Industrial Investors Are More Selective in Wake of Rising Interest Rates, Say InterFace Panelists

by John Nelson

CHARLOTTE, N.C. — Despite strong fundamentals and a plethora of buyers waiting to transact, the industrial sector is experiencing dwindling sales as the industry is still reeling from the impact of rising interest rates.

The U.S. industrial sector recorded $82 billion in sales volume in 2023, a 46 percent year-over-year decline and the lowest sales volume in about six years, according to data from Matthews Real Estate Investment Services. Newmark tallies the first three months of the year totaling $16.9 billion in U.S. industrial sales volume, which would be the seventh consecutive quarter of annualized declines.

Michael Brennan, co-founder, chairman and managing principal of Brennan Investment Group, said that the rising cost of debt inherently makes values a moving target even in a healthy sector like industrial real estate, especially with such a massive upswing in interest rates over a short time frame.

“Interest rates are the No. 1 problem for real estate,” said Brennan. “Buyers and sellers can’t see eye to eye. And make no mistake, prices went down, though maybe not as much as we thought they would have.”

The data backs Brennan up as the average price per square foot was recorded at $130 at the end of 2023, about 4 percent lower than fourth-quarter 2022, according to data from Matthews. While seemingly a step in the right direction, the downward pressure on pricing hasn’t quite shaken loose investment activity up to this point.

Brennan’s comments came during a fireside chat at InterFace I-85 Industrial Corridor, a networking and information conference held at the Hilton Charlotte Uptown hotel on May 20-21. Approximately 400 industry professionals attended the two-day event, which included panel discussions on various topics affecting the industrial real estate sector in some of the Southeast’s top markets along the I-85 corridor. InterFace Conference Group and Southeast Real Estate Business hosted the third-annual conference.

Buyers need interest rate stability

During the investment sales panel, speakers said that they are keeping a watchful eye on interest rates as they underlie every real estate decision.

“I don’t think ever in my 30-year career in real estate have I watched the 10-year Treasury yield every single day in The Wall Street Journal,” said Pete Anderson, executive vice president and principal of Becknell Industrial.

The 10-year Treasury yield spiked in October 2023 at over 5 percent before receding to close out the year. The panelists said that their industry noticed the bump, to say the least.

“There were a lot of deals that were completely pencils down. Buyers were just sitting on the sidelines,” said Rob Gage, managing principal of Brennan Investment Group. “They weren’t taking calls in October, but by January they were seeking out opportunities. I’d say that outlook over the last three or four months isn’t quite as rosy as we thought in January, but the buyers are still there.”

The panelists expressed how much the narrative has changed since the beginning of this year. The 10-year Treasury yield was at 3.86 percent in early January and there was chatter that the Federal Reserve was going to enact three to six rate cuts to the federal funds rate over the course of 2024. Fast-forward to today, the 10-year Treasury yield is at 4.3 percent and several panelists said they don’t expect the Fed to make any rate cuts this year.

During the fireside chat, Brennan explained the interconnectivity between the Fed and the U.S. Treasury Department, as the government historically tightens its spending when the U.S. central bank raises rates. He said that when countries like Japan and Germany are investing heavily in their remilitarization, it’s more difficult for the United States to reel in expenditures.

“When you have fiscal spending raging like you do in the G20 Countries, it’s harder to put spending down,” said Brennan. “And then, after the Inflation Reduction Act, the CHIPS and Science Act and the Infrastructure Investment and Jobs Act, we added another $4 trillion. And that money is still not out of the system yet.”

The investment sales panelists agreed that interest rates remain the ultimate hurdle for buyers and sellers alike. Tyler Swann, managing director of W. P. Carey, joked that he has turned to divine intervention to request more favorable rates.

“When I go to bed at night and say my prayers, I ask for stability in interest rates,” said Swann. “And that’s what I’m hoping for for the rest of the year.”

Anderson added that stability is much needed because, until confidence returns in the market, capital sources will have “one foot in the water and one foot out.”

Earlier this week, the European Central Bank cut its key interest rate for the first time since 2019, from 4 percent to 3.75 percent. Time will tell if this decision, which affects the 20-nation Eurozone, will impact the Fed’s monetary policy this year.

How are buyers responding?

Christopher Skibinski, managing director and principal of Avison Young’s Charlotte office, said that sellers are in a tough spot as they are trying to make a certain level of return to ensure profitability. He told an anecdote about a seller that recently sold a property for less than what it paid two years ago.

“There are a lot of different decision points happening for sellers that are somewhat difficult to predict, it’s very specific to the asset or fund,” said Skibinski. “There’s no shortage of buyers — there’s a shortage of sellers.”

Other panelists agreed that buyer demand is healthy but emphasized that deal activity boils down to what individual opportunities they are pursuing. Gage said that Brennan Investment Group plans to be both a buyer and seller this year, and he anticipates the firm to be very selective when seeking out investment options.

“We are just going to make sure that we cross our T’s and dot our I’s and that we’re buying the right stuff at the right price,” said Gage. “There is money that wants to buy, but they are going to scrutinize; it’s going to have to be good locations with good function.”

Anderson said that Becknell’s pipeline on the development side is going to be smaller infill deals because buyers view those facilities as less risky.

“Capital is going to be more into bite-sized transactions,” said Anderson. “We’re going to focus our energy on that for the foreseeable future. Change creates opportunity, and we always have to be able to change our business models a little bit to reflect what the market gives us.”

Panelists said that outside of smaller infill deals, what’s proving popular are facilities with some vacancy as well as those where the tenant roster is going to turn over in the near future. Gage said that Brennan’s sweet spot right now is industrial facilities leased to tenants with one to five years left of weighted average lease term (WALT).

“We like to kiss a lot of frogs to find a prince,” said Gage. “We love Class B facilities in Class A locations; we are not afraid of taking on some of those vacancy risks. We are looking for that hidden gem that maybe somebody else doesn’t see where we can do something and extract value.”

Gage mentioned that Brennan Investment Group recently purchased a 180,000-square-foot facility in High Point, a city in North Carolina’s Triad submarket along the I-85 corridor. The facility had a long-term tenant that was vacating soon, and recently The Home Depot leased the space and invested heavily in the build-out.

Skibinski said that investors are attracted to value-add deals but made it clear that there is little to no distress in the industrial market, in part because investors are proving to be more sophisticated than in years past.

“The capital stack is more mature, they are not going to give back an industrial asset to the bank if they can absolutely help it,” said Skibinski. “If they do that means that something really went wrong in the economy.”

Gage added that he knew of a fund from an undisclosed investment partner that had a $500 million allocation to acquire distressed industrial facilities. A year into its lifespan and the investment fund has only deployed $40 million.

“That tells me they haven’t been able to find [distressed assets],” said Gage. “We haven’t seen sellers truly in distress yet.”

Multiple panelists said that there’s reason to be optimistic that investment sales volume will pick up soon, whether or not the Fed cuts rates. Specifically, the speakers cited that they’ve seen competition rise for available deals.

“Since the beginning of the year to the end of last week we have seen the amount of offers we’re getting go up about 35 percent,” said Britton Burdette, senior managing director of JLL Capital Markets, who moderated the investment sales panel.

“More buyers are going to keep showing up,” added Gage. “Hopefully we’ll see one or two [rate cuts] between now and the end of the year; that’ll spur additional activity.”

— John Nelson

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