The real estate market’s bad? Not if you own a warehouse.
The Chicago warehouse market is shifting from great to very good.
After falling for two years straight, the local industrial vacancy rate edged up to 4.53% in the first quarter, rising from a record-low 4.50% in fourth-quarter 2022, according to Colliers International.
Though demand for space has moderated a bit and construction is slowing, the boom isn’t over yet. The market’s just pulling back from a euphoric two-year run that few investors, developers or brokers have seen in their careers.
“Demand has remained historically robust, but that’s not robust compared to 2021 and 2022,” said broker Matthew Stauber, vice chair in Colliers’ Rosemont office.
Already strong before the pandemic, the industrial market shifted into a higher gear in 2021 as retailers, manufacturers, logistics firms and other businesses expanded, often to retool their supply chains to accommodate growth in e-commerce sales. Amazon led the pack, signing leases for big warehouses in the city and suburbs, but retail giants like Target and Walmart have gobbled up space as well. Target recently leased a 1.2-million-square-foot warehouse under construction in Joliet, the biggest local industrial lease in the first quarter, according to Colliers.
The industrial market has been so strong that developers are tearing down office buildings, or entire office campuses, to build warehouses in their place. Reno, Nev.-based Dermody Properties is developing a 3.2-million-square-foot logistics park on the Allstate headquarters site in Glenview, and Chicago-based Bridge Development has similar plans for the Baxter International campus in Deerfield. Rosemont-based Brennan Investment Group yesterday unveiled plans to demolish a distressed office building in Rolling Meadows and build 600,000 square feet of industrial space in its place.
The market is losing a little momentum. A key measure of demand, net absorption, or the change in the amount of leased space versus the prior period, totaled 7.4 million square feet in the first quarter, down from 9.9 million in fourth-quarter 2022. But that’s above the quarterly average of 6.9 million square feet over the past five years, according to Colliers. Absorption also fell in 2022, but last year’s total still was the second-highest ever.
Amazon’s expansion supercharged the industrial market during the pandemic — it accounted for 22% of Chicago-area absorption in 2021 — but the tech giant hit the brakes last year. The Seattle-based company didn’t account for any absorption in the first quarter, according to Colliers.
“It’s a demonstration that there are so many vendors, suppliers, retailers that are filling the void, playing catch-up with Amazon,” Stauber said.
The supply side of the market has been hot, too. Developers completed 31.6 million square feet of industrial space in the Chicago area last year, a record. They are currently building 27.5 million square feet on a speculative, or “spec,” basis — without signing a tenant before starting construction.
With developers completing much of that space this year, supply is likely to exceed demand. Still, while developers have a knack for overbuilding, Stauber isn’t concerned about a glut. That’s because construction has slowed as rising interest rates and lender cautiousness make it harder for developers to finance new buildings. The local vacancy rate should rise temporarily but is likely to fall again near the end of the year as demand catches up with supply, according to Colliers.
The direction of the local industrial market also will depend heavily on the direction of the U.S. economy. Demand for industrial space tends to fall in a recession, and many economists predict the economy is heading for one amid higher interest rates and banking system jitters.
But recent first-quarter earnings reports by real estate investment trusts, or REITs, that own industrial property support the narrative that the U.S. market — and Chicago’s — will continue to expand at a strong, yet sustainable pace.
“Industrial demand and market rent growth are moderating from the all-time high levels experienced in ’21 and ’22 but remain healthy,” analysts at Green Street Advisors, a California real estate research firm, wrote in a report released yesterday.
One Chicago-based REIT, First Industrial Realty Trust, offered a positive outlook when it reported its earnings this week, raising its profit forecast for the year. The company owns industrial property all over the country, but Chicago is one of its largest markets, accounting for 9.2% of its portfolio.
Current market activity “is characteristic of 2018, 2019,” First Industrial President and CEO Peter Baccile told analysts on a conference call yesterday, according to a transcript. “We see demand normalizing. And you’ll recall, those were very, very good years. So we’re coming off the kind of bubble created by COVID, and prospect activity is pretty good.”