The United States industrial market has weathered an unpredictable, unprecedented two years. The social restrictions implemented in response to COVID-19 led to a significant increase in both ecommerce users and activity, subsequently driving a boom in demand for real estate to support last-mile and logistics operations. As such, this time has been marked by an extreme imbalance in supply and demand, resulting in an environment of space scarcity. Hitting a new record-low vacancy rate of 4.0 percent in the first quarter of 2022, the national industrial market is starved for space, and numerous major markets have little to no immediate occupancy opportunity for prospective tenants.

Competition for space has driven rent growth well past the nation’s high inflation rate; the average industrial asking rent increased 12.8 percent from one year ago to $9.26 per square foot. Moreover, pent-up demand — which went unmet by supply in the past two years — continues to spill into 2022, keeping absorption elevated significantly above pre-pandemic levels. By the end of March 2022, absorption topped 100 million square feet for the fourth consecutive quarter. Beyond the spillover effect, structural trends that drove 40 consecutive quarters of industrial expansion prior to the pandemic will continue to drive robust demand into the future. In addition, two years and counting of global supply-chain upheaval has driven interest and action in expanding domestic manufacturing, as well as building out domestic supply chains to support those activities.

In the face of such uncertainty and market stimulation, it is worth examining how industrial operations can be improved to bridge the supply gap. Today’s (and tomorrow’s) logistics operations are most efficient in a modern warehouse design, and many industrial occupiers seek best-in-class space for supply-chain optimization. Yet, only a modest percentage of the existing U.S. industrial inventory qualifies as modern, let alone best-in-class. More than 70 percent of existing U.S. industrial space was constructed before the 21st century, and one-third of the inventory is more than 50 years old.

Despite more than 2 billion square feet having been delivered within the past decade, and half a billion square feet set to deliver over the next two years, continued market modernization is essential. This is especially key for mature, dense markets, many of which serve the country’s largest metro populations and most important seaports, but grapple with industrial inventories among the oldest in the country. The average age of northern New Jersey’s industrial inventory is 56 years. In Chicago, which houses the largest industrial inventory in the country on a metro basis, the average age is 48 years. Inventory modernization is instead progressing faster in secondary markets, particularly those with ample land, strong logistics infrastructure, and growing populations. Secondary markets also often pose fewer hurdles to new development, offer greater flexibility in land-use planning, and are experiencing the same rent appreciation trends as gateway markets. Charleston, Phoenix and Austin are among the current top growth markets for new development, all touting about 7 percent or more of the current market inventory under construction (compared with the overall U.S. average of slightly more than 3 percent). As these secondary markets expand, some are now reaching the tipping point from emerging to mature, infill markets.

Market modernization faces a host of obstacles across the United States, ranging from land constraints to a challenging regulatory and entitlements environment, labor shortages, and pricing concerns. While the construction pipeline grew 46.0 percent between the first quarter of 2021 and the first quarter of 2022, the 81.1 million square feet of space completed in the first three months of 2022 was only slightly above the rolling four-quarter average, indicating challenges to timely delivery.

Many of the issues contributing to longer development timelines may continue to be exacerbated by lingering effects of the pandemic. While the United States has largely accepted the virus as endemic, other parts of the world have not: crucially, China. A number of major manufacturing hubs throughout China — including Shanghai, home of the world’s largest port — began phased lockdowns during the first quarter of 2022 on the heels of rising cases. And as the pandemic continues to aggravate supply-chain issues, new shocks to the system come with the war in Ukraine, which has further disrupted the global sourcing and movement of goods. These factors have contributed to a month-over-month rise in inflation since the beginning of the year, reaching heights not seen in over 40 years (8.5 percent in March 2022). Yet, even in light of these challenges, for most markets there is no better time to embark on a new development project from a timing, cost and demand perspective. Sourcing materials and labor will continue to prove challenging and pricey, and land prices have risen swiftly across the country. Some costs may moderate in the next 12 to 18 months, but the cost of capital is certain to incrementally rise from historic lows, as the Federal Reserve plans multiple rate hikes in 2022.

Despite the barriers to getting shovels in the ground, the construction pipeline for the U.S. industrial market has risen to an all-time high of nearly 550 million square feet. Ostensibly an enormous figure, net absorption nearly totaled the same amount in 2021 alone. Long-term need for new, modern space will require a replenished pipeline, even as demand moderates from abnormally high levels. Nearly all of the current volume is set to deliver by 2023, signaling a potential future supply gap if speculative construction starts remain muted due to prolonged disruption.

When it comes to inventory growth and modernization strategies, there are many factors to consider, and creativity is becoming key, especially in dense, land-constrained markets. The renovation of obsolete industrial properties and the redevelopment of underutilized non-industrial facilities, such as office or retail properties, are growing trends that offer solutions to supply and land constraints while modernizing market inventory. Longer-term strategies may include the remediation and revitalization of contaminated land sites. There are an estimated 500,000 brownfield sites across the country, and while industrial redevelopment of these land sites takes time, it also yields notable environmental, economic, and social benefits while satisfying continued robust demand for modern industrial space. Other strategies playing out across the country include prioritizing last-mile inventory additions in high-population-growth areas and expanding market boundaries in search of land and labor. Staying attuned to tenant size requirements, design needs and local labor profiles is also paramount on a market-by-market basis.

In the short- and long-term alike, demand for modern industrial space will remain elevated as firms begin to move from merely reacting to abnormal conditions, to proactively focusing on growth strategies using lessons learned over the past two years. New supply will be needed to fulfill this demand, and firms have already demonstrated a willingness to pay a premium for well located, best-in-class space. While the development environment will continue to pose obstacles this year and beyond, opportunities lie in the solutions.

Lisa DeNight is national industrial research director at Newmark. This article was sourced from Newmark’s national industrial research report titled, The Future of Industrial Real Estate: Trends for 2022 and Beyond.