Industrial sales are not immune to the impact of rising interest rates

Throughout the pandemic, industrial properties were among the most sought after by commercial real estate investors. But in the current market environment, are industrial assets holding up as well?

In fact, demand for industrial properties is down significantly from the first quarter of this year, says Chris Riley, president of U.S. industrial and logistics capital markets at real estate services firm CBRE. “While the market for investment sales is uneven, there remains a small contingent of investors who possess a ‘momentary motivation’ to acquire properties,” he adds, noting that CBRE National Partners has completed 18 transactions. in October, proof that the market is still active.

Following a further rise in interest rates and continued economic uncertainty, the overall volume of industrial transactions in the United States fell 18% year-on-year in the third quarter, reports data provider MSCI Real Assets. But at $35.5 billion, this volume was still 48% higher than the quarterly average recorded between the third quarter of 2015 and 2019which totaled approximately $23.9 billion.

Acquisition activity in the industrials sector began to tighten along with the upward pressure on interest rates this summer and continued through the fall. Sales of single assets were down 21% year-over-year in the third quarter, while sales at the portfolio and entity level were down 14%, according to MSCI.

But rising interest rates weren’t the only thing that caused investors to pause before acquiring new assets. Ultra-low cap rates in the industrials sector – averaging 5.1% in the third quarter, according to MSCI – added to the challenges. A year ago, the spread of cap rates on industrial assets versus 10-year Treasury bills averaged 230 basis points. This figure fell to 20 basis points in the third quarter of 2022. As a result, while investors can still close deals, they face more hurdles in underwriting assets and earning the desired returns.

With higher borrowing costs, investor demand has cooled, notes Aaron Jodka, national director of capital markets research at real estate services firm Colliers. “The 2021 and early 2022 ultra-low cap rate deals are no longer economically feasible, as they would be in a negative leverage situation,” he says. “It stagnated the market.”

Due to quantitative tightening and the ensuing credit crunch, a number of transactions involving industrial assets saw a revaluation and/or were completely scrapped, according to CBRE’s Riley. “This was centered on when the Federal Reserve raised the federal funds rate and the resulting increase in the cost of debt capital (fixed or variable) causing a temporary gap between the capitalization rate at the cash and the capitalization rate.”

Lease terms and location of assets lead to price differences, Jodka notes. In general, prices have fallen by at least 10%, he says. Assets with sharply rising market-to-market rents remain the most liquid. The Commercial Property Price Index (CPPI) tracked by MSCI shows industrial property prices rose another 1.9% in the third quarter compared to the previous quarter. But there has certainly been a slowdown from the 18.1% year-over-year increase.

There’s a bigger gap between sellers’ expectations and buyers’ reality than usual right now, which is keeping cap rates so low, according to Adrian Ponsen, director of US industry analysis at the firm. CoStar Group real estate data.

“Buyers are looking at industrial mortgage rates that are twice what was available at the end of 2021,” Poston says, adding that investors want higher cap rates to help offset the higher cost of capital. . “But most landlords hold properties that are doing very well in terms of occupancy and rent growth, giving them limited incentive to sell. Ultimately, buyers have sold off the most in recent months, although that could change if trends in the economy deteriorate.

CoStar estimates third-quarter industrial sales totaled about $46 billion, down significantly from a peak of nearly $96 billion in the fourth quarter of 2021, but nearly in line with the volume seen in the fourth quarter of 2020.

Although there are significantly more constraints in the debt market than before, funding is still available for quality industrial assets, although market depth is quite low and rates have risen significantly, adds Val Achtemeier, Vice President of Capital Markets at CBRE. . He notes that industrial and multi-family assets fare better in terms of access to finance than most other property typesbut says “debt capital is more valuable and lenders are more selective now.”

Investors also have fewer industrial properties to choose from, especially in the most desirable markets. “The number of properties offered for sale in the fourth quarter is lower than a year ago, while the market was experiencing optimal operating fundamentalscombined with a wall of equity and debt capital for investment,” says Riley.

The lower number of assets available in the market “is related to higher borrowing costs and the lack of clarity on prices today,” according to Jodka. He remains optimistic that interest rates will stabilize in 2023, leading to a recovery in sales volume, likely after the first quarter of the year.

Meanwhile, with the completion of new distribution center projects reaching new heights, many developers continue to sell these projects to investors, Ponsen says. And many large landlords/users are selling their properties to industrial investors under sale-leaseback agreements and realizing significant capital gains in the process.

The good news is that closed industry deal cap rates are no longer falling as they were in 2021, but have remained relatively stable in 2022, he notes.

“This is remarkable, given the dramatic rise in interest rates over the year, and ultimately speaks to the fact that there are still many more investors looking to grow their exposure to the industrial sector that there are investors looking to reduce their exposure.” their industrial operations.

As interest rates on commercial mortgages rise, “we expect some increase in industrial cap rates over the next few months,” Posen adds. But these increases are expected to be modest, given that the industrial sector still offers the most optimistic outlook for net operating income growth for all major commercial property types.

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