“Volatility and uncertainty” describe the current state of the markets, according to Tom Griggs, managing director and head of industrial & logistics for the East at Hines, with the past 12-18 months presenting a difficult environment. Griggs led an expert panel discussion on the outlook for the industrial real estate capital markets at NAIOP’s I.CON East.
Is there light at the end of the tunnel?
Peter Nicoletti, head of capital markets in New York at Colliers International, recalled the third quarter of 2022 when the markets seized up. “In the following months, spreads on deals slowly started coming in until January of this year, when Silicon Valley Bank and Signature Bank failed. At that point, spreads blew back out.” Lenders are risk-off. Colliers International does have $1.8 billion in construction deals and has noticed that there has been a tightening in underwriting standards. Now, a deal’s loan-to-cost is around 55-65%. The days of 85% are gone. Nicoletti anticipates seeing more competitive pricing as those investors who moved to the sidelines return.
Jack Fraker, president and global head of Newmark’s industrial and logistics capital markets, said investors are looking tactically. There used to be premiums to bringing portfolios to market, but he sees sponsors thinking they will get more money by splitting up properties now. Beth Demba, head of capital deployment for the East at Prologis, noted that Prologis is currently finding opportunities incrementally by adding to its existing portfolio. They also keep leverage low, less than 20%, at the deal level.
What challenges still exist in the industrial real estate markets?
The bid-ask spreads remain a challenge. There still needs to be more pricing discovery. For example, Fraker saw a deal in Dallas where the broker guided investors to a high cap rate and received 47 offers. Inevitably, the cap rate settled below 4% and received this great pricing because the vintage of the rent roll was only 1-2 years. Demba said cap rates are out 120-150 basis points across the U.S., and unlike in the past, there is now rate differentiation within different markets. Still, they all agree that there needs to be more deal flow and core buyers beyond the “value-add.”
Another challenge Fraker saw was on a project delivered two years ago. It might’ve appealed to the core buyer; however, the lease rents were negotiated 18 months ago at rates lower than the market bears today.
Nicoletti is seeing pricing on the equity side becoming attractive to the value-add buyers. And at Prologis, Demba said she looks at “how a deal fits into their portfolio. We look at its value excluding rent growth.”
Coming off of strong rent growth, when will it moderate?
Demba expects rent growth through 2023 and said she would not be surprised if the East outperforms the West over the next year. Nicoletti said he believes it’s market dependent, but primary markets can run for five more years.
Fraker looks at construction financing to help buoy rents. There are currently 600 million square feet of speculative real estate construction, but with starts way down, that could go down to 300 million by 2025. The lower supply could mean increased rents.
Do you see any cracks in the momentum of Industrial and availability of capital?
“Last summer, many of us were getting calls from relation-equity partners that they could not make commitments,” according to Nicoletti. “Luckily, there are partners behind them, but you see deals getting done now with more skin in the game from developers.”
“Industrial is the most popular asset class in the world,” said Fraker. “If a fund needs liquidity, it will not sell an office but an industrial asset that has held up in value. There is interest in this space.”
Regarding upcoming trends, the panelists see onshoring as sustainable, and while “niche sectors” can be trendy, Fraker thinks cold storage has staying power.
Do you believe market share will shift away from the West Coast?
The strike at the Port of Los Angeles and Port of Long Beach sparked this audience question. While other markets are coming onboard, Southern California will continue to dominate, according to Demba.
“Los Angeles has roughly 38 million-40 million people. And how many things do we import from China?” maintained Fraker. The Sunbelt will benefit from population growth, and the East Coast ports like Savannah are coming onboard and taking share. Dallas looks attractive and has vast, flat land, but it’s becoming increasingly regulatory. Demba currently likes places that are harder to build and have less competition, such as infill markets in northern New Jersey, Miami, Washington, D.C., and Baltimore.
What risks would impact the industrial real estate sector if realized?
“Geopolitical risk seizes up deals, and time kills all deals,” said Nicoletti.
Demba added that there is potential risk in the financing market if office defaults occur extensively. Since smaller regional banks make up a sizable group of lenders in this space, regulators could come in and stop these institutions from participating in commercial real estate deals to shore up their capital. Losing smaller banks as lenders would be detrimental to financing.
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