While the broader industrial real estate sector is facing rising vacancies and slower rent growth due to oversupply—service industrial continues to experience diverging fundamentals. A year ago, we wrote about why we believed service industrial to be an area of strength in the commercial real estate market. Fast forward twelve months: our thesis remains intact.

Fundamentals have been supported by the continued lack of new supply of service industrial product due to persistent barriers to entry – land scarcity, zoning restrictions, and smaller average check sizes means that development capital continues to be deployed elsewhere in the industrial sector. Additionally, the infill locations of service industrial product lend themselves to conversion into higher and better uses, resulting in negative new supply in many submarkets. In fact, on average for every 100 square feet of small bay space added, 30 square feet is demolished.

Further, demand remains more robust for the tenants seeking service industrial space with proximity to end consumers. In fact, these tenants, with average space needs below 10,000 square feet, have accounted for over 60% of new lease activity since 2010. This segment of the market also remains the most robust today. While leasing activity for this tenant segment bottomed in 2023, it has recovered and sits only 5% below record levels seen in 2019. Meanwhile, for product over 100ksf, leasing volumes have continued to decline over the last few years and today are almost 35% below the 2022 peak levels.

The strength of fundamentals here is apparent as vacancy for industrial assets smaller than 25ksf remains extremely tight at just 2.3%, while overall industrial vacancy reached 6.6% by the end of the second quarter per CBRE. This strength has also driven asking rents to all-time highs in June to $13.50 per square foot on a triple-net basis. This compares to asking rents in larger tenant segments that have continued to decline since 2023.

Looking ahead, the service industrial product remains insulated from competitive new supply and continues to demonstrate tenant demand, which should continue to provide strength in fundamentals in the future.