Industrial construction slows as normal market conditions return

The days of hoarding hundreds of rolls of toilet paper are long gone, and that resetting of consumer demand after the pandemic is creating fundamental shifts on Northern Nevada’s industrial market.

Overall vacancy has crept up from less than 1 percent a few years ago to just over 8 percent – but industrial developers aren’t panicking. In fact, they are embracing the return to more normalized market conditions even though it means the pace of new construction will slow significantly.

Tim Schaedler, Nevada and Northern California Partner for Panattoni Development, told NNBW that demand for new Class A industrial warehouses far outstripped available supply during the COVID years, and today’s market conditions are much healthier.

“We have a healthy equilibrium between supply of warehouses and demand for warehouses,” Schaedler said. “Tenant demand and supply are more in balance.”

The heightened demand for industrial space due to an unrelenting onslaught of ecommerce led to a run on industrial real estate, said Mike Nevis, executive vice president of the industrial team at the Reno office of Kidder Mathews.

Industrial developers added 13.6 million square feet of new Class A space to the Northern Nevada market over the last two years, increasing the overall industrial market under roof by 13 percent, Kidder Mathews reports. Since 2020, developers added a staggering 22 million square feet of new construction, growing the market by 24 percent (to a total of 113.5 million square feet) in just four years.

“Companies were grabbing as much space as they could, and that led to a panic-buying situation where the vacancy rate went from 6 percent in 2020 down to 1 percent in just 18 months,” Nevis said. “Now, with the pandemic over and people out shopping, companies are re-evaluating their real estate, and demand has softened.”

The frenzy also significantly impacted rental rates. In the first quarter of 2017, the asking rate across all types of industrial properties was $.47 a square foot, Nevis said. At the end of 2023, the blended rate was $1.07.

“It was an unprecedented amount of construction that effectively doubled rental rates in two years,” Nevis said. “The market is resetting with a good balance between supply and demand, though it is tipping toward a tenant’s market. Once we get north of 8 percent vacancy, you start to see a shift toward a tenant-favorable market that will lead to a softening of rental rates.”

The slowdown in demand from tenants led to negative net absorption (more companies leaving than leasing) of just over 1 million square feet in the first quarter of 2024. It’s the first time this market saw negative net absorption since 2018, Kidder Mathews reports.

Industrial developers aren’t pausing on their construction plans outright, but they are being more cautious, especially with speculative construction projects.

“New construction and deliveries will be nothing like it was over the past 36 months,” Schaedler said. “It will be more normal, just like tenant demand has normalized.

“We likely will start new construction in 2024 with preleasing a portion of our buildings,” he added. “We currently are in discussions with a number of tenants that could take all or portions of our projects. We really are focused on build-to-suit with maybe some spec associated with it.”

Where interest rates stand in 2025 will in large part determine the pace of speculative development over the next 12 to 18 months,” Schaedler added.

“Inflation and high interest rates will slow down new deliveries. The cost of these buildings is so high that it really needs to slow down and we need to see some relief in construction costs in order for new spec construction to be financially feasible,” he said. “You will see a lot less development from both Panattoni and others in a market like this, and that’s not just Reno, it’s across the United States.”

John Ramous, Nevada partner for Dermody Properties, said these types of cycles are inevitable in the construction industry. The historical construction deliveries and low vacancy numbers are a thing of the past, and both metrics should look more normal moving forward, Ramous said.

“We're getting back to a more normal cycle and pace,” he said. “It’s a healthy process — tenants now have more choices and opportunities, where they didn’t in the past.”

The fundamentals of operating from Northern Nevada still makes sense for companies, Ramous added, and Dermody will continue developing industrial buildings in key submarkets to meet tenant demand.

Dermody’s is nearing completion of phase II of LogistiCenter at I-80 West. Two building shells of 177,000 and 252,000 are already complete, and interior improvements are expected to be complete in June. Dermody also is developing the first of two industrial buildings at Reno Air Logistics Park. The 470,000 square foot project is adjacent to Reno-Stead Airport.

In May, Dermody will break ground a 187,000 square foot building at LogistiCenter at Kiley Ranch, a two-building project totaling 385,000 square feet.

“We always focus on developing well-located Class A logistics facilities,” Ramous said. “Well-located infill assets around labor and amenities are going to be in high demand. Even as vacancy goes up, we think the projects we are building are going to be very attractive to customers coming into Northern Nevada.

“We are in a good position and are planning for additional projects within those phases to continue into 2025 and beyond,” he added. “And we still are looking for other opportunities within the marketplace. We know that long-term, Northern Nevada is very healthy and is a great area for many companies to grow.”