With rising interest rates and stubborn inflation, the Tucson industrial sector remains a strong commercial real estate performer in 2023. The new trend for near-shoring or Onshoring, with a continuation of the e-commerce boom, has only added to the already sky-high demand for Tucson industrial real estate.

The Tucson industrial market continues the trend that drove industrial property performance in 2021, including the increase of direct-to-consumer shipping and just-in-time inventory, which led to lower vacancies and industrial price appreciation.

Growth of Interest Rates and high Inflation will affect the industrial market,

But now, the industrial market may have reached a changing point. The Federal Reserve’s inflation-induced monetary policy with prospects of a near-term economic slowdown and labor market softening. The economic landscape is changing as interest rates increase to their most significant level in over a decade to fight high inflation. Signs of banks tightening credit have emerged in recent months.

Higher interest rates increase the likelihood that the economy will slow down, unemployment rates will rise, and delinquent borrower payments and defaults will increase. Thus, the probability of a recession increases.

Add to that the recent banking turmoil — the high-profile failures of Silicon Valley Bank, First Republic and Signature Bank and the ensuing fallout economists and financial experts predict that the convergence of these factors could precipitate a severe credit crisis in the United States.

In a credit crunch, banks reduce lending, making it more difficult for businesses and consumers — particularly those with weaker credit — to obtain loans. The last significant credit shortage occurred during the 2007-2009 financial crisis.

Reasons for the Strong Demand for Warehouse Space in Southern Arizona

However, both investor and tenant demand are still strong. At the end of the first quarter of 2023, an additional 2 million square feet of warehouse and distribution facilities being developed signal a strong confidence in Tucson industrial real estate.

The recent shift towards reshoring and domestic production, as well as the CHIPS & Science Act, presents new opportunities for the industrial sector in the United States. The Act aims to increase the country’s semiconductor production capacity, critical for various industries, including automotive, healthcare, telecommunications, and defense. Additionally, the Act includes funding for R&D in emerging technologies, which can drive innovation and competitiveness in the industrial sector. These developments may increase the demand for industrial space and infrastructure in Tucson. However, the long-term effects of these changes remain to be seen and are subject to factors such as global economic conditions, geopolitical events, and technological advancements.

Industrial properties are needed for the growing trend to warehouse raw materials and manufacture goods domestically because the days of relying on importing goods when we need them from places like China are over.

E-commerce Supply chains will also need to become more resilient. Despite the recent return of in-store shopping, e-commerce will likely continue to drive retail demand, as consumers prefer online shopping since consumers expect same-day or wait no more than a few days for delivery This means that demand for distribution space is not likely to fall anytime soon.

We expect tenants will keep looking for logistics facilities that can accommodate today’s supply chain requirements, with the transportation infrastructure that allows them to serve large volumes of customers efficiently.

Tucson’s industrial real estate to benefit from Mexico and the Port of Tucson

Tucson’s connection to supply chains will also be a differentiating factor in 2023. U.S.-based production and congestion at the largest seaports have directed more shipping activity toward other points of entry to the country.  Industrial real estate in Tucson will be among those to benefit from its proximity to maquiladoras in Mexico, Port of Guaymas and the Port of Tucson.

While high inflation and concerns over a softening labor market, ample migration is still anticipated across the Sun Belt.  Arizona is projected to be one of the highest net in-migration markets in the country; this translates into increased demand for distribution resources.

Industrial buildings may offer superior returns as construction costs rise.

The recent rise in construction costs and lower asset values in other real estate sectors create a unique opportunity to achieve superior returns by investing in logistics real estate in submarkets essential to supply chain logistics.

Labor shortages and rising construction materials will likely continue to create significant challenges for industrial developers. The cost of steel, concrete, and roofing materials contributes to most of the shell costs of an industrial building.  Price increases for these materials have generated a 50 percent rise in construction costs since 2019. In addition, construction timelines have also increased, with the increase in time to obtain building permits, contractor backlog, and supply chain issues.

The use of automation is becoming increasingly important in the industrial sector, and it can help manufacturers reduce labor costs and improve efficiency. While the initial capital investment for automation tools can be high, it can lead to long-term cost savings and increased competitiveness. Moreover, automation can allow U.S. manufacturers to shift their production base to the same continent as their customers, which can help them reduce shipping costs, improve supply chain management, and better meet customer demands.

The industrial real estate sector will continue to be among the top performers in 2023. Despite some cautions due to interest rate hikes, transaction volume for industrial warehouses has remained robust; furthermore, industrial and distribution facilities have been favored investment prospects for four out of the past five years. These trends suggest that the industrial sector will likely remain a solid and attractive investment opportunity in the coming years.

For more information on the Industrial real estate market in Southern Arizona, call the Commercial Real Estate Group of Tucson at 520-299-3400

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