As the nation’s economy continues to send mixed messages – with high interest rates, high inflation and fears of a recession contrasted by the stock market near record highs, a growing GDP and healthy labor market – southeastern Wisconsin’s industrial real estate market is also sending mixed signals.
While many companies throughout the region are seeing strong business and some are looking to expand their real estate, a challenging development environment is drastically slowing the construction of new speculative industrial buildings as the market absorbs the record amount of space that became available over the past year.
For the first time since the 2007-08 Great Recession there was no speculative industrial space under construction in southeastern Wisconsin during the first quarter, according to Jeff Hoffman, an industrial real estate broker and principal with Cushman & Wakefield | Boerke.
Much of the reason has to do with the challenging development environment plaguing all sectors of real estate with high interest rates, high construction costs and developers struggling to come up with enough equity to plug the gaps left by lenders.
Southeastern Wisconsin, particularly the I-94 North-South corridor, had a significant amount of speculative space come online in the past year with a few big deliveries in the first quarter, which has satisfied developer and investor appetite for new white box construction.
“It’s not as if the spec pipeline is just nonexistent,” Hoffman said. “It makes sense that at peak industrial real estate boom, ecommerce boom, surge in demand in 2021, 2022, interest rates much lower, everybody wanted to develop industrial real estate and now you’re seeing most of those products being delivered. These things take a couple of years to hit the market.”
The result has been an uptick in the overall vacancy rate to 5.8% in the first quarter, up from 3.6% in the first quarter of 2023, according to the latest market data report from the Commercial Association of Realtors Wisconsin.
“What we’ve delivered in the last 12 months is well in excess of what our market can historically absorb in a normal growth market,” Hoffman said. “You’d have to be in a turbocharged market to absorb all the space that was built.”
However, much of the new space waiting to take down its “for lease” signs are in the Kenosha and Racine submarkets. Kenosha County, for instance, has had upwards of 5 million square feet of industrial space delivered in the past nine months, according to Hoffman. Much of this space has been concentrated in a few buildings of 500,000 square feet or more, which moves the needle on vacancy rate a lot more than the smaller buildings that typically get built in metro Milwaukee.
Hoffman said demand for speculative space in Kenosha is also softer than what some investors had thought it would be. The thesis for much of the speculative space built in Kenosha was that, due to metro Chicago’s tight market, users would come north of the border, but the I-55 and I-80 corridors south of Chicago have continued to develop as well and absorb some of that demand, according to Hoffman.
“For the big distribution deals, we continue to miss out,” Hoffman said.
In all, the I-94 North-South corridor has about 18 to 24 months of supply available right now, Hoffman estimates, noting that a couple of large deals could knock that timeline down significantly.
“There is a thought that if the economy doesn’t dip into a recession – and we really don’t see tenants starting to default – because the development pipeline is shutting down right now and we already have what are historically low vacancy rates, by the time we get into the tail end of 2025, and arguably the economy should be back up again, you’re going to see a huge supply crunch again,” Hoffman said.
Still, there’s considerable activity throughout southeastern Wisconsin: in January, Haribo leased nearly 450,000 square feet in Bristol, moving from a 160,000-square-foot space, and in April, Microbial Discovery Group announced that it had added 117,000 square feet in Franklin to its portfolio. Both buildings were brand new, but the region’s stock of older industrial buildings is also performing well – in some cases, even better.
The asset class that has seen some of the biggest rent appreciation has been functional class B buildings in good locations, according to Hoffman. This has been driven by high rents in new buildings that have been prohibitive for some tenants looking to upgrade.
“(Still,) I see continued new construction happening directly with users,” said Matt Judson, president of Pewaukee-based Judson & Associates. “Some of the older generation product is not as functional for users and, with price increases of existing product, building new is being seen as more attractive.”
Generally speaking, rent growth has leveled off in the industrial sector and is more in line with the inflation rate, about 3% to 5%, according to Hoffman. That’s down from recent years with rent growth exceeding 10% in some cases.
“It’s still an incredibly strong market. It’s just not what it was last year, which you can say was as good as it gets,” Hoffman said. “Things are happening, I just think our supply curve got a little out ahead of itself.”
