The Indianapolis industrial market remains hot, with demand for warehouse and distribution space continuing to soar. But when people talk about the busiest industrial markets in the United States? You’ll rarely hear them mention Indianapolis.
That doesn’t bother the brokers working this market. They’re just happy that leasing activity remains so strong here and sales activity, while slowed by higher interest rates, hasn’t cratered.
Midwest Real Estate News spoke with Steve Schwegman, Indianapolis market lead and executive managing director with the Indianapolis office of JLL, about the reasons behind this market’s strong and steady performance.
Why is the Indianapolis industrial market so resilient? It’s all about location, a strong labor force, the availability of space and a government willing to support companies doing business from the city and its suburbs.
Can we start by talking about interest rates? How have higher rates impacted the industrial market in the Indianapolis area?
Steve Schwegman: It has had an impact, but I don’t think that’s been unique to Indianapolis. The rates have had an impact across the country.
From a development standpoint, it makes it more difficult to justify new development when you consider that higher rates, higher construction costs and higher land prices are all coming together at once. It makes new construction more expensive. Because of that, owners need to see higher rental rates to justify a development and earn their investors’ required returns. That has caused it to be more difficult to underwrite a new development.
From the tenants’ standpoint, it makes their inventory carrying costs higher. The higher the interest rates, the more expensive it is just to have inventory on hand. During the pandemic, companies discovered that they didn’t have enough inventory. They tried to over-correct and carry more inventory so that they wouldn’t run out of products. Now many companies are over-inventoried, which means that they have needed more warehouse space.
Carrying that extra inventory and space worked well for the last few years, but now that the cost of getting new warehouse space is that much more, companies are working to get rid of their excess inventory. They are finding ways to use their existing industrial facilities more efficiently instead of buying another 100,000 square feet.
I know higher rates have slowed sales, even in the industrial market. Do you think we’ll see more sales activity once rates finally stabilize?
Schwegman: We will. From a development side of things, rental rates have continued to increase. That is the good news. Rental rates in industrial had been relatively flat for the first 20 years of my career. During the last five years, we’ve seen annual market-rent growth of about 10% to 15%. There’s been a dramatic hockey-stick-shaped curve for rent growth in our market. That’s been a long time coming. Because the rental rates have continued to escalate, once the interest rates normalize, it will help developers justify additional spec development.
Speaking of spec development, are you still seeing a lot of spec industrial development in the Indianapolis market?
Schwegman: Moreso now than ever before. In 2021, our net absorption for the Indianapolis industrial market was close to 18 million square feet. In 2022, that was over 20 million square feet. Those are big numbers for Indianapolis. Developers looking in the rearview mirror saw that record absorption and figured that it would continue to go up. They figured they’d need to add even more spec space. That’s not surprising: Indianapolis has always been a strong spec market. We’ve typically been light on build-to-suit space. We’ve always been more of a ‘If you build it, they will come’ market.
We will now have more than 28 million square feet of industrial product available by the end of this year. For this year at the midpoint, we have had just more than 6.5 million square feet of absorption in our industrial market. If we do the same absorption for the remainder of the year, we’d end up at around 13 million square feet, plus or minus. This means that we will have more industrial space than can be absorbed.
That’s good news for end users looking for space, at least.
Schwegman: It is good news for end users. If you are an end user, you will have options in nearly every submarket. You’ll have space available for any size facility that you need. Tenants are very fortunate to be in this market right now.
What we haven’t seen is any softening of rental rates. That’s good. We don’t want to go backward on rental rates. Because almost all the space available is new spec construction, the developers are on a level playing field. They all face similar construction costs and interest rates, too. It’s not like any developers can try to give space away. That has kept rents strong here.
Do you think the Indianapolis industrial market, considering how consistently strong it’s been, has been overlooked over the years?
Schwegman: Over the last five years, that has changed. Today, Indianapolis is looked at as a core market. It might not be on par with Inland Empire, New Jersey, Dallas, Atlanta or Chicago, but it is pretty darn close. If those are ‘A’ markets, Indianapolis is an ‘A-.’
That can be proven by the amount of institutional investment in the market. You have big-name developers and institutions investing in our industrial market. There is a real belief in Indianapolis from those who are investing in real estate. I can’t say that was the case 10 years ago. You didn’t see the global institutions taking a strong look at Indianapolis then.
What are some of the benefits tenants of locating in the Indianapolis market?
Schwegman: We have the great fundamentals of distribution and fulfillment here. We are very lucky to be a two-day drive to two-thirds of the United States and Canadian population. By virtue of where we sit, we are a very good market from a logistics standpoint. Add onto that the interstate infrastructure and we have great and quick access to so many markets across the United States.
Then there is our labor pool. We have a very strong labor force in terms of availability and work ethic. Our occupier clients tell us that they have less turnover in the Indianapolis area than they have compared to their other facilities across the country.
Real estate is always available here, too. We have a highly speculative market. Tenants always have options. There is always a robust inventory of available real estate here.
I should mention the incentives, too. The greater Indianapolis area has traditionally offered a 10-year real estate tax abatement. That is attractive to tenants but is more like the icing on the cake. The real drivers that bring tenants here are the logistics, labor and availability of real estate.
Why has the industrial real estate market for the entire country been so strong for so long?
Schwegman: The rise of ecommerce has certainly played a major role. Ecommerce has exploded. Online sales were already on a fast trajectory to become a bigger segment of retail sales. But the pandemic made it so that you couldn’t shop in stores. You couldn’t go out. That only accelerated the growth of ecommerce. It has had a generational impact. Folks who refused to shop online were forced to. Companies needed a place to keep all the products that people were ordering. That caused an explosion in the demand for industrial real estate.
On the investors’ side, everyone saw the necessity of industrial real estate. We saw during the pandemic how important it was to have enough warehouse and distribution space. As a percentage of the overall commercial real estate market, both industrial and multifamily are not only growing on their own but are also growing as part of the percentage of the pie. Those asset classes occupy a greater percentage of the commercial real estate pie.
How about during the next two to there years? Do you think demand for industrial space will remain high?
Schwegman: it will stay steady if not grow. We are starting to see new uses for industrial facilities that are growing. A good example is the electric vehicle market. That market is growing and we need industrial space to accommodate it. Those vehicle makers are going to set up shop here. Advanced manufacturing uses will cause the industrial market to grow even more.
