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Area Development - Site Selection, Facility Planning and Workforce Development

Why Smaller May Be Better for Some Businesses

Although records have been set for massive industrial spaces, the market has been shifting to smaller buildings.

Q1 2024
The market for industrial projects exploded during the COVID-19 pandemic when the industrial real estate market pushed a frenetic pace for expansion. In 2021 and 2022 new developments were planned for major distributors and logistics companies that needed more space to meet demand from consumers who were spending more time at home, completing home improvement projects, or rushing to set up remote offices.

The construction pipeline to build large, 100,000-plus square foot industrial sites was seemingly bursting at the seams. At its peak in 2021, the U.S. industrial market set records by completing nearly 400 million square feet of new construction, according to data from Colliers, a real estate services firm. To add to that impressive statistic, the market was also seeing historically low vacancy rates of around 4 percent coupled with record high asking prices for rent.

But today, the industrial market may be moving in a different direction. Demand dropped over the past several quarters and vacancy rates stand a percent higher at the end of 2023 , according to Colliers. Construction starts dropped off last year compared to new heights reached two years ago. Developers started construction on nearly 90 million square feet of industrial space in the U.S. in the third quarter of 2023, down by about half of a record 176 million square feet of starts during the third quarter from the previous year, according to Colliers.

Leasing to multiple smaller tenants can also reduce the risk of new development by allowing developers to diversify their portfolios. As the market rights itself to pre-pandemic levels, a post-pandemic demand trend is emerging in the industrial market: building space for smaller end-users. Those companies that struggled to find the right facility in the 10,000 to 49,000 square foot range at the height of the industrial market boom are again looking for space.

Benefits of Building Smaller Industrial Sites
As that happens, developers will find there’s still a demand for smaller space. Companies looking to relocate or expand can find success in smaller industrial sites, which for the most part did not see the same boom in new development. As developers navigate the industrial market landscape, it’s important that smaller sites are considered to meet the demand.

At the height of the industrial market boom, most developers and investors were in search of credit tenants to fill 100,000-plus square feet spaces. The underlying financial prowess of these large tenants makes them less risky tenants because they are much more likely to be able to continue paying rent in the event of a lease or market disruption.

But leasing to multiple smaller tenants can also reduce the risk of new development by allowing developers to diversify their portfolios. Using this model, developers can diversify not only through different companies, but also different industry sectors and lease expiration dates. The risk of taking on a smaller tenant with less financial might is softened by the potential for other tenants to continue rent payments after one tenant vacates the property or its lease terminates in accordance with its terms.

The pandemic created a high demand for industrial space, which developers rushed to meet. As vacancy rates begin to creep up, the question today is what types of spaces are most in demand. During the development and construction phase of industrial developments, a flexible space allows developers to further hedge risk until tenants can be identified. Developers have found success following a model of designing a large project that can be easily subdivided into spaces or multiple buildings.

Advance design planning on issues such as the placement and style of loading docks and tenant parking allows a developer to seek a credit tenant for an entire project or divide space into multiple suites capable of a diversified portfolio of tenants.

The shift to smaller industrial sites comes with other benefits. It frees up users and investors from only looking at large sites that are increasingly rare close to larger population centers. Smaller sites can naturally fit on overlooked pieces of land that are closer to an urban core, the workforce, and key transportation arteries.

Even if a large site becomes available, it is still possible to develop smaller sites in stages. Property restrictions can be drawn that give a developer great control over the nature of development, architectural consistency within a project, use restrictions or grants of exclusive users, and shared expenses for common amenities to the site. A patient developer can have great flexibility in dictating what can be built and when.

As developers navigate the industrial market landscape, it’s important that smaller sites are considered to meet the demand. Final Takeaways
Vacancy rates may be high across the industrial market, but a need for smaller, flexible spaces for tenants may present an ongoing development opportunity.

The pandemic created a high demand for industrial space, which developers rushed to meet. As vacancy rates begin to creep up, the question today is what types of spaces are most in demand. With so much development of large spaces in the past two years, the need by companies for smaller spaces could remain as an area for continued development.

Tim P. Logan is a partner at law firm Parker Poe. He advises companies and individuals in the acquisition, sale, development, leasing, and financing of commercial real estate. He can be reached at timlogan@parkerpoe.com.

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