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WAREHOUSE DEMAND SOFTENS WHILE FLEX PICKS UP

Industrial vacancy in the Sacramento region stood at 6.5% as of the end of Q4 2024, reflecting the third consecutive quarter in which this metric has increased. It stood at 5.6% one year ago. The market recorded -363,000 square feet (SF) of negative net absorption over the final three months of 2024. This marks the second consecutive quarter in which occupancy growth has been in the red—all told, the market recorded -227,000 SF of negative net absorption over the past 12 months.

Deal activity, in terms of square footage transacted, fell slightly in 2024. We tracked 7.2 million square feet (MSF) of deal activity (gross absorption) in 2024, down roughly 17% from 2023’s total of 8.4 MSF. However, we tracked 623 total leases in the past year, up from 614 in 2023 and 583 in 2022 (when gross absorption came in at 7.8 MSF). Deals simply are getting smaller or, perhaps more accurately, they are returning to what had been historic norms for the region before the immense wave of demand for eCommerce distribution facilities and outsized mega-distribution centers that dominated locally from the late 2010s through 2022.

In terms of new construction, the market added 1.5 MSF of new industrial space in 2024, the least amount of industrial deliveries Sacramento has recorded since the most recent building boom began. Developers had added just 235,000 SF of space in 2019, but with vacancy levels plummeting and the region ranking among the top US markets

for industrial rent growth, speculative industrial development took off. Local inventory increased by 15.5 MSF between 2020 and the end of 2024, reflecting a whopping increase of 11.5% in just four years. But just as this space was coming to the market, industrial demand (both locally and nationally) was downshifting from record-setting to merely solid. Vacancy levels have been creeping up since, with supply outpacing demand for the past ten quarters. But developers have decelerated new construction over the past year, sharply curtailing construction starts. Only one building of 200,000 SF broke ground in the final half of 2024.

There is 2.3 MSF of space under construction as of the end of 2024, all of which is slated for 2025 deliveries. 810,000 SF of that space is in Buzz Oates’ Metro Airpark project in the Natomas/Northgate submarket, while the remainder of the projects are situated in the Elk Grove/Laguna, Folsom/El Dorado, Mather, McClellan and Roseville/Rocklin trade areas (with no individual project larger than 176,000 SF).

The average asking rent for industrial space in the region now stands at $0.81 per square foot (PSF), on a monthly triple net basis. This is down slightly (-2.4%) from the $0.83 PSF rate that was in place exactly one year ago and reflects the first time that we have seen overall rents in the region move backwards (albeit only modestly), since 2011 when the region was still recovering from the impacts of the Great Financial Crisis (GFC) of 2008. We see this as a short-lived trend. While we are not expecting a return to the kind of double-digit growth experienced nearly every year from 2017 through 2022, the recent pullback in new construction should give the market time to work through some of the existing vacancies in the marketplace.

Sacramento Industrial Market

All Classes of Product Q4 2024

Sacramento Industrial Market: Supply/Demand/Vacancy

SUBMARKET REVIEW

We track 16 distinct industrial submarkets across the Sacramento region. Over the course of 2024, vacancy decreased or held steady in nine of them. However, net absorption declines in just a couple of key trade areas were enough to tick the region into the red.

One of the region’s premier warehouse and distribution trade areas, the Davis/ Woodland submarket is home to 17.4 MSF of industrial product including 16.3 MSF of warehouse and 1.4 MSF of flex inventory. Overall vacancy here climbed from 2.0% a year ago to 8.2% as of the close of 2024. Rite-Aid’s closure of their 508,000 SF distribution center in Woodland in Q1 2024 was the primary culprit, though both flex and warehouse product experienced some tenant space givebacks. The current vacancy rate for flex space in the Davis/Woodland market is 19.1%, up from 6.1% one year ago with this property type having recorded -43,000 SF of negative net absorption in 2024. Davis/Woodland warehouse vacancy now stands at 7.5%, up from just 0.4% a year ago. All told, -1.2 MSF of warehouse space was returned to market over the past year.

The Natomas/Northgate submarket, also one of the market’s premier trade areas for warehouse/distribution and logistics space (and one of the primary epicenters of regional development over the past few years) recorded -187,000 SF of negative net absorption in 2024. Warehouse product accounts for 20.8 MSF of this submarket’s 22.9 MSF total industrial inventory. Vacancy currently stands at 12.5% up from 7.9% a year ago. While warehouse product recorded -111,000 SF in negative net absorption in 2024, the primary cause of the recent vacancy spike is that it led all other markets in terms of deliveries over the past year. Over 913,000 SF of new warehouse space came online in the Natomas submarket in 2024, most of which speculative in nature and still available.

Every other trade area in the region that experienced increases in vacancy recorded negligible to modest occupancy declines.

The 2.8 MSF Auburn/Newcastle submarket recorded -113,000 SF of negative net absorption in 2024 as its vacancy rate climbed from 1.7% to 7.1%.

The 7.1 MSF Elk Grove/Laguna industrial market saw its vacancy creep up incrementally from 0.6% to a still incredibly tight 1.5% in a flat 2024.

Folsom/El Dorado Hills, home to 5.3 MSF of product, recorded total negative net absorption of -37,000 SF as vacancy here climbed from 3.9% to 7.3% over the past year.

Power Inn (one of the region’s largest and oldest industrial trade areas with 27.3 MSF of product) recorded -100,000 SF of negative net absorption, inching its vacancy upward from 3.2% to 3.6%.

Roseville/Rocklin, which had a 0.0% vacancy rate one year ago, saw that metric tick up to 2.0% as the end of 2024. Though the trade area posted positive occupancy growth to the tune of 193,000 SF in 2024, moderate leasing activity was outpaced by the delivery of new product. The same trend played out in the McClellan submarket (home to 18.2 MSF of product). It saw its vacancy tick up from 3.9% to 4.0% despite recording 94,000 SF of positive net absorption thanks to the delivery of one speculative untenanted project.

Most of the region’s trade areas recorded declining vacancy and positive net absorption in 2024, though most gains were modest.

The Sunrise submarket recorded 490,000 SF of positive net absorption as its overall vacancy rate fell from 10.9% to 7.3%. There is 11.0 MSF of warehouse product in this trade area; it accounted for 282,000 SF of occupancy gains in 2024 as warehouse vacancy fell from 9.3% to 7.0%. This is one of the region’s larger flex markets with more than 1.8 MSF of space. Flex occupancy grew by 208,000 SF in 2024 with local vacancy falling by more than half. It now stands at 9.1%, compared to a rate of 20.5% a year ago.

Sacramento Industrial Market All Classes of Product Q4 2024

Sacramento Industrial Market: Median Price

Cap Rate

The West Sacramento submarket (also one of the region’s primary logistics hubs), also recorded declining vacancy over the course of the past year. Overall vacancy now stands at 7.4%, down from a reading of 9.0% one year ago. The market recorded 394,000 SF of positive net absorption in 2024, all of which was driven by the warehouse market. Warehouse space accounts for 22.5 MSF of West Sacramento’s total inventory of 23.9 MSF. Total occupancy climbed by 395,000 SF over the past year, bringing vacancy levels down from 9.3% to 7.7%.

The 2.4 MSF Downtown industrial market saw its vacancy rate fall from 5.1% to 3.8% on 32,000 SF of occupancy gains. Likewise, the tiny East Sacramento market (518,000 SF of total inventory) saw vacancy fall from 2.0% to 1.7% in 2024.

The 5.3 MSF Mather industrial market recorded 117,000 SF of positive net absorption, bringing its vacancy rate down to 4.4% from the 6.6% reading of a year ago. The Northeast trade area (home to 6.2 MSF of mostly older industrial product) posted modest occupancy gains of just 41,000 SF in 2024, but it was enough to drop vacancy from 5.1% to 4.0% over the last year. South Sacramento industrial occupancy increased by 53,000 SF in the past year as its 4.1 MSF industrial inventory saw its vacancy rate fall from 28.4% to 27.1%.

LOOKING AHEAD

Though the local industrial vacancy rate has been climbing for the last few years, it is important to remember that it still only stands at 6.5%. In the aftermath of the GFC, it peaked at 14.4% (Q1 2011). With the worst of the supply wave over, we anticipate 2025 to be a year when the market returns to occupancy growth and a reversal from recent vacancy trends. Additionally, the slowing pace of development will help push rental rate growth back into positive territory once more robust economic expansion picks up (in the next 12-18 months).

After waning the last couple of years, we are also anticipating tenant demand to pick back up in 2025. One interesting development in the national industrial market in 2024 was the return of Amazon to the marketplace. They had put the brakes on their record-setting industrial real estate spree in late 2022. In 2020/2021 that had single-handedly inked deals for an estimated 150 MSF of space (via lease, purchase and ground up development). By 2023, they had cancelled, closed, or delayed 99 facilities in their pipeline impacting over 32 MSF of space nationally. That pause would last until this past year (Amazon returned to a much more pace of warehouse dealmaking in 2024, inking more than $2 billion across at least 39 transactions). We are not expecting a return to the recent trend of eCommerce fulfillment and mega-distribution/logistics users driving activity in the coming year, but we do think that those types of users are likely to become more active after having taken a brief hiatus.

Heading into 2025, the US economy appears poised for growth. The Federal Reserve appears to have (for now) pulled off what many economists thought nearly impossible; a soft landing for the economy in their battle to contain inflation. Inflation, though still elevated from the Fed’s target of 2.0%, has been in the mid-2.0% range throughout most of Q3 and Q4 2024. But as recent developments in the bond market demonstrate, that battle may not yet be over.

Unemployment as of December 2024 stood at just 4.1% with that month’s job creation of 256,000 new positions ranking as the second highest of the year. Meanwhile, the latest Job Openings and Labor Turnover Survey (JOLTS) from the Bureau of Labor Statistics indicates that as of November 2024, there were 8.1 million available jobs in the US. While this is down from the post-pandemic (and all time) peak of 11.5 million in December 2021, these numbers remain far above historical averages. From 2015 through 2019, this metric averaged 6.4 million. In other words, the early indicators suggest strong employment growth ahead.

Retail sales have remained strong with early holiday sales projections showing a 3.5% annual increase. Meanwhile, the National Federation of Independent

Source: Gallelli Real Estate; Costar Group

Businesses reports that as of December 2024, their Small Business Optimism Index had increased 3.4 points to 105.1 in December, its highest reading in six years. All of these are extremely positive signs for business growth in the coming year.

But not all the indicators are rosy. Though retail sales have remained in positive territory throughout the past couple of years of heightened inflation, this is largely because Americans have taken on massive amounts of new debt. In 2021, Americans owed roughly $800 billion on their credit cards. That number is now approaching $1.2 trillion. Worse yet, the average interest rate on that debt in 2021 was 16.5%. Today the average interest rate on US credit card debt is nearly 24.0%. Against the backdrop of a recent wave of notable retail bankruptcies, that sector may prove to be the canary in the coalmine in 2025.

Meanwhile, bond yields have spiked globally with the 10-year Treasury up half a percentage point in December alone. Modest upticks in the October and November 2024 inflation readings plus the unexpected strength of recent jobs reports have been factors suggesting that the economy may still be too hot and that the battle with inflation may not be over. Adding to these concerns are investor nervousness over policy uncertainty, global unrest, and the potential impacts of tariffs. We think that much of this uncertainty will lift over the first six months of the new administration, but for now, the impacts of recent bond market spikes have been real and felt primarily by the real estate sector.

Despite three consecutive drops in the federal funds rate by the Central Bank over the final months of 2024 (from a range of 5.25% to 5.50% in September to 4.25% to 4.50% in December), mortgage rates are now higher than they were a few months ago. At the start of 2024, the average rate on a 30-year, fixed rate mortgage stood at 6.62%. This number fell to a low of 6.09% in September but has since climbed to 7.01% as of January 15, 2025. This is because while the Federal Reserve’s monetary policy is one of the top factors impacting interest rates, it is not the only factor. Fiscal policy, trade policy and the strength of the US economy are also factors that influence the rates passed on to consumers.

All these factors will be center stage for the new Trump administration as it takes power in January with the bond market playing the potential role of spoiler. Expected tax cuts and deregulation from the new administration will assuredly spur business growth and economic output in 2025. However, major tax cuts without significant reductions in government spending will increase the deficit—another concern that could further rile the bond market.

Lastly, promised “across-the-board” tariffs of 20% to 60% would certainly have an inflationary impact if enacted in 2025 though it remains to be seen how much of Trump’s rhetoric may be a negotiation tactic for revisiting trade deals. As this report went to press, Bloomberg was reporting that senior Trump advisors were looking at the possibility of gradual or incremental tariffs to avoid inflation spikes. Whether this proves to be the case or not, we see this as a positive development and signs that incoming policymakers will be keeping a close eye on the real-time impacts of policy. Whether that will translate into the ability to change course quickly, if necessary, remains to be seen. But given the immensely negative political impacts that inflation had for the outgoing Biden administration we struggle to see any new administration not taking inflationary spikes extremely seriously quickly.

That said, it remains to be seen if an aggressive new tariff policy will benefit U.S. manufacturing in a significant enough manner to move the industrial real estate

needle. In advance of the Trump tariffs, fashion house John Varvatos has moved their manufacturing out of China where they could have been facing 60% to 100% tariffs within a few months. But they didn’t move it to the US. They moved it to Vietnam, explaining that a 20% tariff there still made more sense than the cost of manufacturing domestically. Still, we think there may be a modest uptick in industrial manufacturing demand in the coming years, though we suspect moves like that of the Varvatos fashion house will be common.

We believe much of the current uncertainty regarding policy shifts will dissipate over the first three months of the new administration with the impacts of those policy shifts becoming clearer by the midyear mark.

In the meantime, we anticipate green shoots to emerge over the first half of 2025. While we are not expecting robust growth, we think occupancy growth trends will return to modestly positive territory in the first half of the year though most of the action will continue to be driven by the private sector with smaller professional services and medical users leading the way.

Should the overall economy cooperate, we think 2025 will be the year in which Sacramento’s industrial market will see a normalization of trends after what a rollercoaster of surging demand, development and vacancy the last few years. Lastly, we expect investment activity to pick up in 2025, though it will remain well below pre-pandemic levels and most trades outside of projects with heavy medical components will reflect some levels of distress or discounting.

Select Sacramento Region Industrial Leases Past Six Months (Q3 2024/Q4 2024)

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about gallelli real estate

Gallelli Real Estate is a private firm that specializes in commercial real estate services and property management. We believe that as a boutique firm whose understanding of the business runs as deep as our core values, our advantage is large. We take pride in our unique approach to offer more individual solutions that address the ever changing needs of our clients and the industry. After all, our success is measured by the success of our clients and the strength and longevity of our relationships.