Category: Industrial

The Fed’s Interest Rate Cut Could Boost Industrial Sales. Or Disrupt Them.

While the rate cut will lower hedging and borrowing costs, it can also drive values even higher in an already highly valued sector.

Can the new interest rate cut lead to an asset bubble in the industrial sector? Or will it result in more sales?

The Fed cut the federal funds interest rate Wednesday by a quarter of a percentage point to about 2.25 percent to protect the U.S. economy from an economic slowdown. As justification for the first rate cut since the height of the Great Recession, the Fed cited concerns over the slowing global economy and trade war with China.

In the short term, “commercial real estate investors will likely take the decision as a signal to continue buying property, even at lofty valuation levels,” says Ryan Severino, chief economist with real estate services firm JLL. “This could extend the trend real estate markets worldwide have seen during the last decade, with investors piling into the (industrial) asset class amid a hunt for higher yields and stable returns.”

The rate cut will also likely decrease the cost of construction and give REITs a boost, notes Byron Carlock, national real estate leader with consulting firm PWC.

In the longer term, however, Severino says the rate cut “risks widening the rift between market expectations and the underlying economic reality, which could form the seeds of an asset bubble. Since we did not see a strong chance of the economy backsliding into negative growth over the rest of this year, if there was no cut, the risks associated with the Fed’s decision may be greater than any boost to the market.”

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Midsize Tenants Dominate Demand for Industrial Space

Midsize tenants drive a significant portion of demand for industrial space in cities.

E-commerce and last mile logistics tenants are fueling additional demand for industrial space expansion in the U.S., spurring midsize space users to dominate the industrial market.

Midsize industrial tenants—those who occupy 50,000-sq.-ft. to 300,000-sq.-ft. boxes, are driving industrial demand in key markets, including Indianapolis, Chicago, Atlanta and Dallas, according to a report from real estate services firm Avison Young.

For example, between January 2017 to June 2019, tenants in Chicago signed 872 industrial leases totaling 97.3 million sq. ft., with an average size of 111,629 sq. ft. Tenants in Atlanta signed 320 industrial leases totaling 36.2 million sq. ft., with an average size of 113,243 sq. ft. Dallas tenants signed 490 leases totaling 52.5 million sq. ft., with an average size of 107,265 sq. ft. Tenants in Indianapolis signed 41 leases totaling 52.5 million sq. ft., with an average size of 146,341 sq. ft., according to Avison Young.

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Speed Bumps Ahead for Industrial Assets Don’t Diminish Investor Appetite

New research predicts a slight softening in demand for industrial space going forward.

Slowing economic growth, trade wars and a pipeline that is delivering new supply to the market may force investors to adjust return expectations for industrial properties, but it doesn’t appear to be putting much of a dent in buyer demand.

Industrial has edged out multifamily as the favored asset class and there continues to be abundant capital targeting the sector as investors expand allocations. In fact, industrial property transaction volume jumped 32.6 percent last year to a cyclical high of $97.7 billion, according to research firm Real Capital Analytics (RCA). Yet a new industrial real estate forecast from Deloitte suggests that investors may need to brace for slower growth ahead.

Deloitte is predicting that the annual demand growth rate, although still positive, will likely decline over the next three years to a little below 0.9 percent—nearly one-half of 2018 levels. Specifically, Deloitte expects the vacancy rate to rise from 7.0 percent in 2018 to 10.3 percent by 2023. Some of the factors that will weigh on occupancies and demand for space include the rising cost of capital, new supply and new space alternatives, such as aggregators that offer on-demand warehouse space for seasonal needs.

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Blackstone Bets $18.7 Billion on Amazon Effect in Warehouse Deal

Blackstone’s $18.7 billion deal with GLP PTE will almost double its U.S. industrial footprint.

(Bloomberg)—The mall is now a warehouse, and Blackstone Group LP is betting $18.7 billion on the shift.

That’s how much the alternative investment manager is paying for 179 million square feet of urban logistics properties — the warehouses used by Amazon.com Inc. and other retailers to fulfill orders from online shoppers. The deal with Singapore’s GLP Pte, the second-largest owner of U.S. logistics real estate, will almost double Blackstone’s U.S. industrial footprint.

The rise of Amazon and other e-commerce companies has increased the need for warehouse space by retailers seeking to expand their digital operations and cut delivery times. The shift toward online shopping is reconfiguring supply chains and shaping the fortunes of industrial landlords, with demand especially high in and around large cities, where e-commerce has taken off fastest.

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High Pricing, Few Available Assets Deter Industrial Investment Sales

In spite of strong demand from tenants, industrial investment sales have slowed down recently.

Industrial vacancy ticked up in the first quarter of 2019 for the first time in nine years, to 5.0 percent, mostly due to new deliveries, which totaled 54 million sq. ft., according to a JLL report. Another 405 million sq. ft. of industrial space is under construction, with more than 1 million sq. ft. underway in 75 percent of markets tracked, noted a national first quarter 2019 report from real estate services firm Transwestern.

Leasing remained strong in the first quarter, with 40 million sq. ft. absorbed, representing more than half of new deliveries. Asking rents increased to an average of $6.28 per sq. ft. nationally, reported Transwestern. Of the 47 markets tracked, 41 experienced year-over-year rent growth, due in part to high demand, but also because new construction commands higher rates.

Industrial and multifamily are currently the most popular commercial property types among investors, notes Mark Glagola, senior managing director of Transwestern’s Mid-Atlantic capital markets group. “There’s lots of money looking for a home, and all types of investors are allocating more to industrial real estate than ever before,” he says.

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Investors Go After Industrial Assets in Secondary Markets

Strong population growth and lower prices are luring industrial investors to secondary cities.

Strong economic and population growth in secondary markets is leading to increased investment in industrial real estate in those areas, according to industry experts.

While institutional investors are targeting secondary markets for office acquisitions, investments in industrial properties in those markets are increasing at the same time. In 2018, overall U.S. industrial sales volume totaled $54.9 billion, up 8.9 percent year-over-year, according to an Avison Young spring 2019 Global Industrial Market Report. Total sales volume in secondary markets was close to $3.9 billion as of March 2019, a slight drop from $4.1 billion in March 2018. Industrial sales volume is not expected to surpass the high of September 2018, as most transactions during that time were from large platform and company deals.

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Industrial Property Owners Increasingly Go After Value-Add Projects

With prices for stabilized properties rising, industrial REITs and other industrial owners invest in value-add and redevelopment.

As REITs and other landlords continue to reap the rewards of the red-hot industrial sector, they’re going beyond ground-up development to satisfy the growing appetite for space.

Several industrial REITs, for instance, are coupling traditional development activity with value-add projects. Meanwhile, a new report from the real estate and construction services practice at professional services firm BDO envisions a rise in the expansion of existing warehouses.

“Developing properties from the ground up is one thing. Redeveloping properties that are in place to make them work better and handle more goods is also part of the thought process,” says Stuart Eisenberg, national co-leader of the real estate and construction services practice at BDO.

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Industrial Sector Remains ‘Red Hot’ Despite Headwinds

Ongoing trade tensions do not concern investors in the industrial sector.

Investors still see industrial properties as favorably as they did six months ago, despite global trade tensions and labor shortages.

Trade talks between the U.S. and China are looming over the industrial sector. Due to these ongoing trade tensions, retailers are importing larger quantities of products than normal, in an attempt to beat potential hikes in tariffs on goods from China.

Barring successful negotiations, the U.S. plans to raise the 10 percent tariff on $200 billion worth of Chinese goods that took effect in September 2018 to 25 percent this spring. The U.S. has already imposed 25 percent tariffs on $50 billion worth of Chinese goods. On the other hand, reciprocal tariffs imposed by the Chinese government lowered Chinese demand for American-made goods. If this trend continues, demand from manufacturing occupiers could decline, according to real estate services firm Colliers International.

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Where Are Cap Rates Going in the Four Core Property Sectors?

Experts predict little change in either direction in the first half of the year.

With late 2018 jitters gone and investor optimism returning, the commercial real estate market should experience mostly steady cap rates through the first half of 2019, although there are particular market segments and geographies that could experience some bumps.

“On the interest rate side, I think everybody has dismissed, at least for the time being, the inflation threat so that kind of stress on pushing cap rates higher isn’t there right now,” says Manus Clancy, senior managing director of applied data, research and pricing with Trepp. “We went through a tough period in December when people were jittery. Now everybody has taken a deep breath; they don’t feel like the wheels are falling off either the U.S. or the global economy.”

Still some changes, although potentially muted, could be in store. Recent trends suggest there is little room left for cap rate compression, according to Matthew Schreck, quantitative strategist with online real estate marketplace Ten-X. “We expect increases to both interest rates and spreads to drive some loosening in cap rates in 2019 across all property types,” he says.

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HNW Investors Might Start Entering the Industrial Sector to Capitalize on Higher Returns

Historically considered too “unglamorous” by HNW investors, industrial assets now offer some of the best returns in the market.

By and large, it’s big institutional investors that scoop up industrial assets in the United States. However, there now appears to be more room for a different class of buyers in the industrial sector—high-net-worth (HNW) investors.

Why? Because industrial opportunities in secondary and tertiary markets—where there is likely to be less competition from institutional investors with big pockets—have grown more attractive.

A new report from commercial real estate services company Cushman & Wakefield says many of the dynamics that spawned the industrial boom, including the e-commerce explosion, will continue to play out in ways that bolster strong demand in secondary and tertiary markets, as well as across a broader array of asset sizes. And a recent report from asset manager DWS Group suggests smaller local distribution facilities—although not necessarily in smaller markets—“generally offer superior investment prospects.”

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