Four Things You Might Be Underestimating About Industrial Real Estate

As with so many areas of real estate, there was an operational and profit high during the last few years that was like an industry getting drunk and then waking up with a headache.

Looking back can create regret, but here are some things that MSCI in its Q1 2023 U.S. Industrial Capital Trends Report suggests are easy to underestimate.

1. Immediate Comparisons Are Unrealistic

Would you compare a little kid running around with a blanket tied around the shoulders like a cape to an actual superhero? Of course not. Nor would you reasonably undergo a once-in-a-blue-moon experience and then expect that should become an everyday event. That is the difficulty in looking at typical year-over-year business comparisons in industrial.

“Industrial deal volume hit a record high of $40.6b for any first quarter in 2022,” MSCI wrote. “The next-highest first quarter period was in 2020 when $34.4b traded. Any comparisons of the current quarter to these record high points for the market are going to look harsh. In truth, the market simply slipped back closer to a normal level at the start of 2023.”

According to MSCI’s analysis, average first quarter deal volume from 2005 to 2019 is $11.2 billion. This year’s Q1 transaction volume fits in with the past.

2. The Industry Was Already Gearing Up For Higher Rates

“It can be difficult to think in terms of anything aside from Covid given the collective trauma experienced, but back in the fall of 2019, investors began to adapt to a rising rate environment,” the analysis said, remembering that concerns about rates existed before the pandemic.

CRE professionals attending industry conferences at the time were concerned about the Federal Reserve tightening its balance sheet. But it had been more than a decade since the Global Financial Crisis. Realistically, how long would the Fed put off cleaning its inflated balance sheet?

“Investors wanted to focus more on asset types that had low capex relative to the NOI for a rising interest rate environment, and the industrial sector matched this need.”

3. Investors Were Under-Allocated

The MSCI report suggests that investors hadn’t allocated enough of their capital to the industrial sector. This was true for multifamily, as they reported in a separate publication.

“It is not yet clear that investors have the allocations that they desire as there are many moving parts in place. But with the RCA CPPI for industrial slowing to only a 3.3% gain from a year earlier and volume back to average levels, one might make that case.”

4. Cap Rates Are Up, But Not That Much

One of the stories floating around is the return of cap rates. They are up some, but that’s in comparison to the depths they visited in 2022. Cap rates are nowhere nearly as high as pre-pandemic levels.

“The RCA Hedonic Series cap rate reached5.5% in Q1 2023, up from a low of 5.2% seen in Q1 2022 before interest rates surged. Cap rates have increased only 30 bps in a time when the 10yr UST has increased 170 bps.”

 

Source: GlobeSt