Not long ago, industrial was the CRE darling. Valuations were high, as was demand. Rents kept escalating as problems with global supply chains and a rapid expansion of e-commerce drove unending demand.
Well, unending until now. Unusual situations that act as drivers are almost by definition temporary and will begin to relax. When they do, the extraordinary demand will probably slack. JLL’s Q3 U.S. industrial outlook observations of a collapse in capital market activity suggests that finally might be the case.
Year-to-date industrial transaction volume at $50.7 billion is down 52% from last year’s $106.3 billion at this point. And that’s with the second quarter seeing the Prologis $3.1 billion acquisition of assets from Blackstone. Without it, the drop would have been 55.2%.
Without that consideration, because big transactions regularly appear on the market, the annual transactions through the third quarter in 2023 was the lowest since 2017.
“Transactions with three to five years of WALT [weighted average lease term] remaining with a mark-to-market opportunity for rents continue to be in favor,” JLL wrote. “Core assets generally continue to have shallower bidder depth given the disconnect between going-in yields and appraisal marks. Transactions of scale (generally $150 million+ deals) without accretive existing debt are still more challenging in the market.”
JLL saw the runup in the yields of 10-year Treasurys as a big reason. Values have descended since the 4.98% high on October 19, but they still stand at 4.44% as of Friday, November 17. However, that represents nearly a 4.5% annualized return with as little risk as might be found in any investment. That creates uncertainty among investors, who “are evaluating their underwriting assumptions, with an increased focus on market rent and rent growth projections.”
Aside from the clear monetary influence, another factor is the realization that investors watch the performance of assets. Last week, Moody’s Analytics CRE noted an industrial slowdown in Los Angeles. In the third quarter of 2023, after months of there was a warehouse and distribution effective rent dropped by 0.6% quarter over quarter. “While no market took as big of a dip as Los Angeles in the third quarter, a few others on the West Coast have seen rent growths grind to a relative halt,” they wrote.
That is minor compared to what JLL observed, not in the sense of an overnight change, but in the picture of an ongoing trend.
“There was a notable decline in leasing volume in Q3 as only 90.1 million s.f. of leases were executed,” they wrote. The amount was the lowest not since the pandemic or immediately before, but since 2015. “Around half of the leases signed were new leases, with major markets like Chicago, Inland Empire, Los Angeles, Columbus, Atlanta, Phoenix and Baltimore all recording over 3 million square feet of new leases. Leasing decision timelines are being extended as occupiers are extremely judicious in decision-making while considering all options and outcomes before executing a deal.”
As leasing slowed and occupiers became more careful, the average contracted lease size dropped by 19.7% year over year. Subleases were up quarter over quarter, which was 8.1% of Q3 leasing figures, probably because there’s been an influx of sublease space, JLL says.