Philly Industrial Sector Due For Reality Check After 'Once In A Lifetime' Boom

Eastern Pennsylvania was a poster child for the unprecedented pandemic industrial boom that caused a flurry of leasing and construction in Philadelphia and its suburbs.

But as the sector’s hot streak continues to cool off five years later, analysts aren’t expecting a repeat when the next upcycle rolls around.

“It was probably a once-in-a lifetime event,” Cresa Managing Principal Eric Zahniser told Bisnow of the Covid logistics boom. “I don’t think ‘If you build it, they will come’ works through every cycle.”

In fact, Philadelphia and some of its immediate neighbors are more likely to be facing a reality check when it comes to asking rents, especially for top-flight properties.

Though Zahniser still believes unique industrial properties in the region present a good opportunity for investors, he noted that Greater Philly is facing high industrial vacancy among its new Class-A buildings.

Owners of those properties don’t have a lot of leverage when it comes to finding new tenants.

“Rental rates are likely going to soften, and/or you’re going to see landlords providing more concessions to tenants,” said Lee & Associates Regional Research Director Heather Kreiger.

‘Tale of Two Worlds’

Every market in Eastern Pennsylvania is at or above the 7% to 7.5% “structural vacancy range” that divides a landlord-friendly market from one that is more favorable to tenants — and the city and its immediate suburbs are well over the line into tenant-friendly territory, according to Lee & Associates’ first-quarter industrial report for the region.

Vacancy rose from 8.9% to 12% year-over-year in Philadelphia and the Pennsylvania collar counties, while South Jersey saw its rate grow nearly 400 basis points to 14.2%.

There’s a major distinction between the Class-A market and older, smaller spaces.

It’s a “tale of two worlds,” said Velocity Venture Partners founder Tony Grelli.

The 23% Class-A vacancy rate Lee & Associates calculated for Philadelphia and its Pennsylvania suburbs is nearly double that of all industrial space in the region and triple the rate for Class-B properties.

“You’ve got a tremendous amount of Class-A product that’s sitting out there vacant and competing with one another,” Grelli said. “What you don’t have is a lot of product geared toward smaller tenants.”

Greater Philly’s once-churning construction pipeline has trailed off in recent months, but there is still 8.6M SF of industrial space under construction and nearly 60M in preconstruction across Philadelphia, its Pennsylvania suburbs and South Jersey.

That new product is set to arrive after a spell of relatively sluggish leasing. The 12-month period ending in March saw just 34.8M SF worth of leases signed across the region, down from 42.5M SF in the year leading up to Q1 2022, according to data provided by Lee & Associates.

Spring is usually the biggest time of the year for industrial leasing as companies prepare for the holiday season, Zahniser said.

“It feels OK now,” he said of leasing activity in recent weeks. “Maybe seminormal.”

But asking rents in Philly and its Pennsylvania suburbs are higher than they should be, Zahniser said, especially since many owners purchased their properties “at top-of-the-market land prices.”

Philly and most of its suburbs were never a destination for nationally minded bulk warehouse tenants, he said. That’s why vacancy is significantly lower in Lehigh Valley, Harrisburg and Northeast Pennsylvania, areas that aren’t much further away but offer cheaper rents.

Cargo upgrades planned for Philadelphia International Airport and the Port of Philadelphia haven't moved the needle yet. Industrial vacancy in the city proper sits at 11%, 7% higher than in Bucks and Burlington counties, which both offer better access to New York City and the Port of Newark.

The situation is grimmest in deep South Jersey. Salem and Cumberland counties have a collective industrial vacancy rate of nearly 31%, according to the Lee & Associates report. The metric rises to more than 52% for Class-A spaces.

Cold Storage, Parking And Adaptive Reuse

There are still opportunities for industrial investors in and around Philadelphia.

Cold storage facilities and sites with access to enough power for a data center remain in high demand, Zahniser said.

That goes for sites with ample trailer parking as well. During the peak of the industrial construction boom, demand for sheer square footage meant developers were making buildings as large as possible, often at the expense of parking. Now, there’s a dearth of Class-A buildings with sizable lots.

Others are creatively repurposing large sites that have fallen out of favor.

Velocity is providing smaller, cheaper industrial spaces to the Montgomery County market by converting a 200K SF multilevel office building into several warehouses.

The firm inked a 130K SF lease for part of the property at 355 Maple Ave. in Harleysville last week. Grelli declined to disclose the tenant but said they’re a construction-focused nonprofit similar to Habitat for Humanity.

Velocity also removed some of the upper floors from the building to create greater clearance heights.

“It was an intense construction exercise,” Grelli said. “Now instead of 13 feet of ceiling height, you have double that.”

The building’s intact bathroom plumbing was another major plus. Building that infrastructure for different potential tenants is a major expense that keeps landlords from subdividing large Class-A spaces, Grelli said.

Relief In Sight, Replication Unlikely

Owners of those big empty boxes should expect the rough patch to persist until sometime next year as the construction pipeline continues to thin out, Kreiger said.

“We’re going to continue to see those vacancy rates push up,” she said. “It will take some time before the market comes back to equilibrium.”

When it does, she doesn’t believe demand for industrial space will touch what the market experienced during the pandemic.

“It basically took about five years of trends and crunched them into a very short time period,” she said.

E-commerce transactions jumped from 11.9% of U.S. sales in January 2020 to 16.3% that April, according to the Federal Reserve Bank of St. Louis.

Tenants shifted their inventory strategies “from just in time to just in case” and leased additional space they didn’t necessarily need, Kreiger said. Many assumed that kind of astronomical growth would be the norm going forward.

But it wasn’t.

E-commerce transactions fell to 14.2% of nationwide sales by April 2022. The rate has been steadily creeping up since then but only recently made it back within 10 basis points of the April 2020 level.

Grelli expects leasing activity to tick back after the tariff situation gets sorted, but he said the limited amount of remaining developable land in the region and frequent resident backlash to new warehouse projects means the pipeline will likely remain small.

“I don’t think we’re ever going to see a massive onslaught of new construction like that come online ever again,” he said.