By John Coleman
Executive Managing Principal-Newmark Grubb Knight Frank
The market predicted a few years ago that the deal stream for large, Class A core industrial would slow down before the investment capital chasing it dried up. I’m not sure if the market predicted, but certainly it hoped, that interest rates and bank financing would loosen so users and local investors could leverage the rising market too. It turns out both occurred, which has been particularly good news for Class B assets.
Lease and sale activity in the 40,000-square-foot to 100,000-square-foot tranche has been very healthy since the beginning of this 2013 calendar year. In the last two quarters alone, our firm completed 14 sale and 12 lease transactions for just under 1,800,000 square feet of activity; in this grouping, the average sale transaction was 67,000 square feet and 70,000 square feet for lease. Most of the assets were single or two-tenant masonry or precast buildings built in the 1980’s and 1990’s – the very definition of Class B product.
Breaking down the numbers, we glean two things from this activity: first mid-cap process and distribution users are expanding and second, “pro” money is fueling activity from the investor/buyer and institutional ownership perspectives. Three-quarters of the transactions we report had occupiers taking more space, not less. We saw specific activity in business sectors such as data storage, plastics, food, building products, medical supplies and logistics and transportation. We also represented users making point-of-purchase and retail displays, companies that sell used industrial equipment overseas, packagers and laboratory users that deal with things like research and development.
Why? A few reasons: A 9% increase in customer demand over the same period in 2012; increasing confidence in a rising economy; and greater availability to capital greased the go-forward wheels and compelled decision-makers in our sample group to enter the market.
Occupiers appear to have reached that juncture where they recognize pricing is inching up and happily find that capital is available, allowing them to play in the real estate market or invest in their business. Bank financing with an SBA component is attainable, competitive money. As recently as a year ago, lenders were still making loans only to users who didn’t need them; that’s changed a good deal and now a solid business plan and compelling story usually satisfies the investment committee. Interestingly, though the cost of SBA financing is creeping up and can be 100 basis points or more above the bank line, the inverse of one year ago. Nevertheless, the switcheroo doesn’t seem to have stemmed activity.
The second dynamic we glean is that professional money – investor/owner/operators and the institutions – are also pursuing Class B opportunities, not just as a default position, but because they have confidence that the better returns Class B provides can and will be realized. We sold buildings in this market class – some with vacancy – to well-known investors such as High Street Equity, Venture One, SPF Group, KTR and Equity Funds. Landlords who already own product with vacancy in this size range and product class are seeing better absorption. We’ve put tenants in buildings owned by Centerpoint, Liberty Property Trust and Manulife, owners accustomed to doing the really big deals.
As the economy strengthens, investor buyers are snapping up much of the available Class B buildings, many in the suburbs, which form the backbone of the Chicago area’s industrial infrastructure. Our activity this year is particularly robust along I-55, in Central DuPage, O’Hare of course, North Cook and the North / Lake County submarket.
Two years ago, many of these buyers weren’t actively thinking about the B market. But a few years of growth and strong balance sheets for companies needing this building type soothed whatever anxieties investors harbored. Starting around the third quarter of last year, investors became more comfortable with the returns and the risk and the numbers today are bearing this out.
We recently put a six-building, 250,000 -square-foot Class B portfolio on the street and the response has been very strong. It will not command the sub-seven cap rates the shimmering big bombers get, but it’s solid bread and butter Chicago industrial and it’s a good IRR builder for a hands-on portfolio operator.
We still see good activity in the bigger deal stream which means multiple segments of the market are doing fairly well at the same time. That’s where we are right now. There are still obstacles ahead, but for every two steps we take forward, we’re only getting yanked a half-step back.
Looking forward, I think the Class B market will continue to trade vigorously in 2014. Users should continue to expand, buying and leasing in the 40,000 sf to 100,000 sf range. Interest rates will rise, but since user buyers don’t typically purchase on yield, slight upticks shouldn’t weaken the deal stream. On the investor side, we expect continued confidence and appetite in the product type due to solid performance and scarcity of core product. Cap rates for core will likely go up next year in response to the rising cost of capital. If that causes core sellers to stand down, then Class B will benefit.
John Coleman leads the 20-person industrial practice group for Newmark here in Chicago. He is an SIOR, a board member of the Association of Industrial Real Estate and sits on the editorial board here at CIP.
