Now that 2022 has arrived, it’s anyone’s prediction what will happen next in the age of the pandemic. However, the general consensus within the developer community in Chicago is that this year will be much the same in terms of high demand for and short supply of new Class A industrial space.
Helping to offer some insight into the trends taking us into the new year, Vestian Global Chairman and managing broker, Michael Silver, connects the dots and discusses what we can expect to see — but also some scenarios where things could become a bit bumpy. Could runaway inflation derail the ride? We’ll have to wait and see.
This last year has been, I guess, we could describe as a roller coaster in many ways. And so in the world of industrial, what were the high-highs and low-lows.
There weren’t that many lows. The industrial market absorbed twice as much space in 2021 as it did in the previous two years. The vacancy rate is around 5% but rent growth is astounding — you know, 7.3% to around 8%. And everyone is panicked about securing the best logistics solution they can and the panic is causing the businesses that want to secure that best point-to-point transportation to ignore the basic fundamentals of what they’re renting; meaning that they’re paying more than they should or they’re paying more than they have to.
There’s a lot of money trading hands, as opposed to just somebody trying to help the business, assess their situation, assess their logistics and help them get the best rent. And so if there’s a low, I would say that this is a year where the occupier — the tenant — is getting fleeced. If there’s a high, it’s for the developer making a lot of money, securing the lease and selling the building at an unprecedentedly high price because cap rates are so low right now. For instance, cap rates are coming down to close to 5%.
We’re already looking at low supply and very high demand from the tenant side, but also from the developer side. So, we have to think about the competition and how many folks from outside of the Chicago area have jumped in. But is there enough room for everybody?
[Developers] are paying more money to secure land and they’re paying more money to build buildings. They’re just simply paying more because that’s the competition. The tenants’ competition is where is the property? And should they end up paying more because they just need it?
But here’s a limit to what you can be paying for land and there’s a limit to what you should pay for a building. A lot of the limitations are governed by the availability of money and the cost of the money. And if interest rates go up, these developers have a problem. And then the consumer has a problem too, with the increased interest rates, which can reduce demand to buy goods and services and reduce ecommerce.
When can we expect to see any major changes in the current industrial market in Chicago? Or will this boom continue well into the future?
I would throw my hat in for 2023, as opposed to this thing going on forever. People are saying that it’s going beyond 2024 and 2025 — and yeah, I just don’t see it that way. And I also think tenants don’t necessarily have to be as fleeced as they are, if they know who they’re doing business with. There’s a big difference between all these players that have jumped into the marketplace and steady institutional players.
Right now, everybody and their brother is putting on a developer hat and their desire is to just fleece the tenant who needs the space and gets them to pay a high price so they can sell [their building] at a higher price. And I think you’re going to see that subsiding when credit isn’t as available as it is right now and the market decides who is going to be the survivor and who isn’t.
So, we’ll see some big changes next year?
Yes, I would say it’s going to begin to happen in 2023 in this straight upward projection for the need to fix the supply chain and move away from China, and regionalization, and playing around with where the ports are — I think that’s going to subside.
What are some lessons you learned from last year? Or was there anything in particular that happened in your business that helped you identify a trend or consider doing things different?
The key to all these deals [that we undertook] that made us think about it was two-fold. One: let’s work parallel paths, meaning, let’s secure multiple offers so that the occupier is not forced into taking the rent that’s being offered. For example, if rents are being offered at $10 a square foot, which we know is too high, and we take multiple offers, we could eventually get that rent down to $8.50 a square foot.
Number two is to get ahead of it by being in the market for a year and a half early. Don’t be in the market six months early and then you’re forced into a situation that you might not want. The CEOs of these businesses that are taking this industrial space want to be protected and they want flexibility at the same time. So they want to know that there’s a rent stream that protects them in an occupancy for 10 years, whereas the typical developer today wants to shut it off around four to six years.
So, the challenge becomes how do you get around that? That’s when you have to have knowledge of what the developer is going to receive by the tenancy in the credit of the tenant. And then you can translate that into an exit price.
What do you predict for 2022? Will we see more of what happened in 2021?
The only impediment in 2022 would really have to be a dramatic increase in interest rates and the availability of money. What did the pandemic do? It slammed demand for a while. People were scared, and then all of a sudden the demands were accelerating. And then when all that demand accelerated, that’s where we were creating inflation: you have an over-demand for limited supply.
The reverse of that, which would really throw a curveball at the market, would be liquidity and the availability of money going out of the market and the demand side all of a sudden being drastically reduced and interest rates going up. So, the cost of bringing a property to market is not worth what the seller would like to sell the building for. But I think having 2022 should be a strong year, unless the scenario that I just described comes into place. I think people are so concerned with fixing the supply chain, that they’re going to ignore the dynamics and the realities of the real estate market.
This article also appears in the January 2022 issue of Chicago Industrial Properties.