What to watch in 2025: Small bay industrial space to remain scarce regardless of US economic performance

Chronic undersupply of small industrial spaces set to persist in the new year

Whether demand for U.S. industrial space will increase in 2025 remains an open question. Over the past 12 months, the total amount of industrial space occupied nationally has increased at the slowest pace since 2012 and momentum appears to have weakened further in the fourth quarter.

While expected cuts to taxes and business regulations under the incoming Trump administration could provide a near-term boost to economic growth needed to lift industrial tenant demand out of its current malaise, several risk factors could blunt the impact of those policies.

Persistently high mortgage rates could continue to constrain U.S. home sales, and by extension, sales of warehouse-intensive goods such as furniture, appliances and building materials. The prospect of increased tariffs at home and abroad could also leave many retailers and manufacturers hesitant to expand their U.S. distribution center networks.

Regardless of how U.S. economic growth and industrial tenant demand perform in 2025, the ongoing scarcity of smaller industrial space is likely to persist throughout the year and beyond.

“We have been focused on small bay (space) as we appreciate the mandatory nature of its existence within a local economy, providing a necessary retail-esque service to communities.” Rob Logan, principal in acquisitions and capital markets at B&D Holdings noted in an interview with CoStar.

The privately-held investment and development firm based in New Jersey owns more than 200 industrial properties across the U.S.

“When combined with prohibitive land costs that often prevent the development of small infill sites and limit competition from new supply, there is a compelling case for the downside protection small bay industrial offers in a shaky economic environment,” Logan added.

The vacancy rate of U.S. industrial properties measuring smaller than 50,000 square feet is currently 3.4% and within one percentage point of the apartment vacancy rate in New York City, a market known for its perennial and extreme shortage of housing.

Even under the very unlikely scenario that the tenant base of small bay industrial properties contracts in 2025 as dramatically as it did in 2009, the average vacancy for this subset of industrial property would remain more than 50 basis points below its pre-pandemic 15-year average of 5.4%. This is largely because there are very few small bay industrial properties currently under construction and on track to help alleviate the space shortage in 2025.

The 23 million square feet of small bay industrial space currently under construction across the U.S. represents less than 0.3% of the existing stock of industrial property nationwide and has been falling since interest rates began moving off their all-time lows hit in early 2022.

Limited new development has long been the key driver behind the shortage of available small bay space. Purchasing and entitling sites for small industrial developments is almost as time-intensive as the process for bulk distribution center developments the size of multiple football fields. As a result, those with industrial development expertise often opt to focus on larger projects, viewing them as a more efficient way to deploy their investors’ capital.

Despite the strong demand for small bay space, many landlords find that subdividing large distribution centers to accommodate smaller industrial tenants is not cost-effective or practical from a design perspective and requires more intensive property management services.

Meanwhile, millions of square feet of small, low-rise industrial properties are demolished every year to make way for large, multi-story projects, most often residential redevelopments in urban areas. Although this trend has abated somewhat in recent years as industrial rents have risen, over the past decade, more than 115 million square feet of industrial properties smaller than 50,000 square feet have been demolished in the U.S.

As a result, the total U.S. stock of small bay industrial property has expanded by 210 million square feet or less than 3% cumulatively over the last 10 years. For comparison, combined employment in industries that use small bay space intensively including construction, wholesale trade and auto repair/maintenance, has increased by 20% over the same period. Fitness-related tenants such as cross fit gyms and pickleball operators also have increasingly leased the minimal supply of available small bay industrial space over the past decade.

Demand for small bay industrial space isn’t completely immune from the negative impact of factors such as higher interest rates and slowing housing construction, which are also weighing on the performance of larger bulk distribution properties.

Total occupied square feet in U.S. industrial properties smaller than 50,000 square feet contracted by about 0.3% in 2024, with a corresponding modest increase in vacancy among these properties.

However, given the chronic lack of new development, mild contractions in tenant demand, like what occurred in 2024, have done little to change the fact that in most markets, businesses looking for small industrial space often have very few options to choose from.

View the full article on CoStar.com.