While office vacancies remain high, demand for industrial product across the nation only continues to intensify. Despite the challenges this has caused for both sectors, many investors have taken the office vacancies as an opportunity to fill the need for additional industrial product. According to an industrial insight report from Newmark, some of the nation’s largest industrial markets are seeing high levels of conversion projects.
“Severe supply-demand imbalances persist in many key logistics markets, and most metro areas boast single-digit industrial vacancies. Asking rents are surging as a result. Tenants with large requirements are facing limited options and rising lease rates as a result. The lack of developable land also creates challenges for developers looking to bring new industrial product online,” said Liz Berthelette, director of research with Newmark.
Industrial vacancies across the United States are at an all-time low, leaving many markets with limited space for ground up development. Currently, U.S. industrial vacancies reach 4.6 percent as of the third quarter of 2021. At the same time, the U.S. office market continues to see minimal activity, and as of the third quarter, reached 16.6 percent, according to Newmark.
As the vacancy gap between the two sectors widen, developers are seeking redevelopment opportunities to help alleviate constraints in the nation’s tightest industrial markets. According to the report, at least 45 office properties totaling 11.3 million square feet have been redeveloped or are currently being redeveloped into industrial space since 2018.
This trend is being observed across the nation, but some markets are seeing more conversions than others. According to the report, Chicago has seen the largest amount of office-to-industrial conversions since 2018, at three million square feet. The Chicago industrial market was followed immediately by Los Angeles, which has seen 2.1 million square feet of conversion projects take place since 2018. Also along the West Coast, Orange County saw a significant amount of conversion projects, reporting 1.5 million square feet of redevelopment projects.
“Our report focuses on 10 markets where this trend is taking place. However, Chicago, Los Angeles, Boston, Northern New Jersey and Orange County account for the lion’s share of conversion volume. Of the markets highlighted, industrial demand is strongest in large logistics hubs like Chicago, Southern California, Northern New Jersey, etc.,” Berthelette said.
Conversion projects are being observed more frequently in low-vacancy industrial areas. For instance, Los Angeles reported a 1.2 percent vacancy in the third quarter of the year. Orange County also reported a 2.3 percent vacancy in its industrial market. Los Angeles and Orange County also reported office vacancies of 19.2 and 16.1 percent, respectively. This trend was also observed in other markets across the West Coast, including in Portland, which reported an office vacancy rate of 15.6 percent and an industrial vacancy rate of four percent. Additionally, in Sacramento, Newmark reported an industrial vacancy rate of 2.1 percent and an office vacancy rate of 11.1 percent.
“Based on Newmark’s proprietary analysis, the most likely office candidates for industrial conversion are older suburban assets with an average land area of 15-25 acres, located within four miles of a major highway,” Berthelette said.
However, many challenges associated with these conversions remain. According to Newmark, potential challenges facing both ground-up development and conversion projects include community opposition as well as zoning restrictions. Challenges from competing uses, including multifamily, healthcare and life science redevelopment also are a hurdle for industrial developers. In addition, Berthelette noted the complications the trend could potentially cause for the recovering office market as more product is taken away.
“As more office product is redeveloped for alternative uses – like warehouse/distribution space – potential functionally obsolete space will be removed for competitive inventory. Ultimately, this could lower office vacancies in markets where this trend is most prevalent,” she said.
Despite challenges, conversion projects are expected to continue as vacancy rates also are expected to drop. The office market also may start to see lower vacancies as conversions create tighter, more competitive markets across the United States.
“Near- and long-term outlooks for the industrial market are strong and we expect many markets to continue to face limited development opportunities. While still niche, this trend will continue to grow and help alleviate the lack of available supply for industrial users,” Bethelette said.