Industrial real estate also has pain points

Thirty Agnew

As we approach 2022, the fundamentals of the industrial real estate market have never been better. The struggles at the moment are about supply to meet global demand and adapt to rapidly rising costs.

In Q1 2022, the US market delivered 89.9 million square feet of industrial space and continued the blistering pace of absorption with 110.8 million square feet, pushing the overall vacancy rate to 3.4 %, a historic low for the sector.

According to JLL Research, labor and material costs have increased more than 13.6% over the past 12 months. For warehouses, they go up to 20-25%. These increases amplify the pressure on rents and complicate development operations, especially those with long deadlines, and forward sales, which are rapidly gaining in popularity.

While the industrial pipeline was considerably robust before the pandemic, the pandemic itself caused significant delays and cancellations. Labor shortages and COVID-related restrictions further delayed many projects, and price volatility for building materials was unprecedented at any time in history.

As a result, developers are getting creative in markets where space and land are in high demand, such as the Inland Empire, Los Angeles and New Jersey, where the current vacancy rate is below 1.00%. . The idea of ​​converting underutilized retail, office and manufacturing sites to logistics use has been popular, as has the adoption of multi-story development concepts to maximize space and revenue for each square foot of urban land.

Population growth and migration patterns have played a role in which cities see the most new deliveries hitting the market, with Dallas/Fort Worth, Atlanta, Inland Empire, Phoenix, Houston and Memphis leading the pack.

Under favorable market conditions and demographic trends, Sun Belt markets also saw some of the largest year-over-year increases in project costs and rents. As such, there has been a shift in investor sentiment towards smaller markets over the past six months, including Salt Lake City, Nashville, Austin, Raleigh, Las Vegas, Reno and San Antonio, which has resulted in a significant compression of capitalization rates.

Due to the overall strength of the market, private equity and institutional advisor/REIT investments continue to be robust. For example, the ODCE (Open-Ended Diversified Core Equity) Index saw industrial allocations double to 28% due to both earnings and appreciation and a bigger push into the sector by some of the larger big buyers.

The sector currently seeing the greatest impact on prices is the single-tenant long-term rental component of the market (10 years), with from 25 basis points on single asset transactions to over 50 basis points based on portfolio transactions based on contractual rent increases offered under the lease. Along with rising interest rates and borrowing costs, investors are diverting capital deployment away from longer lease terms and focusing on vacancy or shorter lease terms, which could create opportunities for some buyers.

Class A and B cap rates continue to tighten and are likely at historically low levels in terms of spread; however, as Class B products tend to have shorter lease terms, they offer increased go-to-market opportunities compared to Class A products and the shallow bay segment of the market continues to outperform in terms of overall growth in rents.

Short-term outlook

According to forecast models from JLL Research, rents are expected to increase by more than 8% on a full basis in 2022 and could accelerate by the end of the year. Given the continued tightening of the market, vacancy rates will remain below the 4% threshold for the remainder of the year.

As projects currently underway are not expected to be delivered until 2023, the market will remain short of supply and will continue to struggle to meet short-term increases in demand. While there continues to be an influx of new deliveries into the global market, development timelines across the country have increased and are expected to remain high.

Intense competition for space will give landlords in the hottest markets (New York, Mid-Peninsula, Silicon Valley, Long Island and Los Angeles) the opportunity to hold vacant space and be selective about rental strategy .

For institutional investors, it would be wise to redirect some capital towards longer-term rental and/or multi-tenant products, which have a weighted average rental term of five to 10 years and are likely to have greater value. Steps. spread over the next two years. These core assets have continued to perform through various cycles. Combining this strategy with a continued push in development to take advantage of rental growth should allow an investor to achieve a high blended return.

Trent Agnew, is Senior Managing Director and Co-Director of JLL Industrial Capital Markets Platform.

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