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If You Build It, Will They Come? Indy Industrial Tenants Demand Smaller Spaces

Pictured is 3910 Waldemere Ave. within Airport Business Centre in Indianapolis. Prologis owns the property.

Recently, my national research colleagues released “The Top 10 Commercial Real Estate Trends for 2019,” a piece featuring predictions on subjects such as trade tensions, labor shortages and the evolution of “co-everything.” Of all the predictions, one stood out as being especially relevant for the Indianapolis industrial market as we inch further into 2019. Indianapolis has lacked industrial space for occupiers seeking to grow, particularly in smaller segments. The great news is that the market is well on its way to remedying this ailment.  

Demand causing shortage

As we all know, the industrial sector is undergoing an e-commerce revolution. This has created a rush of demand by retailers and third-party logistics (3PL) providers for distribution and warehouse space, especially in cities like Indianapolis, which historically has been recognized for logistics strength. As a result, industrial market fundamentals have generally tightened across much of the United States.

Matt Niehoff, Cushman & Wakefield

In the fourth quarter of 2018, the U.S. industrial vacancy rate fell to 4.8 percent, the lowest rate on record. Similarly, Midwestern markets currently sitting at 4.8 percent vacancy have experienced a 50-basis point decline in vacancy since the fourth quarter of 2017. 

Pair that with north of 111.5 million square feet of overall leasing activity in 2018, and it’s a classic case of demand outpacing supply. Indianapolis is no exception to this trend. The highest three-year span for net occupancy growth took place from 2016 to 2018, which made an already tight market even tighter. The vacancy rate has been tracking at or below the 10-year historical average for 12 consecutive quarters.

Signs of relief?

On average, Indianapolis’ supply and demand scales have remained slightly imbalanced over a long period of time. From 2012 to 2018, net occupancy gains averaged 5.6 million square feet per year, while supply deliveries averaged 5.1 million square feet per year. Indianapolis reached its tipping point in 2016 when a rush of demand caused a 6 million-square-foot gap between supply and demand fundamentals.

Since then, announcements about warehouse developments in suburban industrial markets around Indianapolis, such as Whitestown and Plainfield, have been made at the most rapid pace in our statistical history. Subsequently, Indianapolis has delivered 18.9 million square feet of new construction over a three-year period. 

Digging deeper into individual deliveries reveals an interesting anomaly. We are supplying a market demanding mid-sized warehouse space with large bulk space. Over the same three-year period, nearly half the space delivered has been in bulk warehouses consisting of 500,000 square feet or more. 

Data from 2017 and 2018 shows that for every 1 square foot of space in demand, the Indianapolis market supplied 1.3 square feet in construction deliveries. For deliveries of smaller segments, such as 100,000 to 300,000 square feet and 300,000 to 500,000 square feet, the data isn’t as generous. For every 1 square foot of demand in the 100,000- to 300,000-square-foot range, Indianapolis supplied just 0.88 square feet and 1.03 square feet for 300,000- to 500,000-square-foot deliveries.

In 2019, we expect to see supply fill in the segments where Indianapolis is lacking. Forecasted construction deliveries have the momentum to set another market record, as 9.3 million square feet are currently under construction. Most of what is expected to be delivered will fall within the 100,000- to 500,000-square-foot range. Modest forecasts indicate around 5 million square feet of deliveries will take place in this segment by the end of the year. 

Small size segment

Up to this point in the current cycle, demand has been broad based, a tell-tale sign of a healthy industrial market. Industrial demand indicators suggest strong fundamental growth will continue throughout 2019. However, supply must follow suit in the size segments where the market is constrained and tenant demand lies. 

Demand in Indianapolis has reached historic heights. Over the past three years, the market set two net absorption records: in 2016 and again in 2018. In total, Indianapolis has had the most demand on record in this three-year time span. Looking past the flash of record-setting demand, numbers show a similar story to the supply anomaly.

Since 2016, the total square feet of lease transactions in the 50,000- to 100,000-square-foot range has increased by nearly 167 percent. On the contrary, Indianapolis has experienced a decline since 2016 in the number of deals falling within the 100,000- to 500,000-square-foot range. Year-over-year deals within the 100,000- to 500,000-square-foot range have experienced a 35 percent decline in square footage leased. The lack of deal volume isn’t for lack of trying.

Currently, we are tracking nearly 50 requirements for tenants looking for space in the 100,000- to 500,000-square-foot range. When we take into consideration supply constraints, we can reasonably assume that deal volume has fallen off because availability within the 100,000- to 500,000-square-foot range has been scarce. 

Hence, the advice Kevin Costner received from an eerie voice while walking through a Midwestern cornfield in the 1989 hit movie Field of Dreams seems to ring true: “If you build it, they will come.”

— By Matt Niehoff, Senior Analyst, Indianapolis Research, Cushman & Wakefield. This article originally appeared in the March 2019 issue of Heartland Real Estate Business magazine.

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