Tenant Retention Takes Center Stage in Small-Bay Industrial
For years, small-bay industrial owners have benefited from a simple equation: strong demand from local businesses, limited new supply, and a steady ability to reset rents as leases rolled over. That formula has not broken down. But in a more uncertain economy, the immediate priority has changed.
Rather than treating every expiring lease as an opportunity to push rents, landlords should focus on keeping viable tenants in place, according to Juan Arias, national director of industrial analytics at CoStar Group.
The sector still has the ingredients for meaningful rent growth over the medium to long term. In the near term, however, owners must contend with small-business tenants facing higher operating costs, weaker expansion plans and more caution around real estate decisions.
"Tenant retention becomes the forefront of a small-bay landlord right now," Arias told GlobeSt.com. "But in the medium to long term, you can begin to push rents again."
A Durable Supply Constraint
Small-bay industrial entered the current slowdown with a structural advantage: much of the existing inventory is old, infill space that is difficult to replace.
Many small-bay buildings were constructed before the 1990s in areas that have since become more densely developed. In some cases, the land has acquired a higher-value use, putting older warehouses at risk of redevelopment into multifamily, office or retail projects. As a result, inventory has gradually disappeared in some established markets, even as businesses that depend on nearby warehouse space have continued to need it.
New supply has done little to close the gap. Developers face expensive land and struggle to make smaller projects pencil out compared with larger industrial facilities. That has helped small-bay remain tighter than larger industrial product, where development has been more active and tenants often have more alternatives.
Small-bay vacancy has risen, along with vacancy across industrial real estate, over the past year to year and a half, Arias said. Still, the increase has been more measured than in other industrial segments and vacancy remains within historical norms. The sector has not been immune to a cooling economy, but it has not suffered a sharp break in fundamentals, either.
That resilience gives investors a reason to look beyond the current cycle. The business model of many small-bay tenants depends on location, response time and access to the local customer base. Moving farther from a service territory can raise transportation costs and compromise the operating efficiency that makes a small business competitive.
Rent Resets Leave Opportunities
The recent rent-reset cycle has already played out across much of the sector. Small-bay tenants tend to have shorter lease terms, averaging roughly three years, so landlords have had more frequent opportunities than owners of larger logistics facilities to bring rents closer to market levels.
Those rent increases have also contributed to churn. Tenants hit with higher occupancy costs have looked for alternatives, even if choices are limited. That dynamic has become more challenging as local businesses absorb higher costs tied not just to real estate, but also to transportation, inflation and broader economic uncertainty.
Still, Arias sees remaining upside for investors who can identify properties where prior owners have not kept up with market rents.
"There are still probably many properties out there where, if the landlord is not as savvy or not as aware of the market environment, they probably haven't reset rents for their tenants," Arias said.
That opportunity is tied to the ownership profile of small-bay. The sector remains heavily private and fragmented, with less institutional penetration than other parts of industrial real estate.
Many properties are held by local owners, including businesses that operate from the space they own. Those owners may be reluctant to sell because a sale could mean relocating the business itself.
For investors, that fragmentation creates both opportunity and friction. Acquiring enough properties to assemble a meaningful portfolio takes time, persistence and a willingness to navigate a scattered ownership base.
It also requires operational capacity. A small-bay property can have dozens or even hundreds of tenants, making it far more management-intensive than a large distribution building leased to one or two occupants.
Institutional investors historically avoided that complexity. More recently, however, some have become more comfortable with the operating model, particularly through portfolio aggregators that assemble properties before selling them to larger capital sources. Interest has also grown as investors seek alternatives to mid-sized logistics assets, where substantial new development has weakened the supply-demand balance.
A More Delicate Near Term
The immediate operating environment calls for a more measured approach. Small-bay demand is closely linked to population growth, household formation, home sales, renovation activity and employment growth. Those drivers have moderated from the levels seen after the pandemic.
The slowdown matters because small-bay tenants generally are not major, credit-rated corporations with deep balance sheets. They are local businesses whose decisions are shaped by everyday operating pressures. Higher real estate costs, transportation expenses and inflation can quickly narrow margins. Economic uncertainty can also cause them to postpone capital investment, expansion and real estate commitments.
That makes the difference between physical occupancy and economic occupancy more consequential. A landlord may be able to quote a higher rent, but holding out for that increase can be counterproductive if it means losing a tenant that remains viable and paying the costs of downtime, leasing commissions and tenant improvements to replace it.
Arias said landlords should resist treating the current environment as a straightforward mark-to-market exercise.
"Let's pull away a little bit from the greed and focus more on making sure that the tenants are comfortable in that space, that are happy in that space, and are going to be an ongoing concern within the next year," he said.
That does not mean landlords should abandon pricing discipline. It means that renewal negotiations should be grounded in a realistic assessment of a tenant's business health, the property's competitive position and the true cost of vacancy. A modest concession or a more gradual rent increase may preserve income and protect an asset's longer-term value better than an aggressive reset that forces a tenant to leave.
Growth Niches Stand Out
Even as the broader small-bay market works through a softer period, certain locations and tenant categories continue to perform well. The common thread is proximity to parts of the economy that are still expanding.
Small-bay properties near data center clusters are one example. Data centers generate continuing demand from businesses that install, maintain and upgrade equipment; service heating, ventilation and cooling systems and support power and electrical infrastructure. Those service providers benefit from being nearby, creating demand for smaller industrial spaces that can function as local operating hubs.
Advanced manufacturing and defense-related clusters are another area of strength. Arias pointed to markets with companies conducting research and development around technologies such as autonomous boats, autonomous aircraft and drones. Businesses supporting those activities can create localized demand for small-bay space, particularly where facilities need a combination of warehouse, light production and service capacity.
For investors, the most compelling small-bay strategy may combine patience in the current leasing environment with discipline in property selection. Assets in supply-constrained infill locations, particularly those near durable economic growth engines, can offer a more resilient tenant base and a clearer path to future rent growth.
The next few quarters may require landlords to preserve occupancy rather than maximize every lease rollover. But the longer-term case remains rooted in the same fundamentals that made small-bay attractive before the latest slowdown: limited replacement supply, tenants with local service needs and a large, fragmented ownership universe where value can still be uncovered.
As Arias put it, "Even though right now your focus might be on tenant retention, down the line it's still a good asset for rent growth in the medium to long term because of the supply constraints."
(Globe Street | By Erika Morphy)
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