Class B industrial and the new normal of annual rent escalations
Searching for yield
Industrial property investors are no strangers to the hunt. As the 10-year Treasury declined to cyclical lows in 2020-2021, investors sought higher yielding returns in class B and value-add assets, while class A pricing soared. Traditional class A core single tenant buildings that were occupied under long-term leases, often carrying 2.0-2.5% annual escalations, and started to fall out of favor among investors. They were expensive and “priced to perfection” as many investors would say, given the historically low cost of debt. The value-add investment thesis was clear for the years going forward: deals with shorter weighted average lease terms (WALTs) would allow investors to boost returns using “mark to market” strategies, by implementing a regime of higher annual escalations.
Since then, class B industrial sales have consistently accounted for around 31% of functional, post 1980 construction industrial sales volume. In 2024, some cities saw class B sales outpace class A volumes, including major industrial markets such as Chicago, Philadelphia, Northern New Jersey, and Orlando. For some properties with below-market rents and near-term lease expirations, investors are comfortable accepting negative leverage for the first year or two, and lower cap rates are tolerable, anticipating that, in just a few years, owners can create significant value by pushing rents for a “mark to market” opportunity. For investors who purchased assets over the last five years with a “mark to market” strategy, bets are paying off. This year, at the end of the first quarter, overall U.S. industrial rents have climbed nearly 70%, from $6.11 to $10.36. Investors are not only benefitting from market rent growth but also seeing higher annual contractual NOI growth (3.0-4.9%).
A look at class B sales in secondary markets
Our experts analyzed seven high-growth secondary markets to assess the 2020-2024 period—Phoenix, Indianapolis, Denver, Charlotte, Orlando, Las Vegas, and Austin—and noted that class B assets averaged 37% of sales activity. At the start of the second quarter of 2025, class B activity is pulling ahead of previous years with 46% of the volume. However, we forecast that as sales volume increases this year, class B activity may pull back to a more normal pace, as investors could once again seek to purchase stabilized core industrial product.
Annual industrial rent escalations – the new normal?
Average contractual annual rent escalation rates have shifted higher in recent years. Across the country today, investors are most commonly signing leases with “bumps” between 3.0-4.5%, yet in many markets, 2-2.5% had been the norm for years.
Owners of industrial real estate saw sharp demand increases by tenants during the pandemic, with leverage to garner much higher rent escalations. The rationale for this tactic was reinforced by the rise in construction costs and the steep rise in interest rates that began in 2022.
While the 10-year Treasury has pulled back over the last 12 months, and maybe some of the tenant demand has cooled, escalations are not expected to retreat. Today, it is increasingly rare to see tenants secure an annual escalation rate below 3%, which is quite the shift from five years ago when most deals saw rates between 2-3%. Additionally, newly delivered speculative product is increasingly putting out new lease proposals at 4% annual increases, marking the establishment of a new, modern era of rent escalations.
Owners of industrial real estate saw sharp demand increases by tenants during the pandemic, with leverage to garner much higher rent escalations. The rationale for this tactic was reinforced by the rise in construction costs and the steep rise in interest rates that began in 2022.
While the 10-year Treasury has pulled back over the last 12 months, and maybe some of the tenant demand has cooled, escalations are not expected to retreat. Today, it is increasingly rare to see tenants secure an annual escalation rate below 3%, which is quite the shift from five years ago when most deals saw rates between 2-3%. Additionally, newly delivered speculative product is increasingly putting out new lease proposals at 4% annual increases, marking the establishment of a new, modern era of rent escalations.
Retrospective lessons
When analyzing historical escalations from 2020, it’s clear that the 3.0-3.49% segment was the most common rate. At that time, markets with the highest annual escalations were land-constrained geographies including South Florida, Long Island, Northern Virginia and California. Some markets with lower barriers to entry such as Chicago, Charlotte, Denver, Houston, and St. Louis saw over half of leases signed with escalations below 3%.
Today’s escalation expectations
In 2024, markets that are seeing a considerable number of lease transactions with escalations north of 4% include Atlanta, Charlotte, Chicago, Nashville, New Jersey, Northern VA, and Orlando. In some of these cases, escalations exceeding 5% are getting signed on shorter-term leases, while the 4.5-4.99% tranche is rare, with only limited data points in this segment.
A tenant perspective
Across the country, 3.5-3.99% appears to be the new standard for average escalation rates, but every transaction should be viewed on a case-by-case basis within its competitive set and submarket. The brokerage community has made it clear that escalation rates have been recalibrated since tenants coming off 10-year leases last tested the market. Occupiers are increasingly burdened by rising costs across multiple fronts—including labor and transportation, while recent tariff-driven surges in raw material and input costs have added further pressure. Some larger corporate occupiers have managed to offset higher costs by passing them on to their customers. But many local and regional businesses in class B and “small bay” space under 50,000 square feet (sf), face limited relocation options and are increasingly forced to renew.
Rising property taxes and insurance rates continue to push up on gross occupancy costs, but this is not anticipated to force occupiers to “trade down” on the property class spectrum or to migrate to secondary markets for cheaper rent. Some efficiency may be found in racking layouts, but investors currently have the upper hand with pricing on lease negotiations.
Rising property taxes and insurance rates continue to push up on gross occupancy costs, but this is not anticipated to force occupiers to “trade down” on the property class spectrum or to migrate to secondary markets for cheaper rent. Some efficiency may be found in racking layouts, but investors currently have the upper hand with pricing on lease negotiations.
Finding your yield
While industrial assets remain highly sought by investors for many reasons including the new normal of higher annual escalations, the last few quarters have proven that even non-core assets in secondary markets can provide investors fantastic yields. Some savvy investors recognize that strong portfolio returns don’t require the newest properties, the highest-credit tenants, or the most sought-after markets. Plus, because of limited new industrial deliveries over the past year (and forecasted in the near future), tenants will have fewer options and landlords will continue to gain leverage in the marketplace in class A, B, primary, and even secondary markets.
Article author and contributor
