REjournals and Chicago Industrial Properties recently held the CIP Summit, an annual conference exploring the state of the industrial market.
The general consensus among a panel of experts was that some headwinds have emerged, but generally they don’t believe they will have an immediate material impact on the market. The panel included Alfredo Gutierrez of SparrowHawk, Dan Fogarty of Stotan Development, Craig Dannegger of Clarius Partners, LLC and Brock Herr of the Indiana Economic Development Corporation.
“In the 30 years I have been in the market, we’ve never had this much positive momentum,” Gutierrez said. “Despite some of the negatives—the situation in Ukraine, inflation and interest rates, there is a tremendous appetite from everyone.”
Herr agreed, saying the sector is being driven both by and in spite of market forces, adding that the challenges in the market are mounds or hurdles, nothing that will stop the momentum.
There is an old saying, “those who don’t learn from the past are destined to repeat it.” Members of the panel suggested that lenders are continuing to show that they learned from various trouble spots in the past. Institutional life companies are keeping a hold on loan to values to avoid the building of assets that shouldn’t be built.
From a developer’s perspective, Fogarty represented that some of the noise in the market can create momentary uncertainty, much of which goes away because of the underlying market fundamentals.
“Tenants in the market outpace what is being developed. There are markets where 20% of the inventory is being added,” Fogarty said. “But as soon as the pizza is being cooked, it is being eaten.”
Herr agreed, adding that in Indiana, most of the spec space being developed is mostly leased.
Gutierrez said that because of the leasing velocity taking place, buyers are not afraid to buy empty buildings.
Many on the panel focused on the cost of construction materials, and the impact it could have on the market. All agreed that the cost of construction materials is cause for concern, but that the frothiness of the market is countering that right now.
“Rising rental rates solve almost all woes to maintain yields and spreads,” Dannegger said.
He also noted that in spite of various market factors, cap rates can still go lower. “There may be a pause with some of the uncertainty, but overall could still go down because the fundamentals are that strong.”
Providing a bit of a hedge, he also said that if cap rates go up, it isn’t necessarily a bad thing. “It maintains a healthy industry,” he said.
Members of the panel discussed that increasingly, cap rates aren’t the only key measure for owners and investors. Internal Rate of Return (IRR) continues to gain a foothold as a KPI.
“We’ll continue to calculate, use and evaluate cap rates, but it isn’t THE measurement,” Guttierez said.
Herr, speaking from a state government perspective, agreed and said, IRR threshold is the driving metric. Cap rate is important, but at the state level IRR is important.
In discussing the greatest headwinds, Dannegger circled back to construction costs, providing the example that spec shell construction costs have increased anywhere between 50-70 in the last year. “It’s an insane increase. While it seems to be plateauing, you have to factor in the risk and perhaps factor in additional spreads.
Fogarty added that often more concerning to him are the delivery lag times on materials that are prevalent today. In some cases, it may, for example, impact whether a company uses tilt-up or precast construction. “It’s a daunting headwind,” he said.
Herr added that while access to capital generally is not an issue, timelines that shift given the construction material delays could create the need to take short-term measures.
Guttierez added that one potential concern about the market is that the strength of the market may create the impression that anyone with a tool belt and a truck can be a developer. “True developers are far more sophisticated with a level of expertise that allows them to read the market and act accordingly, not in a knee-jerk reaction to current market dynamics.”
The industrial market, in Chicago and across the country, is facing challenges it hasn’t had to face for many years. But there remains optimism not just for the near term, but for a more extended period of time.
“We still have more runway left; as much as five years,” Fogarty said.