Investors Eye Industrial Assets With Shorter WALTs as Capital Costs Rise

Industrial assets with shorter weighted average lease terms, known in industry parlance as WALTs, are becoming more attractive to investors as leases set to roll in the near term increasingly pose the opportunity for “substantial” income gains, according to new research from Newmark.

The firm notes that nationally, market rent growth has “far surpassed” industrial rent increases for deals inked five to ten years ago. Consider a six-year lease signed in 2016 with 2.5% annual escalations: on average, according to Newmark, rents on that lease would be 36% below market rent today – much lower still in markets with the steepest rent growth over the same period. And “on the other hand, assets with a longer WALT, even with significantly below-market rents, have not participated equally in the impressive run-up in values and will not see as much of an increase in basis until market rent can be captured at an extended future date with all its attendant uncertainties,” the firm’s researchers note.

A Newmark analysis of industrial sales transactions last year showed that assets with less than three years left of WALT boasted an average 55% premium on pricing per square foot, with cap rates approximately 70 basis points lower, than assets with nearly a decade or more left in WALT.  And they say that cap rate delta implies a 17.5% difference in value between short- and long-term WALT assets, on average.

“Certainly, deal metrics shifted in the second half of 2022 as cost of debt rapidly increased upon successive interest rate hikes,” write Newmark’s David Bitner and Lisa DeNight. “Overall, monthly industrial capital markets activity has experienced double-digit year-over-year declines since August 2022. However muted, transaction activity does continue, with limited data indicating upward lift on cap rates and a decline in pricing for both short- and long-term WALT assets, but higher premiums and lower cap rates are still placed on the former.”

Owners will have the opportunity to reset currently in-place rents when leases roll in the near future. With more interest rate hikes on the horizon, the acquisition of near-term WALT assets “carries potential for short-term negative leverage, but the prospect of securing greater cashflow and refinancing at a lower rate in the years to come will likely keep this profile of asset competitive in 2023,” Bitner and DeNight maintain.  The pair predict that this year, fundamentals will continue to drive interest in short-term WALT, but “with hyper-focus” on the NOI increase that can be achieved versus the increasing costs of debt.

“Industrial investors who bought quality assets with short-term WALT, rolling in 2024, may foreseeably benefit from refinancing potential at lower debt cost and attractive supply/demand fundamentals for securing new tenancy and appreciating rent growth,” Bitner and DeNight say. “These seeds, given other cooperating factors, could germinate into an environment of cap rate compression in 2024. As lenders become more conservative in the near term, market-specific supply-and-demand fundamentals will become ever more important for investors exploring short term WALT – or any other – industrial investment opportunity.”​