Recent announcements on the economy support some near-term slowdown, but long-term growthAugust 12, 2022
A complex and volatile economic picture has created notable uncertainty, but captures only a snapshot when it comes to the industrial real estate sector. Record leasing and new construction demand continues to guide long-term planning and businesses focus on positioning supply chain and business strategies for the future. In this issue, we examine key economic factors driving the market -- and how industrial is positioned to potentially stay above the economic fray in the coming days.
Capital markets outlook: Managing uncertainty
From high inflation and rising interest rates to strong employment gains, there are many questions about what's ahead for the commercial real estate sector. Moving into what is typically a busy fourth quarter period of deal-making, there is a new layer of ambiguity surrounding deal flow, asset pricing, and overall activity levels for the next 6 to 18 months. Outcomes will vary based on the asset class, geographic market and other factors, but there are many signs that indicate a gentle impact for the industrial sector.
While not immune to the effects of higher interest rates and a softening in investor demand, the industrial sector continues to see strong tenant demand that is driving vacancy rates below 5% in many markets. Rent growth has been in the double digits across many markets, most notably in core markets, port cities, and growing population centers that are attracting a vibrant workforce and the correlating ecommerce activity to support it. Supply chain modernization and risk mitigation have become important elements of corporate capital expenditures and strategic spending.
A look at capital flow
Capital flow is also still strong, despite increased investor caution and a movement to reassess and reposition for changing economic factors. The RCA (Real Capital Analytics) Commercial Property Price Index increased by more than 18% year-over-year in the second quarter of 2022, according to GlobeSt. Industrial prices increased the most, at 27%, followed by multifamily at 24%. And NCREIF research shows that industrial's average total return hit 47.7% in the second quarter, a record high for their research.
Some of those funds are moving outside of gateway markets to growing city centers, as investors spread out their investment geographically to diversify, search for higher yields and capitalize on broader migration and demographic trends. On the industrial side, this trend is benefitting markets such as Charlotte, NC which has seen an influx of residents and a growing demand for industrial space.
Avison Young’s research shows that Charlotte is experiencing record tenant demand with no signs of slowing. During the second quarter, positive net absorption indicated a steady increase in tenant demand, even amid higher rents and tighter lease terms. Interest rate hikes have not impacted investment volume as institutional and private capital continues to buy Charlotte industrial property; however, cap rates are slowly increasing, which is a direct result of the higher cost to borrow money.
Overall, the factors fueling this ongoing industrial expansion -- including e-commerce growth, supply chain modernization and an increase in on-shoring -- are expected to endure despite times of market volatility.
Here's a look at the significant economic shifts that are shaping today's capital markets.
Rising interest rates
The end of July brought several doses of negative economic news, with the Fed boosting interest rates by 75 basis points in an effort to tame inflation. There are two more rate increases expected this year, which will continue to put pressure on consumers to curtail spending. On July 28th, the U.S. recorded two straight quarters of declining gross domestic product. This created concern about a possible recession looming, although many economists downplayed that possibility due to strong job growth numbers (528,000 added in July) and other factors.
Shipping set to slow?
After months of robust shipping activity -- and correlating supply chain disruption, there appears to be a cooling on the horizon. Shipping giant Maersk, which is seen as a barometer for global trade, recently predicted a slowdown in global shipping container demand in 2022 due to weakening consumer confidence and ongoing supply chain congestion. The Danish company reported loading 7.4% fewer containers onto ships in the second quarter versus a year earlier.
Lenders feeling the pinch
The lending community is also adjusting to interest rate hikes and overall economic uncertainty. Many are taking more defensive measures to mitigate risk and more closely scrutinize LTV ratios, tenant commitments, speculative developments, and other factors. The Federal Deposit Insurance Corp. (FDIC) recently announced plans to increase its stress testing of banks with a high concentration of commercial loans across the spectrum of asset classes. Banks remain heavily involved in CRE lending, with levels recently reaching more than $2.7 trillion, well above the $1.9 trillion held in 2008. Although most CRE-concentrated banks felt some stress during the pandemic -- the good news is that loan delinquencies are at historic lows and aggregate loan losses have been nominal.
Consumer Price Index improves in July
Flash forward to August and the economic picture is improving. High gasoline prices, which have been a drain on consumers and businesses, were declining in recent weeks and reached a milestone in the second week of August. U.S. gas prices fell below an average of $4 per gallon, moving to the lowest level since March due to a global decline in oil prices.
The recent interest rate hikes may be having the desired effect. According to data released by the Labor Department on Wednesday, the Consumer Price Index (CPI) was flat in July, compared with June. The July index rose 8.5% year-over-year, but that increase was lower than economists had expected. This caused the stock market to rise sharply on Wednesday, jumping 535.10 points (1.63%) to close at 33,309.51. The S&P and Nasdaq also rose 2.13% and 2.89%, respectively.
The economic picture remains complex and often confusing, but there are reasons to be optimistic about industrial's trajectory over the next 12 to 18 months. Many investors are taking this time to focus on reevaluating their market positions and revising their strategies to account for the many changing variables.
Sources: Avison Young research, Bisnow, CNBC, GlobeSt.
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