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Thursday, January 24, 2013

"Plan B"

By: Erik Foster (Chicago) 

If you look around the national landscape of industrial investment sale transactions in 2012, many of the deals were class A properties in the major markets.  Of these, many of the sellers were large institutional owners who summarily sold to other institutions and even to private REITS.  Yet, there were also some portfolios, which include non-core B product, that were brought to the market and did not trade.

There are several reasons why these non-core industrial B assets did not trade, even while many markets were experiencing brisk industrial sale volumes relative to the past few years.  First, the larger institutions and well-funded buyers, who had the funds and mandate to buy, were snapping up the A product.  Secondly, we have not seen the local and regional buyers begin to get into the market, not yet at least; these buyers are typically the largest aggregators of B product.  So will the future velocity continue to be slower for B assets sales, or will it change?  I believe velocity of B will increase for a number of reasons.

As the largest single industrial market in the country, Chicago is a good place to harvest data for comparison.  In 2012, A sales were 3.8 million square feet (msf), B sales were 14 msf.  The average annual square footage of sales since 1995 for A is 2.7 msf, for B, 14.7 msf.  B is close to its average, but A has been exceeding its average for the last two years.  And, as reported on January 11th, industrial is giving the multi-family sector a run for its money as the preferred investment vehicle for institutional investors. Also, on average nationally from 2003 to 2007, the industrial market had approximately 200 msf of new product under construction; today, there is only approximately 50 msf of new product under construction across the country.   So with A product sales at peak levels and a less-than-average amount of new A product being built, it is likely that more B product will get swallowed by these hungry institutions as they respond to their investors’ demands.  Also, with so little new product being built, rents will improve through all industrial asset classes as vacancy rates continue to decline. This is just one of the reasons being used (and I think correctly so) by acquisition professionals in their respective investment committee meetings in order to green-light the purchase of industrial today.  I believe that more often in the near future, they will be getting the OK from their equity to buy B. 

Some final thoughts on the positive future demand for B product:  industrial rents are rising in most markets, construction and land costs are not going down, and many buildings have been reset to market rents from their market highs.  Although there may be near-term NOI compression with the final seven and 10-year leases turning over from their high levels, the medium term for future rents appears healthy across all industrial product types. Also, commercial-mortgage backed securities (CMBS) leverage is back, and by historical standards, it is cheap. It has also been the B buyers’ preferred leverage option in the past, and it will be in the future. So watch the wave of buyers begin to wade into the industrial waters and bring out the sellers of B industrial product in 2013.

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