Steve Disse, a principal at Colliers International, gets more than a little passionate talking about industrial capital markets; and more than a little bullish on the Chicago market. So when global or national discussions suggest that the recovery may have reached its peak, he is quick and emphatic to point out “there is still plenty of runway left in Chicago’s industrial investment market recovery.”
Steve Disse (second from left) was one of three industrial capital market specialists the Association of Industrial Real Estate Brokers (AIRE) assembled to discuss the state of the market at its November membership luncheon. The panel was moderated by Mark Saturno of Molto Properties (far left), and included Paul White of LaSalle Investment Management (far right), and Ryan Stoller who recently joined VentureOne (second from right).
The biggest news from the panelists was the firm belief that as the market continues to show strong velocity it is certainly possible that some core assets will trade at a sub five cap rate—record territory for the Chicago industrial market.
“For the first time ever, we’ll see a five or sub five cap rate,” Disse said. “And this quarter we should see two to three deals in that range.”
All panelists were in agreement that in order to achieve that record level, “all the boxes must be checked off”. Those “boxes” are the characteristics that define a core asset, including location, institutional quality tenancy and modern construction, among other things.
White noted that record cap rates already are being achieved in other national markets, including LA. He said in Southern California, “for Class A best of the best product, everything is within low fours to mid fives.”
Stoller reminded the audience that his firm, VentureOne, doesn’t “play in that space” but is still seeing lots of opportunity in the Class B buildings it will buy. “For B buildings without all of the boxes checked off,” Stoller said, “we’re seeing cap rates between seven and seven and one half.”
Disse added that the cap rate gap between Class A and Class B properties is the highest ever. Where a 100 basis point difference was generally considered the standard, the gap now is 250 basis points. The general consensus has been that Class B cap rates would “catch up” to Class A rates, in terms of the level of compression taking place. But that hasn’t happened.
“That’s where we see opportunity,” Stoller said. “People still need those Class B assets, even if they are not at Main and Main with all the boxes checked off.” The important thing, Stoller said, is having an eye to the exit strategy.
“We’ll sell to a user and we’ll bundle as a package. We have flexible options,” Stoller added.
Disse added there is huge liquidity in the B market. “The beauty of ‘B’ is you can leverage your acquisition, get an 11-12 percent cash on cash return. And with some rent growth you can push that higher,” Disse said. “It’s been an interesting market.”
Speaking to institutional buying habits, White said, “The recession changed behavior and patterns. The scars and still fresh. The mindset this cycle is quality; quality markets and submarkets, and quality assets.”
Those markets in Chicago, according to White, are the core-core markets of O’Hare, North DuPage, I-88 and I-55. “There are plenty of ways to make money (in those markets),” he said.
Disse narrowed the lens and defined the core, money-making markets as “O’Hare and I-55 more than any other markets.” He suggested that map was unique to the post-recession era. “There has been a flight to quality, and O’Hare and I-55 are rent growth markets.”
He noted investors can also do well in the I-88 and Central DuPage markets.
“Individual assets can push cap rates,” White said. “For institutional investors, there is comfort in being in the core markets. They aren’t that sure about straying from middle of the fairway markets.”
The panelists generally agreed that the likelihood of further cap rate compression is minimal for Class A and greater for B buildings.
“In Class A, cap rate compression is largely done,” White said. “The floor is there for interest rates.”
“For Class A, I’d argue we might have another 25 basis points of compression possible,” Disse said. “There is more potential for Class B, but we’ve been saying that for years.”
“There are plenty of ways to participate in the recovery,” Disse added. “Just because a market isn’t a five cap market doesn’t mean you can’t make money.”
Stoller thinks the spread between A and B is too wide, and that a narrowing of the gap will come from compression on Class B cap rates. “The counter-balance to cap rates,” Stoller said, “is rent growth. And we are seeing that now.”
White agreed and said, “Rents are rising almost everywhere, in all of the markets we’ve covered. We’re seeing the highest rents in 15 years.”
In assessing the current industrial capital market, Disse suggested taking a step back to consider one of the reasons why people and institutions invest in real estate. “It’s a hedge against inflation,” he said. “Do you really want to take a chance on the bond market?”
White added “people sometimes think myopically” instead of considering the global investment environment. “The bond market is at an all-time high. The stock market is at an all-time high. Real estate is at an all-time high, and why shouldn’t it?”
That takes it all back to Disse’s passion for and conviction in the Chicago industrial market. Disse said, “I don’t want to hear that we are in the 8th or 9th inning of the recovery in Chicago, with only 18 months left.”
While it may be that late in the game for coastal markets, Disse believes there is still plenty of game yet to be played in Chicago.
