CAPITAL TRICKLES DOWN TO SMALLER MARKETS Although smaller metros have typically been dominated by local investors , competition in secondary markets is prompting regional buyers to look at buying opportunities in tertiary markets . “ We ’ re seeing an influx from outside sources from Detroit , Grand Rapids , [ Mich .,] and Chicago that have their eyes on Northern Michigan ,” says Steve Poole , CCIM , a vice president at Colliers in Traverse City , Mich . Traditionally , the challenge is that tertiary markets don ’ t have a deep inventory of institutional quality multitenant assets . Northern Michigan , for example , is serviced from bigger distribution hubs in Detroit and Chicago .
Investors also are keeping a close eye on development pipelines and potential overbuilding in some markets .
Most of the industrial sales occurring in Northern Michigan have been on sale-leaseback opportunities of single-user assets . There is a little greater risk because of the smaller market . The timeline to backfill a building with a strong A-caliber tenant can take longer in tertiary markets compared to bigger metros where there is an abundance of options , notes Poole . However , cap rates are going to be higher and there is less competition . Current cap rates on single-tenant industrial assets are trading around 10 to 12 percent , he adds .
INVESTED IN INDUSTRIAL
Many tertiary markets also benefited from the population shift that occurred during the pandemic with more people working remotely . “ Northern Michigan is a beautiful area , and we are starting to see population growth as a result of COVID-19 with a huge influx of people who can work remotely ,” says Poole . Businesses are following that population . “ We ’ re starting to see more and more companies interested in locating a facility in Northern Michigan to serve the growing population ,” he says . The market has traditionally been conservative on spec development , which has resulted in vacancies that remain tight at about 2 percent , he adds .
INVESTORS BATTLE COMPETITION , HIGHER PRICES The biggest challenge for investors is finding good buying opportunities as prices continue to move higher and cap rates lower . Some investors are lowering return expectations due to the competitive environment . According to the RCA CPPI , industrial prices climbed 9.8 percent YOY in second quarter , which is second only to apartments at 12 percent . Warehouse property prices saw an even bigger jump at 11.1 percent , but flex properties also notched some notable gains at 7.5 percent .
Cap rates vary widely depending on the market , tenant credit , and quality of the asset . On average , national cap rates declined by 30 basis points to hover at 5.7 percent at midyear , according to RCA . Best-in-class assets in high-demand markets are selling for a premium . For example , Class A industrial assets in the Atlanta market are seeing going-in yields in the 3 percent range , notes Mitchell . “ Strong rent growth from both contractual escalations and market growth will help investors validate low cap rates ,” he says . “ Rents are likely to increase as net absorption continues to outpace new deliveries . Until supply catches up or demand in the space market slows , we expect rents to continue to rise .”
One hurdle for investors is that there is far more demand than there are buying opportunities . “ The supply of properties for sale is very low , and you have to work hard to convince someone to sell ,” says Bhatt . Many industrial owners are simply reluctant to sell . Especially among smaller ownership groups , there is uncertainty on what to do with the money from a sale , he says . Do they pay the capital gains tax , or do they try to find a replacement property to complete a 1031 exchange ? Owners are taking advantage of the attractive climate for refinancing industrial assets that allows owners to restructure debt at a low rate and take equity out of a property . “ So , for the majority of people , their strategy is to hold assets ,” adds Bhatt .
Investors also are keeping a close eye on development pipelines and potential overbuilding in some markets . For example , Dallas-Fort Worth has record levels of new supply coming online , and it remains to be seen how that space will be absorbed . “ I think the future is bright for industrial , but the buildings we ’ re building right now could create some headwinds where we may see some pressure caused by oversupply ,” says Dunn . Another challenge is finding industrial land in a good location . In many metros , infill opportunities are few and far between , which is pushing industrial development further out to the fringes .
Despite rising prices , the yields investors are generating continue to stack up favorably compared to other alternative assets . That investor demand is expected to support lower cap rates and higher sale prices in the near term . The challenge for commercial real estate professionals will be sourcing deals in a market where some owners remain reluctant to sell and helping clients to acquire assets in the current competitive market .
Beth Mattson-Teig A freelance business writer based in Minneapolis .
Key Figures in the U . S . Industrial Market
$ in Billions
Quarterly Volume RCA CPPI Price Averages
YOY Change
Properties
YOY Change
One-Quarter Change
One-Year |
|
|
Change |
$/ Unit |
Cap Rate |
Industrial $ 29.80 139 % 2,076 98 % 2.4 % 9.8 % $ 120 5.7 % 0.3 % Flex $ 6.10 169 % 409 93 % 1.2 % 7.5 % $ 166 6.1 % 0.1 % Warehouse $ 23.80 132 % 1,667 99 % 3.2 % 11.1 % $ 112 5.6 % 0.3 % 6-Major Metro $ 10.50 145 % 639 102 % 3.2 % 8.4 % $ 175 ~ ~ Non-Major Metro $ 19.40 135 % 1,437 96 % 1.5 % 10.4 % $ 100 ~ ~ Single-Tenant $ 9.00 85 % 456 60 % 2.7 % 8.6 % $ 127 5.8 % 0.1 %
Source : Real Capital Analytics
YOY Change
28
COMMERCIAL INVESTMENT REAL ESTATE MAGAZINE FALL 2021