Industrial Net Lease Will Continue Its Hot Streak

Investment activity and cap rates in the industrial net lease sector “appear to be holding up well” despite rising costs of capital, and experts predict activity to continue apace through the end of the year as sellers bring more inventory to market.

Analysts at B+E Net Lease noticed that while recent rate hikes by the Federal Reserve have pushed some in the market to press pause while assets reprice,  the interruption “is more evident on the buy side where investors are reevaluating acquisition criteria and financing strategies given the fluctuation in interest rates.”  Demand is still outpacing supply for credit tenants, and valuations remain strong as more owners look to sell in the current environment. B+E predicts that this demand, coupled with above-average e-commerce activity in the holiday shopping season, will keep valuations strong.

“In 2023, we expect Industrial activity to remain robust, but cap rates will push upwards for the properties valued at over $5M – basically all properties that require debt,” Camille Renshaw, CEO and co-founder of B+E Net Lease, tells GlobeSt exclusively.  ”Cap rates will remain surprisingly compressed for properties that do not require debt.”

The flight to quality is also expected to continue amid market uncertainty: NNN FedEx assets, for example, are “highly sought after” by investors and “are generating very competitive pricing.” According to B+E’s, such assets are listing at an average asking price of approximately $15,585,000 as of November with an average cap rate of 5.27% among transactions listed currently, more than 50 basis points lower than the 5.8% average cap rate last year.

“Cap rate compression has been a hot topic across the NNN industrial market over the past 18 months,” B+E’s Q4 industrial report notes. “With the Fed continuing to raise interest rates, there is considerable discussion and speculation of how higher rates may impact cap rates. Although there is not a direct correlation between Fed rate increases and long-term borrowing rates, rising rates are putting pressure on yields for leveraged buyers. However, cap rates for industrial assets have not moved significantly.”

In addition, B+E notes that cap rates for net lease warehouse facilities have moved 109 basis points so far in Q4 over Q3 numbers, to average of 6.05% as of November 9. Notably, the increases come on the heels of record cap rate compression but they still remain “relatively low” for best in class assets, the report notes. The firm expects pricing to remain strong through the end of this year and into the first half of 2023 given the amount of capital and demand still in the market.

“Competitive cap rates are a byproduct of strong buyer demand and more capital that has been targeting net lease industrial assets. The hands-off style of passive investments with longer lease terms and reliable cash flows are commanding premium pricing,” the report notes. “At B+E, we’ve seen bidding wars between buyers, often leading to industrial assets being sold at or above asking price in this market. Over the past year, there has been a flood of new entrants in the industrial net lease market, which has further added to what was already fierce competition. Cross-border and institutional capital, as well as REITs, have been on a massive buying spree. Even giant investment firms, which we have not traditionally been active in the net lease space, have launched multi-billion dollar net lease platforms.”

At the GlobeSt Net Lease conference this fall,  net lease REIT executives unanimously noted that demand remains high for industrial net lease product.

“We are still seeing demand for product with rates still going up,” said panelist Michael McKenna, vice president of leasing at Rexford Industrial.  “We are 99% occupied and what is left over is rough.”

B+E also notes that Amazon’s announcement earlier this spring that it would slow its expansion plans and sublease 10 million square feet of space did have the dire effect many predicted.

“The amount of space they plan to sublease is a fraction of the firm’s massive, +/- 400 MSF footprint, and there are plenty of tenants waiting in the wings to move into that space,” the report notes.  And so far pricing for Amazon assets has held firm with an average cap rate of 4.32%, 22 basis points higher than the 4.10% average in 2021.