Link to CREJ: CREJ Industrial Quarterly – Kenai Capital Advisors – Shifting Capital Allocations
(PUBLISHED in Colorado Real Estate Journal – September 17, 2021) The Industrial sector has been a consistent headliner in commercial real estate, boasting overwhelming demand from end-users and investors alike. This asset class has been flooded with investors who see value in allocating capital towards industrial and away from office and retail as a safer investment vehicle in today’s favorable economic environment. The increased investment volume into the sector has created changes to both individual and portfolio opportunities as the market has more aggressively pursued this asset class. The composition of capital pursuing the various industrial asset class subtypes has been notably shifting as well, which has led to record-breaking pricing and heavily competed transactions.
As competition has increased for industrial assets, institutional investors have reduced their minimum equity check size in an attempt to place capital. Simultaneously, private investors have increased their interest in industrial opportunities and have exchanged or diversified out of their retail, multi-family, and office assets for industrial holdings. This has led to intense competition for middle-market industrial assets (meaning those valued between $5 million and $30 million). Portfolios that traditionally may have been uninteresting to institutional buyers because of the tenant credit and building vintage are being seen now as opportunities for institutional capital in the current market. The individual assets within these portfolios were traditionally geared toward private investors, but now as a package, these assets are being flooded with offers from institutions trying to place equity to meet capital allocation goals. Although many of the marketed portfolios are still large from a valuation and square footage perspective, the make-up of many portfolios on the market today includes properties that would have typically been on the smaller size for institutions. On an individual asset basis, institutions are proving to be less sensitive to remaining lease term on existing buildings, as well as more willing to involve themselves earlier in forward contracts for new construction assets whereby they assume lease-up risk for a discounted spread versus a similar fully occupied asset. Furthermore, many large investors have adopted aggregation strategies that add middle-market products into their portfolios as a strategy to meet their allocation demand.
Many private investors, high net worth individuals, and family office groups who have traditionally played in the multifamily space have identified value in diversifying their portfolio into the industrial asset class as multifamily returns have shrunk. These groups, specifically family offices, recognize industrial as an opportunity for consistent dividend paying assets, an extremely liquid debt market, and longer-term leases than multifamily or office. As family offices and other private investors shift their allocation goals to meet their portfolio return requirements, they are realizing that industrial assets provide arguably better risk adjusted returns compared to multifamily in today’s market. Not only are they shifting their asset allocations, but they are also writing larger equity checks to compete for both portfolio and individual industrial assets. As family offices enter the already heavily competed upper middle-market industrial space, their adjusted return profiles and larger equity checks place them direct competition with private equity firms, funds, and other institutional investors in the space. Denver has been identified as one of the preferred geographic locations for private capital to invest, with family offices and high net worth individuals diligently looking for investment opportunities. The result for current owners of industrial assets, regardless of the size or age of the buildings, is that there will be someone interested in buying their properties.
As the industrial market continues to see increased competition, investors still feel compensated for their risk, even as cap rates continue to compress. Market characteristics show a favorable outlook that generally supports the increased pricing on a square foot basis, as construction prices ($/SF) for new product have accelerated upward at a faster rate than existing product’s sales pricing per foot. Positive absorption is promoting investor’s movement towards industrial products and bolstered the belief in upwardly trending market rents. The low-interest rate environment and lender demand for industrial product has also supported the yield compression within the sector. Each of these items allow investors favorable conditions to underwrite industrial assets and feel comfortable with their risk adjusted returns compared to other assets classes currently. There are risks associated with the sector, however. As new supply is planned and delivered in the Denver MSA from developers rushing to build product to meet current demand, investors are seeing new industrial assets coming online (and to market) at a record pace. High cube distribution and manufacturing spaces top the list for product in the pipeline, yet sub-sections of the industry such as flex-industrial, life science, and data center space are also teed up for near term delivery. Projections are for approximately 9 million square feet of supply to come online in the Denver MSA over the next few years, potentially applying downward pressure on rents and rent growth as demand for space is met and excess supply is realized. To combat this risk factor, some developers have begun to diversify their offerings of new properties to life science and single-story flex properties, as these asset types have become desired for their high-ceilings and multi-faceted uses. Thanks to COVID, traditional office users too, are seeing value in the single-story open floor plans and lower occupancy costs found in flex-industrial assets. With no elevators, less common area to maintain (lower OpEx), lower rents, and the popularity of an industrially designed office, there has been increased demand from tenants for this type of space. As more user types enter the industrial market, the risk of oversupply diminishes and may create even more opportunities for investors to enter the industrial space, and into assets that are not just oriented toward logistics, manufacturing, and warehousing.
Owners of existing industrial assets should rejoice, as the current market conditions are extremely favorable for them if they choose to sell, refinance, or recapitalize. The investment market continues to show favor towards, and value in, industrial assets as more investors and lenders have entered the space. The shift in portfolio allocation from nearly all classes of investors has also led to increased demand for industrial opportunities. This has led to an increase in developer activity, promoted by tenant demand for all types of industrial product, and favorable capital markets that have kept prices rising. Even with significant supply coming online, investors can realize favorable risk-adjusted returns in today’s climate. Whether it is institutional or private equity, capital allocation has shifted favorably toward the industrial space with investors looking aggressively for more opportunities in Denver.
