The industrial real estate market has been a hot spot in the commercial real estate space for years, even before the pandemic amplified demand across the country. A few recent dips in sentiment and disruption in the capital markets have raised questions about the outlook of this asset class and what it means for owners and investors. Jonathan Consani, a partner at Allen Matkins, and Mike Kendall, vice chair at Colliers, share their views on what's happening in the California industrial real estate market and where they see it headed as part of the Summer 2023 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey.

Fundamentals Are Weakening Across the Country, but Deals Are Happening

After years of a market environment in which a single landlord would have multiple tenants interested in a space, landlords are now scrambling to win over a smaller pool of tenants. Rental rates are softer, and vacancy rates are higher as demand shifts with consumer sentiment. The generally negative view of the economy has led to decreased spending, which means companies don't need as much warehouse space to store goods.

However, growth is still happening where people are living, and Consani notes that tenants are considering geography when choosing where to lease industrial space. They are leaving urban centers to areas in the southwest and southeast with lower tax rates. However, Kendall points out that demand is still consistent in communities along the coasts with high concentrations of residents. As long as people are living in an area, there is a demand for consumer goods and warehouse space.

All Eyes Are on the Fed as Global Capital Begins to Reemerge

Higher interest rates have made debt more expensive, but the overall market is in good shape compared to historical averages. Both Consani and Kendall agree that price discrepancy currently exists between buyers and sellers as they navigate price discovery, but sellers are increasingly more willing to sell. Disruption in other asset classes, including office and retail, is bringing more sellers to the market as their industrial holdings tend to be more liquid than other asset classes. They're able to sell these properties to book profits.

At the same time, global capital is reentering the space as groups in Europe, Asia, and the Middle East begin seeking opportunities in U.S. logistics. This space is still considered a safe real estate investment for international investors. Kendall expects transaction volume to increase as these global investors begin buying in bulk, which will increase transaction volume and lower supply.

Growth in the Inland Empire Slowed as Companies Sought to Prevent Future Supply Chain Disruptions

The COVID-era supply chain disruptions are still present in the minds of consumers and retailers, leading companies to diversify their warehouse space. Manufacturers have shifted away from production in China to avoid future supply chain issues and have begun onshoring in Mexico and the U.S. As a result, they've moved to outlying areas around Phoenix, Las Vegas, and Savannah, where they are not as dependent on the west coast ports. They're also showing more interest in smaller spaces spread out across the country instead of concentrating in a single area.

Southern California and the Inland Empire saw additional challenges during the dockworkers' strike that arguably helped slow interest and reduce volume at the ports by about 30%. Some of this shift is likely temporary, and demand should return to the West Coast now that the dispute has been resolved. Kendall points out that Southern California is home to 25 million people, but entitlement issues remain a challenge for developers who are now pushing out to the state's border where they can build and still service this significant market.

Industrial Is Still the Most Desirable Real Estate Class

Comparing the current transaction volume to what was happening in 2020, 2021, and 2022, doesn't provide a practical view of the market. Yes, leasing fundamentals are weaker, and demand has dropped, but developers are still building. Consani compares it to driving on a highway, noting that if the pandemic-fueled market was a freeway with no speed limit, we're now on a highway with a 65 mph speed limit. We're still moving at a fast clip, but the normal market feels slower.

The Fed has hinted at another rate hike this year, and Kendall believes it will be the last hike now that the economy is cooling. At some point, the Fed will begin cutting interest rates to inject some liquidity into the broader economy. Although this can have the double effect of decreasing demand, transaction volume should start to tick upward into next year. Overall, Consani and Kendall expect more of the same for now in the industrial market, and they anticipate sizeable portfolios and one-off transactions in the near future.