— By Nellie Day —
Everyone is tired of hearing about the challenging lending climate — no one more so than investors and developers who would like to keep the gravy train moving.
“I think the glory days of the last four to five years are now tempered with the increased interest rates,” says Jordan Schnitzer, president of Portland, Ore.-headquartered Schnitzer Properties. “I also believe the hyper growth of big box industrial developments over 500,000 square feet is grinding to a slower halt. A significant amount of that growth has been from Walmart, Amazon and other large retailers that now may have enough space for the next several years before they enter a growth phase again.”
So, what’s an industrial player to do when interest rates are high and the industry darlings that have been so active for so long now say their needs have been met?
You pivot.
“While it’s easier to collect a single check from a 500,000-square-foot tenant, we would rather roll up our sleeves and work harder to get 50 tenants from a 500,000-square-foot building,” Schnitzer continues.
New Strategies For A New Era
Schnitzer notes that his firm began to see cap rate compression on Western-based industrial projects about six years ago, which caused the company to ramp up its development activities.
“We now have 11 million square feet of projects over the next five to eight years planned in the six states we operate in and hope that those projects will be successful,” he adds. “Our sites are all in land-constrained submarkets, and since we are a long-term owner, if we have to wait an extra year or two to develop some of the projects, so be it.”
One of the projects Schnitzer is currently developing is Phase I of Sherwood Commerce Center, a 1-million-square-foot asset in the Portland submarket of Sherwood, Ore. This 435,000-square-foot phase will offer flex and mid-bay spaces for large- and small-space users. Schnitzer believes his company’s ability to target users of all sizes will set this project apart from some of the other massive box players.
“These buildings are being designed so that we are not competing with Trammel Crow, Phelan and Panattoni projects in the same submarket,” he says.
High interest rates also make this an attractive market for cash buyers like CapRock Partners.
“CapRock is actively acquiring land for development, as well as middle-market, value-add assets across the Western U.S.,” says Jon Pharris, co-founder and president of CapRock Partners in Newport Beach, Calif. “In the current investment landscape, CapRock is focusing its efforts through its flagship value-add fund series, which is strategically aimed at securing institutional assets in prime locations within primary markets. Our target markets exhibit low vacancy rates, high barriers to entry and a strong historical demand.”
Pharris notes the firm is actively working to secure assets below replacement cost, which pave a clear pathway toward increasing cash flow. On the land acquisition side, CapRock acquired 85 acres in Las Vegas this summer for a future 1.5-million-square-foot, multi-building development. The firm estimates construction will commence in 2025.
Phoenix is another primary market on CapRock’s radar when it comes to land acquisitions.
“In markets with larger land supply, such as Phoenix, CapRock continues to focus on infill locations with immediate freeway access that demonstrate strong historical demand,” Pharris says.
John Ramous, Nevada region partner at Dermody Properties in Reno, Nev., also sees infill sites being the current play.
“Over the next few years, in Southern Nevada, the last of the infill locations are being developed throughout the Valley for smaller logistics projects of typically less than 350,000 square feet,” he says.
The firm is currently developing LogistiCenter at Nellis Boulevard, a 327,000-square-foot, single-load building just south of Nellis Air Force Base in North Las Vegas. The building will be divisible to 78,362 square feet, with occupancy beginning in the first quarter of 2025. When it comes to infill, Dermody is also working on LogistiCenter at I-80 West Phase II, a two-building industrial center in Reno that will total more than 429,000 square feet, as well as LogistiCenter at Kiley Ranch, a two-building park in Sparks, Nev., that will offer 385,364 square feet for lease.
Demand Drivers
Jarrod Hunt, vice chair of Utah industrial for Colliers in Pleasant Grove, Utah, notes that although many big box players may be taking a break, there are still plenty of industries active out West.
“We see continued growth in the cosmetics, nutritional supplement and enhanced drink arena,” he says. “We are also seeing an increase in the mid-market-size requirements as some companies pull their warehousing/fulfillment in-house. Many firms can now justify the expense as their volumes have grown.”
One industry experiencing a lot of industrial demand may be surprising, given the current interest rate environment.
“Another growth area is the building supply segment,” Hunt continues. “Many of our regional and national supply houses are upgrading or consolidating space into larger facilities, which has been a good source of business recently.”
Colliers will soon deliver a 123,000-square-foot space to building materials and services provider Builders First Source at the Catalyst Business Park in American Fork, Utah, about midway between Salt Lake City and Provo. The company is also finalizing a lease for an unnamed building material supply company that will take 43,000 square feet at Deer Park, a 252,130-square-foot, two-building asset also in American Fork.
“[The activity in the homebuilding and related sectors] has been a little surprising to everyone because of the national news and general downtrend in housing,” Hunt admits. “But these groups look long-term and can’t base their business too much on cycles or they will go crazy trying to read the short-term future. When it takes 12 to 18 months to deliver space, it’s impossible to get market timing perfect.”
There’s one more industry that’s recently caught Hunt’s eye as demand and activity shifts.
“We are seeing new conversations with manufacturing segments we haven’t seen historically,” he adds. “There is interesting growth in the composite manufacturing arena, as well as other industries, such as micro-chip/semiconductors that are being incentivized to re-shore production with some of the federal government grant programs.”
Hunt notes Texas Instruments recently announced an $11 billion expansion of its Lehi, Utah, facility to accommodate the expansion of the 300-mm semiconductor wafer fabrication.
“With these high-tech or manufacturing expansions come growth of their suppliers, as well as subcontractors’ need for space, so there is a large spin-out of the spending market wide,” he says.
Transportation efficiency is obviously a huge consideration for many industrial tenants, but Schnitzer knows there are many users that don’t have to travel across country day in and day out. This can make markets with seemingly difficult geographic barriers seem attractive to the right investor.
“Historically, Portland has never been a particularly strong distribution market because ships have to travel up the Columbia River, so it takes an extra day compared to the ports in Puget Sound or Los Angeles,” he explains. “Therefore, the majority of the industrial warehouse market in Portland serves the Portland metropolitan area and sometimes the greater Pacific Northwest if it is within a three- to eight-hour trucking time.”
Industrial rents in Portland have gone up by 25 percent to 40 percent in the past four years, Schnitzer cites. This, he says, is partially due to more domestic manufacturing, the increased population of the Portland metropolitan area and the popularity of ecommerce.
With that in mind, Schnitzer acquired 100 acres in Wilsonville, about 17 miles south of Porland, where the firm is currently working through rezoning issues. It hopes to begin construction on its 1-million-square-fooot project in 2025.
Tyler Mattox, principal at MCA Realty in Santa Ana, Calif., sees business parks as another opportunity in this current market if investors can stomach some risk.
“There is currently a large supply of business parks on the market for sale across the Western region,” he says. “Both DWS and Stockbridge are selling large portfolios of assets of this type. Despite the constrained debt markets, these assets are still garnering strong interest from investors at cap rates in the low-5 range.”
Mattox admits these rates are higher than they were in late 2020 through mid-2022. However, with debt costs in the low- to mid-6 range, he believes leverage is still negative.
“If we see rent growth moderate, which is currently beginning to happen, there may be a further increase in cap rates,” he says.
Still, Mattox doesn’t see negative leverage as the biggest threat to the industrial market right now.
“The biggest threat to Western markets may be one of tenant affordability,” he says. “As rents have escalated significantly, the rent burden on small and medium businesses may start to be felt.”
As for MCA’s current strategy, it’s all about finding that diamond in the rough.
“We look for opportunities where we can acquire an asset that has problems that we feel we can fix,” Mattox says. “Deferred maintenance, functional obsolescence that can be mitigated by renovation or re-design, poor management or leasing or some combination of the above. I think we may see more assets coming to the market from institutions that need to raise liquidity, and this asset class is still one of the more liquid in today’s constrained capital environment.”