Don’t Look Now But Investor Interest Reviving In Warehouses

Despite Recent Economic Deceleration, Investors Insist That U.S. Industrial Real Estate Positioned For Long-Term Growth

While the heated apartment market continues to grab headlines in the ongoing CRE recovery, a number of investors are quietly turning their attention to the warehouse sector anticipating a strengthening economic rebound as the U.S. jobs picture continues to improve, leading to increased consumption and consumer spending, according to the latest PwC (PricewaterhouseCoopers) Real Estate Investor Survey.

“Warehouse demand is rapidly picking up, especially in coastal markets with international port access,” said one participant in the first-quarter 2012 survey, while another respondent noted that “absorption levels have been impressive even though U.S. economic growth has been weak.”

The ongoing recovery for the industrial sector was weak during the first half of 2011 as the European financial crisis accelerated and U.S. economic growth slowed. However, leasing demand grew significantly during the second half of 2011, allowing the sector to reabsorb virtually all of the space vacated during the last recession.

Led by the outperforming big-box warehouse sector, nearly all U.S. industrial markets reported positive absorption in 2011. Many investors surveyed by PwC feel that leasing demand for distribution space will remain strong in the coming months, despite concerns about Europe and the torpid U.S. recovery.

Increasingly strong aggregate absorption numbers don’t tell the whole story of the strengthening warehouse market, according to Shaw Lupton, senior real estate economist for Property and Portfolio Research (PPR), CoStar’s analytics and forecasting division, who noted that many market participants complained about weak tenant leasing during most of 2011.

Lupton said those touting recovery in warehouse absorption and those noting the weakness in leasing transaction velocity are both correct.

“The common perception in the marketplace of flat leasing activity is accurate, yet slowing [tenant] move-outs have increasingly supported positive net absorption — consistent with the recently outstanding profitability of companies that survived the recession,” Lupton said in a recent daily update. “Given this leanness in the industrial economy, we expect move-outs will remain somewhat stickier in the near term, setting the stage for marginal improvements in move-ins to contribute significantly to net absorption.”

While a number of markets throughout the U.S. will see continued low demand and elevated vacancies and cap rates over the next two years, a handful of key distribution hubs such as Southern California’s Inland Empire are already in full recovery.

Investors’ upbeat outlook for warehouse space is tied to the healing U.S. labor market, with underlying positive signs outweighing concerns. Combined with limited construction over the past few years, the potential for rent growth in most markets is now a key driver for acquiring industrial assets, several investors stated.

Rent growth assumptions for the national warehouse market in PwC’s survey have increased over the past two years. Also, the number of surveyed investors that are pushing rents has jumped from 25% in the first quarter of 2010 to 60% this quarter.

In one of the most significant commitments to the U.S. warehouse sector since the economic downturn, Brookfield Asset Management and Dallas-based developer Hillwood last week announced a joint venture backed by a $400 million equity commitment to invest up to $1 billion in industrial properties over the next three years. The venture will acquire, develop and manage mostly large warehouses across the U.S.

“Industrial development slowed during the downturn due to a lack of equity and debt,” said Ross Perot, Jr., chairman of Hillwood. “Given the liquidity and resources supporting our investment, our joint venture is well-positioned to benefit from renewed demand forindustrial space which will increase as the economy continues to show signs of improvement.”

Last fall, Blackstone Group LP acquired a portfolio of mostly suburban office properties in seven markets for $1 billion from Duke Realty Corp. (NYSE: DDR), which is seeking to shed office properties to raise capital to increase its holdings of industrial properties in key distribution markets.

In addition to the national distribution markets, buyers are especially interested in industrial properties located in energy and high-tech markets like Austin and California’s Silicon Valley, where job gains, leasing demand, and rent growth are expected to lead the country. In December, PS Business Parks Inc. acquired RREEF America LLC’s 5.34 million-square-foot portfolio in the Silicon Valley and East Bay for $520 million.

Despite the increased appetite for warehouse acquisition, investors are carefully monitoring both the economy and its impact on the sector’s fundamentals as well as developers’ plans for new supply.

While new construction has been constrained so far, a shortage of quality bulk warehouse space is spurring speculative construction and build-to-suit activity in several markets, especially the Inland Empire. In fact, “the list of markets where the number of vacant blocks larger than 500,000 square feet is approaching pre-recessionary lows is growing and today includes even the recently overbuilt metros of Dallas and Phoenix,” according to Rene Circ, PPR’s director of research for industrial property. “The industrial sector is very responsive to the business cycle and new construction can come back as quickly as it retreated.” Investors realize too much new supply could easily undermine the recovery, squashing rent growth and capital appreciation for the entire sector.

Pricing, Values Firming Across All Property Types
Across the entire CRE spectrum, investors surveyed by PwC see a broadening stabilization in values and pricing. Over the past year, the number of markets posting quarterly declines in overall capitalization rates across all CRE property types has fallen while the number reporting either increasing cap rates or no change has increased.

Industrial cap rates edged down about 7 basis points in the first quarter from the previous quarter to 7.41%, the only national market besides net lease (7.46%, -13 bps) and power-center retail (7.32%, -3 bps) to see continued compression.

Medical office and flex/R&D properties held steady at 7.92% and 8.71%, respectively, while CBD office rose sharply by 19 bps to 7.03%, followed by suburban office, which increased 9 bps to 7.52%

Surveyed investors reported that most of the falling cap rates this quarter occurred in city-specific office markets such as Charlotte, Manhattan, Houston, southeast Florida, suburban Washington, D.C., Northern Virginia, the Pacific Northwest and Los Angeles, all of which posted double-digit declines.

While apartments have led the real estate recovery, “many investors have turned their focus to the office sector as job growth accelerates and limited additions to supply are expected to bolster rental rates in many office markets,” PwC said in the report.

Source:  CoStar

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