Just a couple of years ago, the words “industrial development” conjured images of large, speculative structures being built at record speed to keep up with a demand that seemingly could not be met.

The situation is a bit different these days. A supply surplus and softening demand, combined with a spike in interest rates, slowed the breakneck pace of speculative industrial development. Furthermore, the record levels of construction were simply unsustainable.

This doesn’t mean that industrial speculative development has stopped altogether. However, more tenants are weighing their options. They’re considering the benefits of a build-to-suit approach versus automatically taking space within existing product.

Getting From There to Here

People in the commercial real estate industry understand that the COVID-19 pandemic and resulting lockdown spurred a huge tenant demand for industrial product, especially among bulk warehouse tenants and logistics occupiers. Added to this demand was an abundance of available “cheap money.”

Banks and other capital institutions were more than happy to offer loans at low interest rates and higher leverage to speculative industrial developers, secure in the knowledge that the borrower could effortlessly fill that 100,000- or 200,000-square-foot structure. Even better, there was plenty of upside in the form of increasing rents upon completing a two- or three-year lease.

This prompted developers to buy up large land parcels where they could build massive warehouses or distribution centers. Backed by willing capital partners and confident of seemingly unstoppable tenant demand, those developers could count on a 4% to 6% annual rent increase – or higher. Against this backdrop, the build-to-suit concept didn’t stand a chance, not with longer lease terms and less opportunity for hikes in rent.

But real estate is cyclical. The recent speculative building boom wasn’t an anomaly. However, additional supply slowed rent growth and absorption. Meanwhile, inflation and higher-for-longer interest rates made tenants more selective about what type of building they want and where it should be. New construction minimum terms are increasing from a couple of years to five years on the lower end.

Additionally, the 3PL and warehouse occupiers are giving way to more specialized tenants.

Positive Fundamentals for BTS

At KDC, we’ve seen an uptick in tenants considering build-to-suit facilities. Here are some of the fundamentals driving this trend:

Land Availability

Developers hoping to take advantage of the buy-develop-rent boost methods of 2021-2022 are finding different conditions in 2024. They are no longer certain of higher returns but are more open to the concept of offloading these assets, putting quality acreage acquired during and after the pandemic on the market. This means a larger inventory of site options for build-to-suit focused tenants.

With this setup, tenants can pick their developer of choice, working with these experts to survey the market and ultimately acquire a preferred site.

Tenant Choice

As already mentioned, tenants are becoming more selective about where to operate. As a result, many are gravitating toward the build-to-suit model.

Rather than setting up shop in an empty building because it’s there, companies want locations close to where their employees live and where their clients do business. Additionally, the build-to-suit process means decision-makers can design a facility according to their specific building needs through an open-book process.

Capital Accessibility

When issuing loans, capital sources once liked a quick upside through short lease terms and high rent growth. Not anymore. Lenders these days are more interested in providing financial help to borrowers and buildings occupied by credit-worthy tenants over a longer lease period. In other words, a long-term lease in hand from a credit-worthy tenant is far more likely to be capitalized than a speculative project.

When a BTS Makes Sense

Though the current environment supports build-to-suit industrial properties, it doesn’t mean you should now encourage all of your tenants to go in that direction. Here’s when a build-to-suit development makes sense.

Usage

Be sure to examine products, services and processes to determine if a tenant needs a customized build-to-suit to improve their operations or efficiencies. Clients with unique functional needs, such as manufacturing space or outside storage, and customized design needs, such as abnormally high clear heights, tend to be better build-to-suit candidates.

Timing

More specialized users, such as data storage entities, chip manufacturers, and R&D companies, are entering the market. The building timelines for these tenants and owner-occupiers tend to be longer than those of traditional industrial tenants of the past. The more conservative timelines provide these users and their design-build partners ample time for site selection and power infrastructure determination. The extra time also supports customized interior and building shell designs (including fortified exteriors to withstand weather-related hazards) that better serve the occupiers’ operations and activities.

Location

There are multiple considerations when it comes to location. Certainly, you’d expect any industrial building to be near reliable modes of transportation. But the tenant or owner-occupier might want a build-to-suit near where certain employees call home or closer to their suppliers. They might also want extra land to offer their suppliers to ensure a seamless supply chain and quick turnaround in manufacturing and delivery.

Infrastructure

Proximity to roads, highways, rail transport, sanitary sewers, and water continues to be essential for most industrial users. Additionally, access to power, fiber and water with proper in-place zoning are driving factors for manufacturing and data center site selections.

These facilities can consume between 10 and 500 megawatts of power. As a result, the specialty occupiers want sites adjacent to existing substations and untapped transmission lines. It is also important that these buildings—and their power sources—be in locations that are better protected from weather-related hazards like flooding.

The Takeaway

The industrial sector is undergoing a cooling-down period, which is not surprising. The wild ride of 2020-2022 wasn’t sustainable. As a result, we’re beginning to see less speculative development than before. Depending on your clients and the industries in which they operate, a build-to-suit strategy could be a viable solution in the current environment.

The BTS approach can result in a building or buildings your client wants and needs while allowing you to take advantage of the still-strong industrial sector fundamentals.