Demand for industrial space in Northern Jersey sunk into unfamiliar territory last year as net absorption, or the change in occupied space, posted the first negative annual tally since 2012. Totaling a negative 355,000 square feet, net absorption for the region was a far cry from nearly 3.2 million square feet of positive net absorption recorded in 2022.

Moderating demand for logistics space came against a backdrop of the most active year on record for project completions. All told, the Northern New Jersey market digested 3.9 million square feet of new space in 2023, primarily in Linden, Somerset and Landing.

Also weighing on the lackluster demand picture is a mismatch between the type of industrial space occupiers want and the size of new projects developers are building. With tenants recalibrating the amount of warehouse and distribution space required for optimized operations, they are increasingly seeking out smaller facilities. The average size of new industrial leases in 2023 was 18,300 square feet, down 24% from the prior year’s 24,100 square feet.

Meanwhile, market participants have noted that the sweet spot for industrial tenants today is roughly 50,000 to 150,000 square feet. That’s precisely the size cohort that’s seeing a shortage of available space. Moreover, developers in the region are in the process of delivering four projects totaling over 250,000 square feet.

The largest of these will be a 585,000-square-foot facility in Mount Olive at the Matrix Logistics Park. The two-building distribution center sits off I-80 and is expected to be completed this summer.

Of the four biggest developments, three are still without a signed tenant. They will add 1.2 million square feet to Northern New Jersey’s inventory at a time when there is already 5.8 million square feet of available space at industrial properties sized 250,000 square feet and larger.

Although the metropolitan area is entering the home stretch of its pandemic-induced supply binge, macroeconomic and labor challenges are expected to persist in the near term.

The latest forecast models expect net absorption to eke out a gain of 135,000 square feet this year, an assumption that hinges on the economy maintaining cruising altitude in the face of still-elevated interest rates and steady progress on a new labor contract for East Coast dockworkers.

Should either of these variables fall short of expectations, industrial property owners may instead be looking at a second straight year of negative absorption.

 

Many U.S. industrial properties began 2023 in a well-leased position and remained that way throughout the year. Even property owners with leases that were expiring were, in most cases, able to renew those leases, often at rents that were more than 40% higher than rents that prevailed just five years earlier.

But 2023 was a challenging year for newly built and vacant big-box distribution properties that needed to secure their first tenants. Higher interest rates weighed on the economy and tenant demand for additional industrial space waned significantly as the year progressed. Coinciding with a giant distribution center development wave underway, this drop-off in tenant expansions has fallen hardest on the 350 million square feet of industrial projects that finished construction in 2023 and remain unleased.

As the supply of new industrial space outpaces tenant demand, the U.S. industrial property vacancy rate has been rising for more than 12 months. At 5.6%, the national vacancy rate is still at a relatively low level that favors most building owners, having risen from the all-time low hit during the pandemic.

However, industrial vacancy is now rising at a faster pace. Two key questions for the industrial market heading into 2024 are when the amount of vacant space is expected to peak and how much further vacancy will increase along the way.

Given the large tally of speculative industrial projects still under development, it is all but certain that vacant newly delivered space will continue piling up during the first six months of the new year.

A total of 416 million square feet of unleased industrial space is currently under construction across the U.S., which amounts to about 1.3% of the stock of existing properties nationwide. Under the baseline assumption that the tenant base maintains its current size and all this space under development is completed without any signed leases, the U.S. industrial vacancy rate would rise to 6.9%. That vacancy level was last recorded in 2014 and is significantly higher than the 5.3% vacancy rate averaged during the five years before the pandemic.

But just as there is a high probability that the U.S. industrial vacancy rate will rise significantly during the first half of 2024, there are also signals that supply pressure from new development completions will subside significantly in late 2024, setting the stage for vacancy to stabilize.

More than 80% of the unleased space under construction is comprised of projects that broke ground before August 2023. That is when the Secured Overnight Financing Rate, or SOFR, a short-term bank borrowing rate used as a benchmark for setting interest rates on construction loans, reached its 2023 peak of 5.3%, where it has remained since.

Rising interest rates had already been reducing the number of industrial projects breaking ground during early 2023, but after SOFR surpassed 5%, industrial construction starts plummeted to 10-year lows in the second half of the year.

The fact that more than 80% of unleased industrial projects under construction today have already been under construction for more than five months is critical to the market outlook. For context, the average development time for large U.S. industrial projects from groundbreaking to completion is 14 months. This suggests that more than three quarters of projects currently under construction will deliver within the next nine months, most of them in the first half of 2024, leaving very few projects on track to complete construction by the fourth quarter, an after effect to the 10-year low in construction starts that prevailed during the second half of 2023.

This looming drop-off in new additions to industrial supply means that even a modest increase in tenant demand by the end of 2024 would be enough to cause the U.S. industrial vacancy to stabilize or begin tightening again. If the economy falls into recession between now and then, any reduction in vacancy would likely be delayed.

However, with retail inventories running lean again, and the decline in imports that prevailed during most of 2023 beginning to level off, early signs that tenants may soon be looking to rebuild inventory levels and expand their distribution center networks are already emerging.

 

While a famed Italian fashion house might have closed 2023 by splashing down more than $800M on Fifth Avenue real estate, foreign investors captured a historically small portion of the U.S. commercial property market last year.

With property prices still in flux and geopolitical instability spreading across the globe, these big-pocketed players aren’t expected back in the market in force soon.

Investors based outside the U.S. accounted for just 3.4% of U.S. property acquisitions in the 12 months ending in September 2023, according to MSCI Real Assets data provided to Bisnow, the lowest share since December 2008.

After spending more than $15B on U.S. CRE in the first quarter of 2023, foreign investors spent $10.1B on U.S. CRE in the six months ending in September, the least over two quarters since the second and third quarters of 2020, according to MSCI data.

“There is some caution and fear out there. Even though the U.S. is more stable than other parts of the world sometimes, when you’re looking for safety, you stay closer to home,” MSCI Real Assets Executive Director Jim Costello said.

Cross-border investment was down 56% in 2023 through the third quarter, according to JLL, compared to a 50% decrease in overall U.S. CRE investment. International investors have pulled back from the U.S. commercial real estate market for the same reasons all investment has retreated.

Increased interest rates and the pullback of lenders have made even funds that typically buy with cash more cautious to transact, despite falling values that might seem appealing.

“Multiple interest rate hikes, rising inflation and recession fears discouraged foreign investors to actually pull the trigger,” said Cecilia Xu, global capital placement director at Cushman & Wakefield. “I don’t believe it’s a long-term trend, as foreign investors still view the United States as one of the safest countries in the world to put their money. There was still a lot of deal interest, underwriting and negotiations last year. But honestly, the uncertain economic environment made it hard to actually close the deals.”

Foreign investors have pulled back for a variety of reasons, not the least of which is to shore up their own portfolio allocations and values from the aftershocks of rising interest rates, CBRE Vice Chairman Will Yowell said.

“[Foreign investors] are very focused on taking care of legacy issues and legacy portfolios,” Yowell said. “So there’s a lot of internal, ‘Hey, let’s address some of the issues we have with our internal portfolio.’”

According to preliminary full-year MSCI data, the most active sources of cross-border investment in 2023 were Singapore, Canada and Japan, with Singapore investors pumping more than $10B into the U.S. property market, making up more than 34% of all international U.S. CRE investments in 2023.

In late December, an entity connected to the Prada family purchased its flagship Manhattan store at 724 Fifth Ave. for $425M and 720 Fifth Ave. next door for $410M, Bloomberg reported. The purchases made Italy the seventh-largest source of cross-border U.S. investment in 2023 after placing 24th in 2022.

Japanese investors put $3.7B into U.S. commercial real estate as of early December, their largest volume of capital into the U.S. since 2016, The Wall Street Journal reported, citing MSCI data.

Tokyo-based Mori Trust Group led the charge, purchasing a $700M stake in 245 Park Ave. in Manhattan from majority owner SL Green. It also paid Boston Properties more than $500M in September 2022 for a trophy D.C. office building.

Japanese investors are moving first back into the market, Costello said, in part because the return to offices has been so strong in Japan. Xu attributed the influx of Japanese investors to the relative strength of the yen.

Their purchases also signal what types of properties other global investors will be interested in purchasing when they return to the market.

“If I’m going to hop on a plane and look at assets, I want to be able to write a $50M check,” Costello said.

Trophy buildings, even office buildings amid concerns over the future of work, are the best places to do that.

“There’s already a bit of demand for that, but there’s not willing sellers,” Yowell said. “When those institutions come back, and I think they will, that’s where the capital will be focused. They will be focused on the core trophy assets.”

In August, Orlando, Florida-based Estein USA purchased the Three Ravinia Drive office tower in suburban Atlanta from Blackstone for $175M, using capital raised from its German investors, Yowell told Bisnow.

Much of the activity to this point has been from those types of high net worth investors rather than the institutional wealth funds, Yowell said.

“We’re seeing that private capital step up,” he said.

Half of global real estate investment firm chief financial officers surveyed by Deloitte said they expect the cost of capital and capital availability to worsen throughout the year. They said their chief concerns are the continued war in Ukraine, extreme weather events and weaker-than-expected economic recovery in China.

“It doesn’t matter if it was New York, Tokyo or London,” Costello said. “Nobody wants to overpay for an asset.”

Adam Omar Al-Shanti, who invests on behalf of investors based in the Middle East into commercial properties in the U.S., Saudi Arabia and the United Arab Emirates, said his investors are more focused on keeping their money close to home.

Al-Shanti plans to close on $100M of high-end hotels and rental properties in Dubai and Saudi Arabia rather than shopping in the U.S. Yields on commercial real estate investments there are stronger than in the U.S., fueled by government spending, by high global oil prices and by an influx of young Russians and Ukrainians to the region, Al-Shanti said.

He said his investors expect U.S. prices to keep dropping, especially in the office buildings that they prefer to buy. There is more than $115B of U.S. office debt expected to mature this year, which could force some owners into sales.

“I would expect that institutional investors are probably interested if there’s something they can scoop up at highly attractive prices,” Al-Shanti said. “Their perspective is that things haven’t bottomed out yet.”

Xu said investors active in the market today are “mostly like bottom fishers” attempting to buy properties at discounted prices.

Yowell also said some foreign investors are scouting the U.S. property markets for distressed deals, especially coming from countries where yield is more difficult to generate.

“The Japanese might be more on the front end [of the cycle] this time around,” he said.

Despite the pockets of interest, Costello said he expects foreign institutional investors to be out of the market for some time out of fear of making poor investment decisions.

“The cost of being wrong is that you don’t get a chance to raise the next fund because everybody remembers how you called it wrong on the market timing,” he said. “The institutional and cross-border capital might be down for a bit. By the time they’re back, the market is already back.”