Industrial buildings are often visually unattractive, but to developers and investors they can be just as good as that big coveted house at the end of a cul-de-sac.
Demand for the low-rise, nondescript concrete warehouses, distribution centers and manufacturing buildings popping up in the Twin Cities suburbs remains very strong even as other major segments of the commercial real estate industry stagnate, but construction hasn't surged enough to meet demand.
The average vacancy rate for industrial buildings in the metropolitan area has hovered around 4.5% over the past six months, 1% higher than a year ago and slightly below the historical average, according to the latest data from commercial real estate brokerage Colliers.
That's just a fraction of the double-digit vacancy rate in the office sector. Demand for office space has fallen, rents have plummeted, office development in the Twin Cities has stalled, and apartment construction is disappearing.
So the Twin Cities, like many other big metros, should be in the midst of a new industrial revolution: The rise of e-commerce and online retail, which relies on giant warehouses and distribution centers with high ceilings and plenty of space to store goods awaiting delivery, will have an impact on the struggling office and multifamily markets, if it hasn't already had an impact on developers.
But while demand for industrial space is strong, supply remains low. Rising borrowing and construction costs have meant fewer new projects and soaring prices.
“Debt costs and inflation have forced developers to pull the plug,” said Joe Owen, vice president at Colliers Minneapolis & St. Paul. “It just doesn't make sense to build it.”
Increasing demand
According to Colliers, just 2.8 million square feet of industrial space was under construction across the metropolitan area by the end of June, down 73% from a year ago. Meanwhile, industrial rents are trending upward, with the average lease rate at $9.55 per square foot, up nearly $2 from a year ago, especially in metropolitan core submarkets where supply is most limited.
“It's a very tough situation,” Owen said. “The industrial market remains very healthy.”
Minneapolis-based Opus Group broke ground on an industrial project in Dayton this week: building a 132,200-square-foot distribution and light industrial facility on a 10-acre site. The company says the Dayton Parkway Business Center will feature 28-foot ceiling heights, 19 dock doors (expandable to 34) and four drive-in doors. There will be 136 vehicle parking spaces and 14 trailer parking spaces, plus space for employees and delivery drivers.
“The northwest Twin Cities industrial submarket continues to lead and outperform the rest of the metro with active users and strong demand,” said Nick Murnane, Opus vice president of real estate development and general manager. “This facility allows us to uniquely serve users seeking smaller spaces in a submarket that has historically been dominated by larger spaces.”
Murnane said TurbinePros, a company that provides on-site services to rotating equipment manufacturers, has already signed leases for more than 87,000 square feet, with about 44,000 square feet still available.
Opus has several industrial development projects in various stages of development and construction, including River Valley Business Park in Shakopee. River Valley Business Park includes two adjacent industrial buildings totaling 450,000 square feet on 51 acres of land. It is a “speculative” project, meaning no specific tenant is in mind, allowing the eventual lessee to tailor the undeveloped space to suit their needs. The buildings have 28-foot and 32-foot ceilings, multiple dock doors and hundreds of parking spaces for delivery vehicles.
The company is also nearing completion on building a custom aluminum recycling facility for Spectro Alloys in Rosemount. The 90,000-square-foot building will enable the aluminum recycler to increase production of recycled billets and sheet ingots from post-consumer scrap aluminum, such as aluminum cans.
In addition to these industrial users, another factor driving increased demand is office tenants. While the trend toward higher-quality offices is driving demand for flashy, well-appointed high-rises with hotel-like amenities, Owen says, more companies are looking for office space in no-frills industrial buildings that incorporate so-called “flex tech” office space.
The appeal of these single-story buildings is that they are much cheaper to build and outfit than most mid- and high-rise office buildings, Owen said.
“A lot of office tenants are looking for cheaper space,” Owen says, “and they're consolidating their footprint and costs into single-story technology buildings.”
Supply Shortage
This shift is one of many factors driving the rise in office vacancies. The latest data on the Twin Cities office sector shows that office vacancy rates across the metro have risen to an average of 22 percent, according to JLL's second-quarter report, which found that, according to various sources, office seekers are seeking roughly 3 million square feet of space, roughly one-third of the space sought by industrial users.
A huge surge in demand for industrial space has driven rents in the asset class to rise at double-digit rates annually, but the cost of that space can be nearly half that of some high-rise office buildings.
“This is very situational and a little complicated,” Owen said, “and it's up to the user.”
The Twin Cities industrial scene is overwhelmingly driven by a combination of office/warehouse users and bulk distribution companies. Sweet Harvest is one such company, best known for its honey but also selling agave and molasses. Earlier this month, the company moved into a 360,000-square-foot “distribution center” that Twin Cities-based Oppidan developed on 23 acres in Lakeville.
Jay Moore, Oppidan's senior vice president of development, led the project. It's the company's largest industrial building to date and the largest in the Capital Region in recent years. Moore said an increase in existing space being vacated by businesses such as Sweet Harvest is offsetting the slowdown in construction. Still, the amount of vacant space in the Capital Region has remained steady so far this year, according to a Colliers report.
Since 2015, when Oppidan began developing industrial buildings, the company has completed construction on approximately 5.5 million square feet in North Carolina, South Carolina and several other states, including California.
“The reality is that the amount of new space being built is going down,” Moore said. “There's not as much product being built.”