Higher interest rates show effect on industrial real estate as market softens

While many industrial real estate analysts have been saying that the region is currently a “landlord’s market,” Bill Wolf, vice chairman of CBRE said the second quarter saw some balance returning to the market along the I-78/I-81 corridor and potential tenants may be able to find a break. 

He said in the second quarter tenants were able to find rent at about 10% less than previously as available properties sat on the market longer. 

“Rental rates are stabilizing as some landlords are prioritizing occupancy rather than holding out for that last nickel or dime,” Wolf said. 

He noted that sublease availability was five-times higher than it was in mid-2022 before the market shifted into a high-interest rate era. 

He said this comes from companies that may have been in a rush to expand their inventory and add warehousing and logistics space and found they no longer need that space. 

He said with the aftereffects of the COVID-19 pandemic now over, many companies aren’t as concerned about maintaining larger inventory levels closer to their customers as they had been. 

“You may say they bit off more than they can chew,” Wolf said. 

Most of that activity came in the third-party logistics sector, which was the industry that grew the most and the quickest in the wake of pandemic supply chain issues. 

3PL companies placed nearly 1.2 million square feet of space on the market for sublease, nearly 75% of all the sublease vacancy added this quarter. 

Both Lehigh and Northampton counties saw negative net absorption rates in the second quarter, while Berks County saw a slight, but what Wolf called “negligible” increase. 

While demand may continue to soften, the market is not positioned to add excess supply through construction in the near-term, which Wolf said he expects impact the balance. 

The latest CBRE industrial real estate report on the I-78/I-81 corridor showed developers continued to react to rising vacancy rates, and only 2 million square feet of new projects broke ground this quarter.  

The overall 8.7 million square feet current construction pipeline was significantly smaller than the post-pandemic average of 21 million square feet and even lower than the 14.2 million sq.-ft. average posted during the years leading up to the pandemic in 2018 and 2019, the report said. 

Wolf said the decrease in construction is a direct result of the Federal Reserve policies, which raised interest rates in an effort to slow inflation and stabilize the economy. 

One trend that Wolf said is starting to become evident is the distribution of leasing activity by geography.  

Demand within the I-78/I-81 corridor is currently primarily focused on the Central Pennsylvania and Lehigh Valley portions of the market, mostly due to their location.  

But as the spread in pricing grew, he said a larger portion of demand went to the Northeast Pennsylvania submarket.  

Before Class A logistics rent growth started in earnest in 2021, the Northeast submarket claimed about 20% of leasing activity, on average.  

As rents within Central Pennsylvania and the Lehigh Valley became much higher than rents within Northeast Pennsylvania, that share has shifted to 33.1% on average since the start of higher interest rates.  

The report showed that the average Class A logistics asking rent in Northeast Pennsylvania was 5.6% and 30.2% less than Central Pennsylvania and the Lehigh Valley, respectively. 

But while Wolf called the current market a break for tenants, he said he doesn’t expect it to be a permanent one, so those businesses looking to add space may find that now is the time to consider entering into a lease. 

“The second half of the year will be strong and this pendulum swing will be a short time opportunity for tenants,” he said.