Peter Harwood, executive vice president at Jones Lang LaSalle, recently spoke to Chicago Industrial Properties about the industrial real estate sector in the Chicago area.
Here is some of what he had to say:
Chicago Industrial Properties: How has the first half of the year been in terms of market activity?
Peter Harwood: It’s been phenomenal. Let’s take a historical perspective. Nationally, at the top of the previous cycle from 2005 to 2007, we were at roughly $50 billion to $60 billion worth of industrial investment sales. In 2009 and 2010, after the crash, the volume was down in the $10 billion to $15 billion range and then 2012 was in the plus or minus $35 billion range. There was a big increase from the bottom of the recession, but still not anywhere near the $50 billion to $60 billion at the top of the peak. Year-to-date through July, nationally we’re at about $17 billion and investment sales are heavily weighted toward the fourth quarter, so that would portend somewhere in the $40 billion to $45 billion range for total activity for 2013. That’s great. We’re getting pretty close to where we were at the height of the previous cycle. In Chicago, what we have seen this year compared to last year is that cap rates have compressed by 75 basis points on average for Class A product. In 2012, the average cap rate for a Class A building would have been six-and-a-half in Chicago, now we’re at five-and-three-quarters. A lot of that was driven by debt. Even with recent volatility in the debt markets, we’re still seeing Class A product trading at a 5.75 to 5.8 cap range.
CIP: What do you predict the second half will be like in terms of industrial space demand?
Harwood: The demand is there. There is more demand than there is product. There is not enough Class A product to satiate the demand of the market. The B market never materialized in 2011 and it never materialized in 2012. I’ve been on countless panels where people have said, “OK, this is the year for Class B,” and it still hasn’t materialized. The spread between A and B is 125 to 150 basis points or even more from a cap rate point of view, and part of the problem is that everybody knows what Class A is, but B has a whole lot of different categories in it. Without that definition, it is really hard to pinpoint. What we’ve seen is that there have been a number of portfolios in Chicago that have had Class B product that have not gotten the reception that the owners had hoped to achieve. We’re still seeing that now. So more B product is going to come onto the market, and even though there’s not enough A to hit the demand of the investors out there, that money has not quite gravitated to the B product just yet. But there is going to be a tremendous amount of demand for A product.
CIP: What will be some of the important economic factors in determining demand?
Harwood: It’s employment growth, economic expansion and a continued low interest rate environment. We’re seeing demand in the three major sectors: e-commerce and consumer retail goods, third-party logistics and food distribution. Then a distant fourth that people really don’t think about a lot is manufacturing. It’s grown a ton recently as well. Those four probably comprise 60 percent of the demand that’s out there from a user point of view and that continues to grow.
CIP: What are the reasons to be optimistic about the second half?
Harwood: From a sales point of view, historically the third and fourth quarters are the largest quarters from investment sales activity. A lot of buildings that hit the market in the second quarter and early part of the third quarter don’t close until the fourth quarter. A lot of the groups have allocations for deploying capital, and if they haven’t hit their allocations, they start to chase things and maybe pay a little bit more than they otherwise would. Some of the portfolios that are on the market that are on the cusp of getting done may cross the finish line. Also, the continuing low interest rate environment from the debt capital side will continue to drive values and an overall confidence in the economy is going to continue to drive investment into industrial real estate.
CIP: What is going to be the appetite for industrial product in the second half?
Harwood: It’s still off the charts. There’s not enough product to satiate the demand there. All of the large institutional investors want to accumulate Class A product and they’re all in competition with each other. They don’t want to sell to their competitors, so there just isn’t enough product out there to satisfy the demand. That’s now why we’re seeing speculative construction across the country but also here in Chicago specifically. Spec is in every primary and secondary market across the country. Build-to-suit is still going to out-build speculative in virtually every market. Here in Chicago, there is about 8 million square feet of spec that’s either proposed or under construction right now and we’re up to just under 2 million square feet of things that have actually broken ground. All of the name brand developers are in the ground now building spec and most of those guys have multiple other sites that they’re trying to build.
CIP: What other factors will determine the success of the market in the second half?
Harwood: Assuming that the Fed doesn’t make any changes to the interest rates or signal that a change is imminent, then I think we’re in good shape to continue to move forward. We saw in 2013, compared to 2011 and 2012, corporates finally making decisions for expansions and extending lease terms longer than just a year or two just to get through the early part of the cycle. If there is any signal of a change, then those corporates will continue to push those decisions down the road versus being willing to place a stake in the ground and make those decisions. We’re at a point in the cycle right now where large corporates are willing to make decisions. As long as the status quo remains from the interest rate environment, the stock market continues to perform well and unemployment numbers continue to decline, I think we’re in good shape for the second half of the year.
CIP: Where are you seeing most of the demand in the Chicago market?
Harwood: It’s all driven by transportation and logistics. Good accessibility to the highway system here is critical. So if you’re in any of the major transportation sectors, you’re fine. There still is a little bit of a negative stigma to Cook County because of the real estate taxes, but you can get over that with the right location. For any of the submarkets, as long as you have a good location within that submarket, your buildings are going to be in good shape.
CIP: What else is behind the stronger interest in industrial properties?
Harwood: It’s a much lower beta type of product than many others. Office in particular is much more subject to boom and bust where you can see a second generation, A-building in Chicago be worth $200, $125 or $300 per square foot depending on where you are in a cycle. Industrial property isn’t subject to that same kind of swing in value. Industrial is going to continue to be a sought-after product.