Minneapolis-St. Paul industrial market report
Q1 2023
The Twin Cities industrial market continued to thrive in the first quarter of 2023, albeit at a slower pace than the last two years. Absorption remained positive for the twelfth consecutive quarter, the vacancy rate is still trending downward, and rental rates are holding steady. That said, the market is undoubtedly cooling.
Leasing activity experienced a slight decline, with the number of lease deals and their total size being more in line with 2017-19 quarterly averages than what we saw over the last two years. Third-party logistics providers continued to lead tenant activity, which is unsurprising given that they recently surpassed retailers and wholesalers as the largest leasers of warehouse space in the nation. Also, an increasing number of non-traditional users have been leasing flex spaces and older, low-clear height industrial properties, showing that new properties aren’t the only thing in demand.
New construction predictably slowed as developers began to reassess demand and see how quickly the new product gets absorbed. Speculative construction is likely to decline through the rest of the year. Additionally, while construction costs are stabilizing and lead times are becoming more predictable, some long-lead items are still creating a drag on the development process. For example, electrical switch gears have been taking 12-18 months to procure.
Lastly, owners have remained reluctant to offer months of free rent or substantial tenant improvement allowances. However, they have eased up on lease language and been open to smaller, non-monetary concessions. Some owners are still at odds with tenants on lease terms, pushing for shorter leases and betting that they’ll be able to sign renewals at higher rental rates in just a few years. It’s a risk, but some owners need to keep rents high because of low cap rates at the time of their purchases, as well as the fact that property taxes have been climbing due to new assessments of the many high-priced purchases made in the last couple of years.
Leasing volume is stabilizing
Leasing activity slowed and is now more in line with pre-pandemic levels. The total number and size of leases signed in the first quarter, 113 and 2.47 msf respectively, resembled the 2017-19 quarterly averages of 122 transactions and 2.41 msf. By contrast, the quarterly averages from 2021-22 were 127 transactions and 3.48 msf. Most brokers view this as an expected correction from the recent frenzy. Tenants continued to be patient when considering their options and owners showed only a slight willingness to offer concessions.
New construction is slowing
The 6.33 msf of product under construction in the first quarter was 7.3% lower than in Q4 2022 and 20.7% lower than in Q3 2022. As the pandemic-driven demand has weakened and interest rates have climbed, more developers appear to be pumping the brakes and waiting to see how quickly this new flood of product gets leased. Whether the market has been oversupplied is up for debate amongst brokers, but the consensus is that speculative construction will continue to decline through the rest of the year.
Vacancy rates continue to fall
The overall vacancy rate for industrial and flex properties remained at 3.5%. The rate for industrial properties specifically also stayed flat at 3.2%, while the rate for flex properties dropped from 5.8% to 5.1% -- its lowest since Q3 2016. Overall vacancy has been trending downwards for years, but brokers envision that it will increase slightly as all the new product under construction hits the market.
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