add to the overbuild the cooling we’re seeing today, and you’ll likely see flat to decreasing rents for commodity buildings.”
Amidst this landscape, notable developments are on the horizon, with Dermody recently making a significant investment in Pleasant Prairie. The company plans to build 2.4 million square feet of industrial space on the 190-acre property. This site stands out due to its unique attributes, being Wisconsin’s only rail-served site with connections to Union Pacific and Canadian Pacific, along with the potential to provide over 100 megawatts of power.
“By spring, the UP railroad service will be reactivated for our new tenant, WestRock. We’ve been engaged with other rail users since we bought the site last summer and we expect that to continue,” Driscoll shared. “We’re extending the public road through our site and completing the rest of site work so we can quickly respond to similar build-to suit-requirements.”
“In a market where tenants require extensive infrastructure, this site has it all,” Frank emphasized.
Landlords and developers are adopting creative and flexible strategies to attract and retain tenants, according to Frank, who highlighted the importance of being as innovative as possible.
“Growing tenants into space over time, giving free rent upfront and granting tenants the right to purchase a building during their lease are just a few examples,” he said. “With the amount of options that tenants have, industrial landlords and developers have to get imaginative.”
Driscoll predicted that success will boil down to the simplest approach.
“Good buildings in good locations will continue to attract good tenants,” he said.
Southeast Wisconsin isn’t just a good location, it’s a great one if you ask Frank.
“The market will continue to attract tenants because of its transportation infrastructure, skilled workforce and business friendly environment,” he said. “These factors keep the demand from industrial users strong, which will lead to absorption of space and a reduction in the vacancy rate.”