Many U.S. industrial properties began 2023 in a well-leased position and remained that way throughout the year. Even property owners with leases that were expiring were, in most cases, able to renew those leases, often at rents that were more than 40% higher than rents that prevailed just five years earlier.

But 2023 was a challenging year for newly built and vacant big-box distribution properties that needed to secure their first tenants. Higher interest rates weighed on the economy and tenant demand for additional industrial space waned significantly as the year progressed. Coinciding with a giant distribution center development wave underway, this drop-off in tenant expansions has fallen hardest on the 350 million square feet of industrial projects that finished construction in 2023 and remain unleased.

As the supply of new industrial space outpaces tenant demand, the U.S. industrial property vacancy rate has been rising for more than 12 months. At 5.6%, the national vacancy rate is still at a relatively low level that favors most building owners, having risen from the all-time low hit during the pandemic.

However, industrial vacancy is now rising at a faster pace. Two key questions for the industrial market heading into 2024 are when the amount of vacant space is expected to peak and how much further vacancy will increase along the way.

Given the large tally of speculative industrial projects still under development, it is all but certain that vacant newly delivered space will continue piling up during the first six months of the new year.

A total of 416 million square feet of unleased industrial space is currently under construction across the U.S., which amounts to about 1.3% of the stock of existing properties nationwide. Under the baseline assumption that the tenant base maintains its current size and all this space under development is completed without any signed leases, the U.S. industrial vacancy rate would rise to 6.9%. That vacancy level was last recorded in 2014 and is significantly higher than the 5.3% vacancy rate averaged during the five years before the pandemic.

But just as there is a high probability that the U.S. industrial vacancy rate will rise significantly during the first half of 2024, there are also signals that supply pressure from new development completions will subside significantly in late 2024, setting the stage for vacancy to stabilize.

More than 80% of the unleased space under construction is comprised of projects that broke ground before August 2023. That is when the Secured Overnight Financing Rate, or SOFR, a short-term bank borrowing rate used as a benchmark for setting interest rates on construction loans, reached its 2023 peak of 5.3%, where it has remained since.

Rising interest rates had already been reducing the number of industrial projects breaking ground during early 2023, but after SOFR surpassed 5%, industrial construction starts plummeted to 10-year lows in the second half of the year.

The fact that more than 80% of unleased industrial projects under construction today have already been under construction for more than five months is critical to the market outlook. For context, the average development time for large U.S. industrial projects from groundbreaking to completion is 14 months. This suggests that more than three quarters of projects currently under construction will deliver within the next nine months, most of them in the first half of 2024, leaving very few projects on track to complete construction by the fourth quarter, an after effect to the 10-year low in construction starts that prevailed during the second half of 2023.

This looming drop-off in new additions to industrial supply means that even a modest increase in tenant demand by the end of 2024 would be enough to cause the U.S. industrial vacancy to stabilize or begin tightening again. If the economy falls into recession between now and then, any reduction in vacancy would likely be delayed.

However, with retail inventories running lean again, and the decline in imports that prevailed during most of 2023 beginning to level off, early signs that tenants may soon be looking to rebuild inventory levels and expand their distribution center networks are already emerging.