Industrial Sector Grapples with High Interest Rates and Port Problems but Still on Solid Footing

May 22, 2024

Industrial Market Trends
The NCREIF NPI 1Q24 returns for industrial assets indicate continued depreciation. Value depreciation for the quarter was 0.85 percent, notably less than the 4Q23 depreciation of 3.18 percent. The lower denominator and continued reset of below-market leases at higher market rates drove the average income return to 0.97 percent last quarter, a noteworthy increase from 0.92 percent in 4Q23.

In the West region where some of the highest depreciation occurred, market rents have fallen from peak levels seen in 2023. Market participants report that leasing activity has slowed down across the country though absorption remains positive. The slowdown in demand results primarily from a higher cost of corporate debt which has incentivized tenants to better optimize their space usage. Industrial real estate vacancies are slowly rising and stand at approximately 6.0 percent nationally according to Cushman & Wakefield. Though this level of vacancy is not alarming, the upward trend reflects slowed demand and continued addition of supply from projects that began before the recent spike in the cost of financing. Vacancy will likely inch up in the near term, but the trend is expected to reverse itself over the next 12 to 18 months as the addition of new inventory slows, eventually decreasing vacancy and putting upward pressure on rents.

Port Activity
Port traffic disruptions are also negatively impacting logistics demand. West Coast ports continued to regain market share in 4Q23 and 1Q24 after union negotiations were eventually finalized in June 2023, and this trend is expected to continue through 2024. East Coast ports, on the other hand, are on track to lose market share in 2024 due to contentious union negotiations. Additional pressures to port activity include bottlenecks in the Suez Canal due to political instability and in the Panama Canal due to low water levels.

Looking Forward
Further declines to industrial property values are likely in 2024. Additions to supply and more restrained demand have put the market slightly out of balance, leading to increased vacancy and restrained rent growth. At the same time, high interest rates are putting unfavorable pressure on consumers, tenants, lenders, and investors. While there remains hope that the Fed will move to moderate interest rates before the end of the year, the elevated cost of capital remains a near term reality that negatively impacts both market fundamentals and investor pricing. The silver lining for this asset type is that the long-term prospects for future growth remain strong and for that reason it continues to receive greater weighting from institutional investors.