Five Factors that are Driving Net Rents in the Industrial Real Estate Market?
Almost every occupier of industrial real estate has either directly experienced the seemingly rapid increase of current net rates, or has heard stories about strong net rate increases on renewals, new construction, and existing vacant space across the Twin Cities Metro area.
Five main forces are driving net rents upward and will continue to do so for the foreseeable future:
Low Supply: Industrial vacancy rates across the country are at all-time lows. Minneapolis and Saint Paul are no different. The Third Quarter’s industrial vacancy rate is at 4.0% with distribution space and office-warehouse vacancy rates at 3.4% and 3.5% respectively. With tenants competing for fewer spaces, price (rental rate) paid is increasing dramatically.
High Demand: Net Absorption of available space YTD is 3.87 million SF compared to 1.20 million SF through Q3 2020. Many tenants need more space to expand fast-growing operations. Other tenants are migrating to higher-quality buildings that provide operational efficiencies, lower operating costs, and attractive work environments that help to retain existing employees and attract new hires. The increased tenant activity coupled with a lack of available space has compounded the upward pressure on rental rates.
Limited New Development: The cost of new construction has dramatically risen over the past 1224 months and supply-chain delays are adding time and additional expense to every new project; not to mention the soaring cost of land. The Mortenson Cost Index registered a 9% construction cost increase over the past 12 months in Minneapolis/St. Paul. New development is simply not being delivered to the market fast enough to meet the high demand for industrial space.
Increased Inflation: As inflation takes hold, it appears as though it is not “transitory”, but rather sustained. As a result of the strong industrial real estate market paired with generationally high inflation, Landlords are demanding annual net rent increases of 4-5%. Many tenants are surprised when proposed lease renewal rates are 10-15% (or more) above their current net rates. Many tenants ultimately end up paying these renewal rate increases because of the lack of vacancy in the market.
New Landlord: Link Logistics Real Estate is now the largest industrial landlord in the Twin Cities and continues to aggressively acquire more properties. Currently, Link Logistics owns approximately 16 million SF in the Twin City area and has increased net rates on renewals, and new lease transactions, while limiting tenant improvement allowances and free rent. The other landlords in the market are following Link’s lead, resulting in higher net rent in every industrial product type.
We anticipate that the market characteristics specifically described above will continue uninterrupted for the next 12-24 months, subject to an unforeseen exogenous variable impacting the industrial real estate market. A deadly strain of Covid-19, an unplanned war, or hyper- inflation could all alter the strength and resiliency of the US economy and the industrial real estate market.