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Logistics Companies Are Betting Big On Midwest Industrial. So Why Are They Signing Shorter Leases?

With the coronavirus pandemic raging and Americans ordering more products online than ever, Amazon and third-party logistics providers have been going on industrial leasing sprees in markets from the Pacific Northwest to Philadelphia and New Jersey.

But if these companies are making big bets on the future of industrial, why are the leases they are signing so short?

“The leases we’ve been seeing recently are in the range of two to five years, rather than more traditional five to 10-year leases,” said John Sharpe, a principal at Lee & Associates. “They’re leasing space left and right, but it’s on a shorter-term basis.”

In Sharpe's home markets — Chicago and its environs, including southern Wisconsin and western Indiana — industrial lease terms have been dropping. Between January and July of 2019, the average industrial lease term in those markets was 5.1 years. In the same months in 2020, the average had dropped to 4.7 years, an 8% decline.

Though the drop may not sound massive, Sharpe said, it means that far more two- and three-year leases are being signed than seven- and 10-year leases. Terms longer than 10 years are becoming incredibly rare. But if the large logistics players believe the e-commerce revolution is here to stay, wouldn’t they sign longer leases? Not necessarily, Sharpe said.

“Part of what they’re paying for is flexibility if market conditions change,” he said. “They aren’t sure what their site requirements are going to be five years down the road.”

If the pace of e-commerce growth keeps up, a logistics company could easily outgrow the space it leased today. By signing short-term leases, companies keep the option of moving to a larger location, or even building their own distribution centers nearby. 

Technological change and automation could also make some warehouse locations obsolete in the near future, Sharpe said. If some local or national event reduces demand, they will have the option to let their lease expire.

Month-to-month leases are now becoming all the more common among third-party logistics tenants. These leases often include "kick-out clauses" that let owners boot month-to-month tenants with around three month's notice, Sharpe said.

Because space rented out month-to-month is typically listed as vacant, these leases tend to go unnoticed by the wider industry, but that doesn't mean they don't have a large impact. Sharpe said he is currently brokering four month-to-month leases that he expects would have come in as three-year leases in a more predictable economic environment.

“As much as they believe strongly in the future of what they’re doing, they’re not always sure what’s coming next,” Sharpe said. “They’re willing to put up the money to keep their options open down the road.”

The companies that are large enough to pay for flexibility are the ones that are currently driving industrial absorption and will likely continue to drive it, Sharpe said. In Q1 and Q2 of 2020, 286 lease deals for industrial space were signed in the Chicago area, with a lease volume of 32.3M SF, compared with 363 deals for 27.5M SF in the same quarters of 2019, according to a recent Lee & Associates report.

The numbers reflect a trend that Sharpe is seeing in the market: The deals going through now are fewer, but they’re larger, and they come from bigger players in the industry. 

The slowdown in deal volume is not really a product of smaller industrial tenants going out of business, Sharpe said, because with a few exceptions in the trade show industry, most industrial tenants are still in business. But many smaller industrial tenants are biding their time before signing any new leases.

“We should continue to see fewer, bigger deals through the balance of the year,” Sharpe said. “Then we’ll have to see whether we open up or not.”

This feature was produced in collaboration between Bisnow Branded Content and Lee & Associates. Bisnow news staff was not involved in the production of this content.