The pandemic undoubtedly amplified the demand for industrial real estate. The already flourishing market was spurred by a rapid shift toward e-commerce shopping and last-mile delivery. Yet, real estate professionals understand that the industry moves in cycles—what goes up usually comes down, or at least evens out. The Winter 2023 Allen Matkins/UCLA Anderson Forecast California Commercial Real Estate Survey offers insight into what’s happening in California’s commercial real estate market; Barbara Perrier, Vice Chair at CBRE, and Seth Garrett, a partner at Allen Matkins, share their perspectives on current trends in the California industrial real estate market.

Developers Are Taking a Wait-and-See Approach as Concerns of Recession Rise

Developers are facing a degree of uncertainty as interest rates rise, and the threat of recession remains a factor in the broader economy. According to Perrier, “We’ve already started to see a little bit of a slowdown in the smaller tenant space.” She adds, “There’s no question that recession will have an impact on the market. As consumers might spend less, there’d be less need for goods, and it ripples down.” Garrett agrees, pointing out the effect of inflation on consumers’ budgets. “As sales start to drop, developers and e-commerce giants such as Amazon will postpone new investments.”

Interest rates are a more pressing concern for some developers, as the market is likely healthy enough to weather a mild recession. Garrett sees e-commerce growth as a driving force, adding, “The biggest challenge the market will face is the continued rising interest rates, which will increase the cost of capital and postpone new development and investment.” Without access to capital, developers will likely cut back on speculative construction.

The Industrial Real Estate Market Is Headed for a Turning Point

Garrett admits that “a potential recession is unlikely to cause e-commerce sales volume to fall off dramatically,” and the data supports this. The latest Survey results indicate a drop in developer sentiment; industrial space outperformed expectations during the pandemic, yet it has struggled to keep up with market demands. For several years, occupancy rates and lease rate growth have remained high. Perrier notes, “Developers have had the best years of their lives over the last five years in industrial [real estate]—a huge win-win for people who’ve been buying land and developing buildings.”

Perrier sees a cooling of the overheated industrial market. “We’ve seen 50% to 70% year-over-year rent growth, which is unprecedented.” She cautions, “So we think rent growth is going to either plateau or curtail for a bit as we absorb this tremendous growth coming off of 2022.” Garrett agrees with this assessment of the market. “From a sales perspective, industrial assets experienced the largest drop in sales volume in the fourth quarter of 2022 compared with a year earlier.” This should be no surprise. He continues, “At some point, supply will catch up with the slowing demand, and naturally, vacancy rates will increase and rental rates will decrease,” he adds.

A Slight Decline in Sentiment Does Not Deter Future Growth

Developers are still planning projects across the state. Two-thirds of the respondents in Southern California have at least one project in the works, as do about half of those in Northern California. Inland communities continue experiencing significant growth as people move to areas where they can find more affordable housing prices and more space while still having easy access to the city as needed. This trend increases demand for multifamily and retail space, which can have a ripple effect all the way to the industrial market.

Perrier admits that one of the headwinds affecting the industrial market is rising anti-development, anti-truck, and anti-warehouse sentiment in communities. “There’s been several different ballot issues passed—or on the docket—that would curtail industrial development.” However, these challenges don’t change her belief in the future of industrial real estate. “I think it all may translate to some bumpy returns, but it’s nothing that a strong market can’t preclude.”