Era of Scarcity: Rent Growth Doubles Prior Record

Companies continue to prioritize resilience over lean inventory levels, leading to a significant shift in real estate strategies. The need for more space drove increased competition in prime locations with low vacancies. The combination of robust demand and limited new supply led to further drops in vacancies in the U.S. (3.2%), whilst Europe retained the previous years’ record low levels (2.7%) in 2022.ii Structural demand factors—including the build-out of e-fulfillment capabilities, nearshoring, and inventory growth for resilience and greater product variety—will drive expansion in 2023 through the economic cycle.

Regulatory barriers to supply

Rent growth was strongest in prime consumer-end markets where land scarcity was greatest and regulatory barriers presented the biggest challenge to new supply. Increasingly, stringent regulatory barriers are limiting space expansion and increasing entitlement timelines, which doubled in many markets during the last three years. In California, Oregon and New York, several municipalities are enacting moratoriums on industrial developments. Similarly, restrictive measures are considered in France, the Netherlands and Germany. Meanwhile, under-construction volumes rose as developers turned to alternative locations with fewer restrictions to meet demand. To illustrate, despite rising demand for space and rent growth in urban locations, the share of total European development in urban markets dropped from 28% to 19% from 2017 to 2022 ⁱⁱⁱ As a result, companies need to make swift decisions to secure much-needed space in prime locations, which are expected to remain structurally undersupplied going forward.

Construction costs

Building costs rose as materials ran short and supply chains were disrupted by COVID-19, the war in Ukraine, labor turmoil and rapid inflation. As a result, material costs rose 39% in the U.S./Canada and 35% in Europe in 24 months (October 2020-2022).^iv Rising construction costs, in combination with land acquired at peak pricing, caused developers to increase rents to support new development. Growing replacement costs underscored rent growth across markets, but the relationship was strongest in land-rich locations where new supply can rise quickly to meet demand and trader-developers build at low margins, such as Poland. Supply chain pressures are starting to ease, which is reflected in material costs stabilizing in some markets and falling in others. The expected declines in material costs and land values in 2023 are offset with yield expansion, requiring higher rents to justify the risk of development.

EXHIBIT 4 - CONSTRUCTION COST COMMODITIES BASKET ^iv

Outlook

Location is key as transportation costs fluctuate substantially and consumer service level demands remain high. As a result, markets with high-quality infrastructure close to the end consumer are likely to outperform. After 2022’s record rent growth of 30%,ⁱ we expect to see normalization in the pace of rent growth driven by a slower pace of deal-making (as economic growth and urgency cools) and increased supply in some markets. Structural forces, including e-commerce growth and supply chain reconfiguration, are likely to drive expansion through the cycle. Regulatory barriers, land scarcity and rising capital costs, however, will continue to limit new supply and, in the most constrained markets, leasing conditions are unlikely to ease.

EXHIBIT 5 – Lease MARK TO MARKET EXHIBIT

Regional Highlights

Rent growth in the U.S./Canada accelerated to an all-time high of 34% year-over-year.ⁱ With vacancy rates at record-low levels in most locations and widespread demand, rent growth was strong across many markets. The vacancy rate hovered in the low 3% range through 2022.ⁱⁱ Our customers reported both strong activity and high utilization of space throughout the year. The IBI, our proprietary survey of customer sentiment, showed activity at a healthy 60 and utilization rate a high 86% at year-end,ⁱⁱⁱ indicating minimal shadow space and a continued need for warehouse space to accommodate future growth.

The pace of decision-making is normalizing and, with growing economic uncertainty, not likely to reaccelerate next year. At the same time, users will have more options due to the record pipeline of 545 MSF across Prologis’ 31 markets. Against that backdrop, while rent growth will likely slow from its recent robust pace, it should maintain a healthy rate above inflation.

EXHIBIT 6 - EFFECTIVE MARKET RATE, U.S./CANADA ⁱ

EXHIBIT 7 - TOP 10 RENT GROWTH MARKETS, U.S./CANADA ⁱⁱⁱ
 

1. Los Angeles
2. Inland Empire
3. Toronto
4. South Florida
5. Phoenix
6. Baltimore-Washington DC
7. Las Vegas
8. Reno
9. Columbus
10. Indianapolis

Rents grew at a record pace in Europe in 2022, rising 15% year-over-year.i 2022 year-end vacancy was near the record low at 2.7%,ⁱⁱ leading to an acceleration of rents across markets. We see a clear relationship between true months of supply (TMS)/supply risk and rental growth as the growth trajectory was steepest in those locations with the lowest vacancy and highest barriers to supply, e.g., Prague (0%).ⁱⁱ Significant increases in replacement cost (accelerated by the war in Ukraine) pushed rents upward, even in more land-rich locations. Take Poland, for example, where rents increased more than 20%, a market that has lagged in the past.

Development slowed in 2022, and lower completions are expected to coincide with softer demand in 2023, allowing for only a moderate rise in vacancy. An economic slowdown could further soften market conditions, although market vacancy rates are exceptionally low and may only rise moderately, offsetting negative cyclical impact on rent growth. Indeed, rents rose (3%) in Q4 2022,ⁱ even as the macro landscape became more uncertain.

EXHIBIT 8 - TMS vs. NER Growth, country level Europe

EXHIBIT 9 - EFFECTIVE MARKET RATE, EUROPE ⁱ

EXHIBIT 10 - TOP 10 RENT GROWTH MARKETS, EUROPE ⁱ

1. Prague
2. South Netherlands
3. Greater London
4. Warsaw
5. Berlin
6. Hamburg
7. Midlands
8. Greater Silesia
9. Rotterdam
10. Munich