If first-quarter data points are any indication, the U.S. industrial real estate market has moved beyond the “firing on all cylinders” stage to another white-hot plateau. Tenants and lessees occupied 109.1 million square feet more space than they vacated, an all-time quarterly record, roughly double the long-term average and nearly 67% higher from the first quarter of 2020, according to data from Colliers International (NASDAQ:CIGI), a real estate services and investment management company. 

About 355 million square feet was under development in the 2021 quarter, based on Colliers data. That easily surpasses the previous record of 321 million square feet set in the fourth quarter of 2020. Of 12 facilities with more than 1 million square feet that were built during the quarter, just one, in South Carolina, remained completely vacant by the end of it, Colliers said.

Nationwide, vacancy rates dropped to 5.2%, a 40-basis-point decline from year-earlier levels, Colliers said. In seaport markets, vacancy rates are well below that.

Asking rents for “triple net lease” agreements, which require lessees and tenants to pay taxes, building insurance and maintenance, rose to $6.41 per square foot, 4.2% higher than in the first quarter of 2020, Colliers said. 

With e-commerce activity expected to remain permanently elevated, demand for industrial space — which is dominated by logistics services that fulfill mostly online orders — is unlikely to abate much. By the time that 2021 winds down, there is a good chance that decades-old records will have fallen across the board.

For now, though, there is a fly in the industry’s ointment. The cost of construction materials has soared along with other inputs as ultra-tight inventory levels meet strong demand in the industrial and residential sectors. Industrial construction completions will be delayed through the second quarter and perhaps for the rest of the year, according to Jack Rosenberg, national director of Colliers’ logistics and transportation solutions North American practice group. Tenants and lessees, which for years have been hit with rate hikes, will see their tabs rise anew as costs rise for new construction and building improvements, Rosenberg said. 

The lack of available steel, and the higher costs associated with the shortages, appear to be the prime culprit, Rosenberg said. “Steel prices are rising rapidly and if you ordered steel today, you wouldn’t get it until November,” he said. 

Rosenberg said inflation is clearly evident in nearly all types of construction-related commodities. He was puzzled that the Federal Reserve, which up to now has publicly downplayed the threat, doesn’t see what financial markets are seeing and what businesses are experiencing.

Rising steel costs have thrown a sharp punch at the final-mile segment, where site selection is heavily influenced by urban land availability and pricing. Land constraints and sky-high rents were a fact of life long before commodity prices spiked, so the latest developments are disproportionately unwelcome. With only a limited supply of space to be leased and cost pressures rising, many tenants are looking to convert urban retail locations to last-mile facilities to quickly push products out to online consumers, said Kelsey Rogers, senior research analyst of the industrial market at real estate services firm JLL (NYSE:JLL).

Perhaps no company feels the blowing wind more keenly than Prologis Inc., (NYSE:PLD), the world’s largest logistics warehouse developer, owner and operator. CFO Tom Olinger said on a recent analysts call that he expects U.S. replacement costs to rise 20% to 25% over the two-year cycle that ends this year. That is the fastest rate of increase ever, Olinger said. However, Prologis already procured enough steel for 5.2 million square feet of construction starts and at prices about 5% below market, according to Olinger. This provided the company with a 10- to 20-week scheduling advantage over rivals that don’t have Prologis’ scale and reputation, he said.

Industrial completions actually slowed in the first quarter, but not due to materials cost and availability pressures, according to CBRE Services Inc., (NYSE:CBRE) a real estate services firm. Only 58 million square feet was completed, of which 58% was already spoken for, said James Breeze, the company’s industrial head of research. This meant that comparatively little “first-generation” space hit the market, Breeze said. In addition, the first quarter is typically the year’s slowest for industrial completions, the one exception being 2020 when pandemic-related lockdowns in the second quarter slowed activity to less than a crawl, he said.

Breeze said that materials shortages have braked the speeding freight train of industrial development but have not come anywhere near derailing it. As evidence of the continued faith in the sector’s outlook, 47% of the square footage under construction in the quarter has already been pre-leased, based on CBRE data. In addition, 14 U.S. markets that each have more than 4 million square feet under construction are experiencing pre-leasing activity in excess of 50%, according to the firm. 

Not everyone sees an unfolding problem. AmeriCold Logistics LLC (NASDAQ:COLD) and privately held Lineage Logistics, two of the biggest players in the white-hot temperature-controlled warehouse subsegment, haven’t felt much impact from the shortages, if any at all. Brian Devine, whose firm ProLogistix staffs warehouse labor for industrial clients, said he’s heard more complaints about higher input costs from friends who work in the residential housing world than from his side of the business.

In the end, commodity prices and availability will rightsize once the supply-demand scales reach equilibrium. Right now, such balance is likely to be achieved by a slowdown in the breakneck speed of consumer and business spending. Walter Kemmsies, a longtime transport and logistics economist, said the “frantic” pace of stimulus-driven spending in the U.S. should slow somewhat by the end of the third quarter. This may give some breathing room to suppliers, but perhaps not a great deal, he said. The supply chain will remain very active as businesses scramble to rebuild inventory levels that still remain too low, especially with the ongoing surge in demand, Kemmsies said.