Industrial Wakes Up
As liquidity and buyers return, this sector is poised to rise and shine.
Gently shaken by improving fundamentals, the once-slumbering industrial sector has begun to stir. Investment activity and user sales increased approximately 35 percent and 50 percent respectively from 1Q09 to 1Q10, reports Cushman & Wakefield. Though the sector seems to have turned the corner, some markets are faring better than others. Thanks to government spending, growing export demand, and other factors, Baltimore, Chicago, and Phoenix all posted significant increases in industrial sales activity during the first quarter, according to Cassidy Turley.
Lower asking prices also have spurred on buyers. Overall investment sales volume dropped to more than $1.6 billion in the first quarter, down from more than $2.5 billion in 4Q09, according to Real Capital Analytics. Capitalization rates climbed from 8.8 percent to 8.9 percent during this period but are expected to tighten as demand picks up.
Though institutional investors ramped up in the first quarter, private investors and regional owner-users, motivated by the narrowing bid/ask gap, still accounted for the majority of transactions. “Investor committee members don’t want to stick their necks out yet,” says Paul A. Waters, CCIM, CRE, SIOR, executive vice president of brokerage for NAI Global in New York. “The small private shops are more nimble, not having to rely on the Wall Street money that requires vast modeling and variable analyses to react.” As industrial experts search for more signs of recovery, these nimble reactors will continue to create pockets of activity across the country.
Actors and Reactors
Today’s industrial sellers are those who have to sell, according to Tom Attivissimo, CCIM, senior director of Greiner-Maltz Co. in Plainview, N.Y. “They bought at the height of the market and lost tenants or never got a tenant that would pay a high enough rent to cover debt services,” he explains.
In smaller markets, owner-users are pouncing on these vacant 25,000- to 300,000-square-foot industrial properties to accommodate the 45,000 manufacturing positions that employers added in the first quarter. “Users are buying vacant buildings at great prices since most real estate investment trusts and institutional investors don’t want the lease-up risk,” notes Tim DeGoosh, CCIM, CPM, vice president of Sares Regis Group of Northern California in San Mateo. In the Southwest, for example, high-end manufacturing buildings, basic warehouse facilities, and other industrial product are available at prices that are 20 percent (or more) below 2008 levels, according to Robert Glaser, CCIM, SIOR, principal with PICOR Commercial Real Estate Services in Tucson, Ariz.
Research and development and flex properties, which are more closely tied to job growth, are seeing less action. “We have not seen many smaller flex users looking in market, and the few that have toured are trying to renegotiate a better deal in their existing locations,” says Brian J. Young, CCIM, associate with CB Richard Ellis/The Furman Co. in Greenville, S.C. As the economy continues to improve, however, these sectors should follow suit. In Tucson, for example, R&D-using industries like solar, optics, aerospace/defense, and bioscience lead the prospects for industrial sector growth, Glaser says.
In markets where institutional investors are active, there’s a flight to quality. “Institutional capital is chasing any class A product that comes to market and seeking out off-market
acquisitions as well,” says Steven J. Medwin, CCIM, SIOR, executive vice president of Jones Lang LaSalle in Miami. Thanks to the fierce competition, “Pricing in some cases is almost back to 2007 levels with cap rates in the 7 percent range.”
Viktoria Telek, CCIM, associate with ComReal in Weston, Fla., notes that ProLogis and Industrial Development International both recently put portfolios on the market. IDI’s asset, which includes four buildings totaling 679,000 sf in the Weston Business Center in Weston, received approximately 25 offers from various REITs, institutional investors, and private buyers, according to DailyBusinessReview.com. RREEF purchased the portfolio in April for $65 million, or about $96 per sf, on behalf of a German fund.
In southern Florida and elsewhere, there’s still a lot of money on the sidelines searching for quality properties with stable occupancy. Competition among institutional investors is expected to remain stiff throughout 2010.
As a result of increased demand for warehouse and manufacturing product, many markets are poised for solid activity. The problem is that lenders have swallowed the key to many of these transactions. “Op funds, vulture funds, and private investors are doing the buying typically because the resources are private” — cash, partner groups, and alternative sources of financing, Waters explains. If you don’t have the cash and can’t get creative, you’re out of luck.
Luckily, CCIMs are well-schooled in the art of creative deal-making. For example, in January the Michigan Institute of Aviation & Technology purchased a 124,000-sf former La-Z-Boy warehouse on 10 acres in Canton Township, Mich., for $5.4 million. Terrance W. Bixler, CCIM, vice president, and Darcie Moss, CCIM, senior business development manager, of Thomas A. Duke Co. in Farmington Hills, Mich., collaborated on the deal. Bixler, who marketed the property on behalf of the seller, recognized the property’s alternative-use potential and began negotiations with the school, which planned to turn 26,000 sf of the property into classrooms.
As completion costs grew to nearly $9 million, a lack of financing threatened to kill the project. But Bixler was confident. “As CCIMs, we’re trained to identify obstacles and implement solutions that the market offers,” he says.
Moss, a financing expert, stepped in and put together an $8.9 million loan package that included 90 percent interim financing, a $4.4 million conventional first mortgage, and a more than $3.5 million Small Business Administration 504 energy conservation bond — nearly twice the average size of SBA bonds for similar projects. To secure the debenture, the team produced an Energy Conservation Report that demonstrated that MIAT’s proposed facility would use at least 10 percent less energy than its then-current location. The bond amount was directly indexed to the energy savings that exceeded 10 percent. “CCIMs should know about the SBA 504 energy bond public policy option,” Moss says. “It’s a good tool to have in the toolbox.”
Though prices have dropped and cap rates have spiked, distressed industrial properties remain rare due to the unique nature of the asset. “You can lease them for low numbers to cover debt service and expenses,” Waters explains. Plus, he adds, in terms of repositioning and related metrics, these inherently boxy properties “can turn on a dime.” As of 4Q09, industrial properties represented only 3 percent of the $172 billion in total troubled assets, according to Real Capital Analytics.
In markets where distressed properties are available, “the banks are not interested in a fire sale,” says Scott K. Perkins, CCIM, SIOR, managing director of corporate services at NAI James E. Hanson in Hackensack, N.J. “The discounts off the amount of debt on the property are very conservative.”
For example, when a 60,230-sf manufacturing property in Norman, Okla., fell into receivership, the receiver recognized the asset’s potential and recommended that the bank hire a broker. Tim Strange, CCIM, SIOR, managing director of Sperry Van Ness/William T. Strange & Associates in Oklahoma City, and his team stepped in and quickly identified four qualified buyers. The property went to the highest bidder for $2.05 million, which was high enough to cover 100 percent of the bank’s investment, including carrying costs and fees.
Though more distressed product eventually will make its way into the market, industrial investment sales are not expected to make a major comeback this year. However, as the economy grows, this sector could be the first to emerge and soar. Until then, “The bread-and-butter B-level infill product will continue to trade,” Waters says. “But caution will be the overriding trend.”
The Future of Industrial Investment
During his more than 25-year commercial real estate career, John E. Huguenard, CCIM, SIOR, managing director and co-head of industrial investment sales with Jones Lang LaSalle, has represented institutional owners, real estate investment trusts, and developers in industrial transactions. His deals include the $145 million sale of a 10-building East Coast portfolio and the $116 million sale of an 11-building portfolio in Cleveland. CIRE asked Huguenard to weigh in on some of the factors that shape the industrial investment landscape.
As the economy rebounds, who will be the next generation of industrial sector investors?
Huguenard: REITS, institutional investors, and foreign investors have a lot of money to spend this year.
What kind of space will they want?
Huguenard: Investors are looking for quality class A modern bulk product in good industrial markets, including both single and multitenant buildings with unit sizes ranging from 100,000 sf to 600,000 sf.
Which markets are poised for the most growth going forward and why?
Huguenard: Demand already is picking up along the East, West, and South coasts. Cap rates in these markets are recovering more quickly. Because the Midwest has no barriers to entry, demand is not as high there as it is in the coastal markets.
How have current market conditions influenced investment strategies?
Huguenard: Last year, a $100 million deal was large. Now, $300 million to $500 million deals are possible and preferred, although the product isn’t necessarily available. Investors are flocking to markets where quicker recoveries are expected.
Which markets are those?
Huguenard: Sales are picking up in South Florida, Washington, D.C., Baltimore, Southern and Northern California, and Seattle. Sales in most port and rail cities also are picking up, but not as quickly as they are in the coastal markets.
How has the lending environment changed this year?
Huguenard: The biggest change from 2009 to 2010 is the number of lenders who are willing to finance purchases. Last year, loan-to-value ratios were 50 percent to 60 percent. This year we have seen LTVs in the +/- 70 percent range with lenders competing for the business.
How can commercial real estate professionals position themselves to succeed when the sector begins to recover?
Huguenard: From a user perspective, controlling tenants and product is key. Most investors want to talk to the brokers who control the tenants and the product.