Industrial’s Eye-Popping Numbers Will Be Tested By Interest Rate Hikes

The industrial asset class has been on a tear since well before the pandemic began, and the sector has seen enormous growth since 2020, when more customers than ever before began shopping online. 

But eye-popping pricing and deal flow will likely be tested by the recent increases in interest rates and financing costs. Since the beginning of the year, the 10-year Treasury rate has ticked up by 150 basis points, and the Fed has indicated that a series of additional interest rate hikes are on the horizon for 2022.

“Debt coupons have increased correspondingly, reducing the premium between mortgage coupons and industrial acquisition yields,” CommercialEdge analysts note in a new report. “Because demand for industrial is so robust, and rents are expected to keep increasing, investors have been paying high prices. Deal flow could moderate if banks become more conservative and reduce leverage or if buyers demand higher yields

to make up for their increased cost of capital.”

CommercialEdge has logged about $19 billion in industrial transactions through April of this year, and analysts there note that the figure could increase over time due to lags in collecting data.  However, the firm says deal flow in 2022 is likely to lag last year’s historic highs.

The national average sale price of an industrial asset through April was $135 per square foot, a full 20% higher than the $113 per foot average observed in 2021, according to CommercialEdge. And some experts posit that in the current inflationary environment, industrial deals with lower lease terms remaining will command premium pricing as buyers mark to market rents more quickly.

At least a half-point rate hike is expected in June, with other increases to follow this year. Higher rates will make debt more expensive as commercial and multifamily rates increase, and that will impact levered IRRs and will “undermine levered returns achieved by real estate investors,” Newmark analysts note in the report. But despite that, a record amount of dry powder stands to be deployed this year into CRE generally, with Newmark noting that deal volume has already increased by nearly 56% year-over-year in the first quarter to reach nearly $171 billion, a historic first-quarter high.