Industrial Real Estate – Year End 2023

The industrial real estate cycle is pointing at Recession. It should not be a surprise because it was brought intentionally by higher interest rates in an effort to combat inflation. Based on my market experience, it’s a mild recession. Tenant activity is adequate, not robust. Rents are down after surging during the Supply Chain Chaos, but they are still above pre-covid levels. Sale prices are also down because higher interest rates require a price adjustment.

When rents are falling, landlords need to close those deals immediately. If they stall and get lost in the back-and-forth, that tenant will skip to a cheaper building.

There are overleveraged buyers who purchased at the peak when rents were their highest. The best example are outside storage yards. But almost any building that was purchased with short term or adjustable-rate finance will have to digest higher rates with some needing to add cash. Businesses, too, are facing higher interest rates. Private credit facilities have entered the void left open by the banks. These companies, who own their real estate, are motivated to sell and leaseback.

The current financial environment makes Sale Leasebacks advantageous for both buyers and sellers. In periods when it’s difficult to obtain financing, lenders will be more generous with a 10 year (or longer) lease in place. Corporate sellers and owner-occupiers, facing higher interest rates, can look to their owned real estate to raise lower cost financing in a Sale leaseback transaction.

There are generally three different types of sale leasebacks:

The first is an Absolute NNN lease with no landlord responsibility including casualty and condemnation. The tenant keeps paying rent no matter what. It has elements of a corporate bond in its reliance on the tenant’s credit. A Credit Tenant Lease is for critical manufacturing, distribution, or infrastructure for a long term lease with a rated tenant.

The second form of Sale Leaseback is used to raise cash for lower rate financing or for other financial engineering reasons. Owner users and corporates can unlock years of “unrealized” equity. There are often balance sheet advantages. Sale Leasebacks are routine with private-equity owned businesses. Pricing is closely related to the tenant’s credit rating.

The third type of Sale-Leaseback is in name only. Because either the lease term is short, or tenant credit is weak. These deals are more fully underwritten on the real estate. Tenant term and credit is less a factor than building quality and market acceptance. Buildings in major metros that are easy to backfill are good candidates.

A good use of the sale leaseback is with growing companies. Retailers are a common example. In the manufacturing realm many companies benefiting from the Inflation Reduction and CHIP Acts are using Sale-Leaseback’s to finance their new factory building and acquisitions.

Sale leasebacks are a common tool in the CEO playbook. Located in Los Angeles, we ally with local SIOR independent, market experts from across North America and Europe to support our activities. We will respond rapidly to industrial building opportunities you may have in Los Angeles and elsewhere in the United States.

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Declining Industrial Building Rents

Rents are declining from pandemic highs. The rent range for greater Los Angeles (including property taxes) is $1.00 per foot for older spaces to over $2.50 per foot for newer bulk space. More space is available in almost all size categories. Smaller spaces are rare due to the higher cost to build. One note for the South Bay. Rents are lower in The Gardena/County Strip area because of RV encampments, concerns of employee safety, and local government failure. Rents are highest in the LAX, Beach Cities, and LAX where there is high-tech manufacturing, defense and airfreight.

Property Taxes

Property Taxes have a big impact on rents. At one time, property taxes were only a few cents per square foot (psf) but with a rise in property values, it’s common to see up to $.50 psf once properties are reassessed. It can be 25% or 30% of your total rent. Due to Proposition 13, when a property is sold, taxes are re-assessed at the new value and that increase is normally passed through to tenants. Looking at the chart below, lowest taxpayers are almost always longtime property owners, families or partners. High taxes are more common because of the long investment boom since 2010.

Power

Tenants seeking heavy power, 2000 AMPs or greater, will face delays of twelve (12) months or greater because electrical switchgear and transformers are on back order. Many tenants are seeking EV chargers which increases load. In some parts of town, vandals strip vacant buildings of electrical breakers and copper wiring making the buildings inoperable. The graph below shows there is an ample supply of buildings with sufficient power. Many buildings with the most power will lack the most modern features since they date back from L.A.’s manufacturing past. Developers are installing large panels in their new buildings.

Industrial Sale Market

Higher interest rates have changed everything. Relatively high rates have restrained the long investor led boom since 2010. With many investors sidelined, owner/users have the opportunity to buy. Even at current mortgage rates, the loan payment approximates the amount you would pay for rent. Loans are prioritized for long term credit tenants and not risky investment deals. Large acquisition funds are selling their less desirable assets. Carrying paper is attractive.

Jim Klein, SIOR a 40-year background of industrial real estate brokerage and investment in the Los Angeles area. Our specialty is representing corporations and local landlords. While we practice in Los Angeles, we have moved many customers out of state with help from our SIOR colleagues throughout North America. Klein Commercial recently added new sales staff, IT and analytics to our brokerage service. Please consider us for your next industrial real estate deal.

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