Possible Changes Coming to the Industrial Market

Based on recent movement from online marketing giant Amazon to sublet at least 10M SF of warehouse space in areas including Atlanta, New York, New Jersey, and Southern California, it looks like the industrial market is evolving. According to Bloomberg, the company may also decide to negotiate lease terminations with current landlords like Prologis, Inc. This particular industrial real estate developer considers Amazon its biggest tenant.

Why the change? Perhaps because the company’s leaders are hedging their bets. While Q4 2021 saw the company leasing about 370M SF of industrial space — double what it had leased in 2019 — Amazon reported slower growth and a weaker profit outlook in April 2022. For example, the company reported losing $3.8B in Q1 2022 compared to a net income gained of $8.1B in Q1 2021. Its CFO also said the company incurred an additional $2B in expenses as the result of industrial overcapacity.

Space it’s hoping to sublet equals about 5% of the square footage it added during the pandemic to accommodate incredible growth in online shopping and consumer demand. And although online shopping has declined since 2020, it remains robust even as it fluctuates quarter-over-quarter and remains higher than pre-pandemic levels.

Yet some experts say that despite Amazon’s movements and rising interest rates, the commercial real estate market — including the industrial property market — will continue growing. What’s propelling growth in the industrial property sector is a shift from lean manufacturing and limited inventory storage to a “just-in-case” approach to maintaining larger inventories to address increased demand. Even if larger companies elect to reduce the number of warehouses they’re building, subletting remains a viable option for many, the National Association of Realtors believes rents will continue to rise and vacancies will remain below 5%

Benefits to Subleasing

Subletting or subleasing space is often a more affordable option than standard commercial leases. There are often fewer strings attached than with some commercial leases. Because many of subleased spaces come equipped with technology or alarm systems already in place, companies opting to move in may save on operating costs — especially if they the area doesn’t require substantial retrofitting or renovations.

Many subleases offer another important advantage — a flat-rate monthly rent. Sublessors (or their landlords) are typically required to maintain and/or make repairs to common areas. Thus, companies subleasing a property don’t need to worry about common area maintenance (CAM) charges or other unpredictable fees. That stability makes it easier to budget for rent.

While some market players forecast double-digit rent growth for the next six to 12 months (especially for newly constructed facilities), sublet spaces offer discount rent opportunities within the 10% to 30% range, pending terms. After all, tenants can afford to offer deeper discounts when they may have leased these facilities many years ago when rents weren’t nearly so high. 

Why Amazon’s a Bellwether for the Industrial Sector

Large, modern warehouses — with 500K to 3M SF and automated AI-managed facilities soaring up to 60-ft clear-high spaces — are used not just by Amazon, but other Fortune 500 e-commerce retailers like Best Buy, Target, and Walmart, too. 

These behemoths have helped retailers maintain enough stock to meet explosive online customer demand, which is critical during a time when supply chains issues remain a problem.

But it’s no secret that Amazon has driven huge demand within the industrial sector, making millions of dollars for landlords over the years. Earlier in June, it put the brakes on its industrial growth, announcing the postponement of opening various fulfillment centers in Davenport, Alcoa, and San Antonio. 

Iowa’s five-story warehouse won’t open now until 2024. Tennessee’s ware house has been bumped from May 2022 to June 2023. And San Antonio’s East Side $200M fulfillment center has been indefinitely delayed. The company has also cancelled other fulfillment center builds in Churchill, PA and Austin, TX. The company cited multiple reasons, including continuing supply chain issues and slower than expected growth for rethinking its fulfillment center opening strategy.

But Amazon’s moves indicate a strategy to offload its more traditional, mid-market warehouses in favor of upgrading to the latest, more high-tech, newer facilities, freeing up older stock along the way. And it looks like the company’s in, well, good company. Other Fortune 500 retailers are adopting the same strategy — subleasing traditional warehouses they’d signed long-term leases with because those warehouses no longer meet evolving needs. 

For example, many warehouses originally considered first-mile now fit into the mid-market classification because the cities have grown around them. These warehouses don’t really fit as first- or last-mile use spaces. They’re not close enough to customers for practical use as last-mile distribution centers. And they don’t meet the requirements for first-mile use. 

So… Now What?

Is the overall demand for industrial space finally cooling? Not necessarily. You could say it’s evolving. Considering that many markets have low or no vacancy, returning some warehouse space to the market is a positive (especially for companies looking to expand their warehouses). Several experts who study the industrial real estate sector theorize that even with Amazon subletting space in several states, overall market vacancy rates will see little impact. After all, Amazon’s 30M SF it plans to sublet represents less than 25% of the industrial real estate inventory in the U.S. 

Amazon isn’t the only retailer likely to dial back on its space. With higher than normal inflation continuing to curb consumer spending, people are already purchasing fewer durable goods and household products. It’s possible that, should demand dip further, the amount of available industrial space will increase as companies sell off accumulated inventory and their own space needs decrease.

But for right now, demand for industrial warehouse space remains high. Retailers continue adding space for inventory storage to ensure they can deliver on consumer expectations even in a world of ongoing supply-chain challenges. Transportation and logistics companies are also continuing to expand.

Chances are good that even should more Fortune 500 retailers opt not to renew leases or reduce their own space needs, the supply-demand imbalance and current vacancy rates will remain relatively unchanged through the end of this year. Next year, however, should inflation remain high and ecommerce sales remain flat, vacancy could become a greater concern.

Are you a commercial real estate investor or looking for a specific property to meet your company’s needs? We invite you to talk to the professionals at CREA United: an organization of CRE professionals from 92 firms representing all disciplines within the CRE industry, from brokers to subcontractors, financial services to security systems, interior designers to architects, movers to IT, and more. 

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