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  • Writer's pictureRealFacts Editorial Team

Is the Distribution Bubble about to Burst? Or Will Price Gains Endure?


industrial area

The industrial real estate market has witnessed unprecedented growth over the last decade, with industrial property prices and rental rates soaring. This surge was initially driven by the COVID-19 pandemic, which forced global lockdowns and transformed consumer habits. As online shopping became the norm and supply chains were stretched thin, the demand for warehousing space skyrocketed, pushing up both property values and rents.


Graph of market rent

 

Adding to this dynamic, recent legislative measures such as the CHIPS Act and the Inflation Reduction Act (IRA) are anticipated to further fuel demand for industrial properties through increased domestic manufacturing and re-shoring efforts. Despite these robust drivers, the recent slowdown in the pace of appreciation raises questions about the sustainability of current valuations and hints at the possibility of a market bubble in industrial real estate.


A Decade of Remarkable Gains


Since 2013, industrial property prices have consistently outpaced inflation, as demonstrated by the Warehouse Commercial Real Estate Price Index (CREPI). A particularly dramatic spike occurred in the second quarter of 2022, with a 26.6% year-over-year increase. Although the growth rate has since moderated, prices have remained well above inflation levels. Similarly, rents for industrial spaces have surged, peaking at over 20% year-over-year growth at the end of 2022, before settling to a still-impressive average growth rate of nearly 10% in 2023.


Signs of Exuberance or Market Fundamentals?


To assess whether these gains indicate a market bubble, statistical methods used by the Dallas Federal Reserve to monitor housing markets for “potential market exuberance” have been applied to Moody’s CREPI and warehouse rent series. Both indicators have shown periods of explosive growth since 2015, suggesting potential concerns about speculative behavior.


Graph of rental vacancy rate

However, a deeper dive reveals that these price increases may be driven more by fundamental shifts in the market rather than speculation. Vacancy rates in the industrial market have significantly decreased from over 10.5% in 2020 to under 5.5% currently. This reduction, coupled with rising rents and prices, suggests that genuine demand changes underpin the trends. This contrasts sharply with the early 2000s housing bubble, where rising vacancy rates and surging prices indicated an imbalance.


The Future of Industrial Real Estate


While a dramatic price drop is unlikely, a slowdown in the rate of price and rent appreciation is anticipated. The initial surge in e-commerce, a major driver of recent industrial property demand, has plateaued as pandemic-induced shopping behaviors stabilize. Moreover, the shift towards omnichannel selling and stores-as-hub fulfillment strategies means that e-commerce will have a more tempered impact on the distribution sector moving forward.



Internet Sales Expansion Will Slow


Graph of percentage internet sales

Legislation like the IRA and CHIPS Act and nearshoring trends are expected to bolster the industrial sector. However, the anticipated increase in industrial manufacturing production has yet to materialize, with declines noted in the second half of 2023. Advances in productivity and the obsolescence of older warehouse facilities may lead to a price divergence between modern and outdated warehouses.


Supply Chain Disruptions and Future Outlook


Ongoing supply chain disruptions continue to sustain demand for warehousing space. Recent events, such as the collapse of the Key Bridge in Baltimore, have exacerbated storage conditions, highlighting the persistent challenges in the supply chain. The Moody’s Supply-chain stress index remains above pre-pandemic levels, indicating continued pressure in the sector.


Industrial Production is Set To Grow


Graph of industrial production

Despite the anticipated moderation in price and rent growth, the industrial real estate market remains fundamentally strong. The extreme gains of the last decade are unlikely to be replicated, but the market is poised for steady, sustainable growth rather than a dramatic downturn. As we move forward, it is crucial to temper expectations while recognizing the robust underpinnings that support current valuation levels.

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