Article originally posted on CoStar on January 25, 2024

Phoenix leads the country in industrial construction in early 2024, usurping the Dallas-Fort Worth region as the nation’s construction hot spot, a throne it has held since 2016.

Both markets are contending with record supply additions over the past few years as renewed focus on domestic supply chains spurs development for large distribution properties. In addition, strong manufacturing momentum has filled the pipeline with several big, purpose-built facilities used in advanced assembly.

The Phoenix industrial market is navigating a historic construction boom. About 45 million square feet of industrial space is underway, the most of any market in the nation. This is on top of the 30 million square feet completed last year and the 25.9 million square feet finished in 2022, causing the Valley’s industrial inventory to increase by 15% since the fourth quarter of 2021. For comparison, the U.S. recorded inventory growth of about 5% during the same two-year period.

Much of the new development is being built without a tenant in place, which caused vacancy to spike in the second half of 2023. Marketwide vacancy rose from the mid-4% range in the second quarter of last year to 7.8% in the fourth quarter as unleased projects came online. Further increases in vacancy and a meaningful slowdown in rent growth are expected in the near term as the market digests the supply glut.

Empty space is more likely to accumulate in larger buildings with about 60% of the pipeline comprised of properties 250,000 square feet or bigger. Small-bay properties, meanwhile, are expected to be more insulated from the supply injection, keeping performance comparatively healthy.

Moving forward, elevated costs for construction financing, materials and labor have begun to slow the pace of groundbreaking. New construction starts declined 37% year over year in 2023 and may ease further throughout this year. As a result, supply pressure could start to wane by early 2025 as the number of new projects completed each quarter begins to decline substantially.

Industrial construction is pulling back in Dallas-Fort Worth, with 35 million square feet under construction in early 2024. That level is down from the peak of about 83 million square feet at the end of 2022, and the first time the market has not ranked first since 2016.

Market vacancies face supply side pressure with more logistics completing, a result of the surge in speculative building over the past few years. Developers added around 70 million square feet last year with half that volume consisting of logistics buildings 500,000 square feet or greater. The vacancy rate for logistics buildings has spiked to 10.5%, almost doubling since the end of 2021. Outlying logistics nodes, including south Dallas and Kaufman County, report vacancies north of 20%. Meanwhile, smaller logistics buildings, identified as 50,000 square feet or smaller, report stable vacancies of 5%.

The pace of construction is turning a corner with the heaviest wave of completed buildings in the rear-view mirror. Meanwhile, groundbreakings are slowing due to the greater cost of construction and financing of new projects. Developers began work on 2.2 million square feet in the fourth quarter, the lowest volume in about a decade.

Industrial vacancies are expected to rise this year, topping out near 9.5% by the end of 2024 before re-tightening as construction levels stabilize and tenants fill available spaces. Demand for industrial remains sturdy, normalizing after the spike in 2022 and holding above pre-pandemic averages. Tenants moved into 30 million square feet, above the average of about 24 million square feet reported from 2017 to 2019.