Demand for Industrial Real Estate Remains Strong; Debt Pricing on the Rise

While demand for distribution and warehouse space remains strong across most U.S. markets, investors should expect to pay more for debt financing heading into 2019, said Avison Young, Toronto.

The 10-year U.S. Treasury rate has edged upward nearly 75 basis points during 2018 to 3.06 percent on Nov. 20. The rate has not fallen below 3 percent since early September.

“While the industrial sector continues to be a favored asset class, investors are now seeing tangible effects from the upward movement in interest rates,” said Avison Young Senior Vice President David Krasnoff. “This rise in rates has led to numerous loans running into debt service coverage issues prior to closing, leaving many borrowers with their loan proceeds being reduced at the last minute, requiring them to invest more equity than previously planned.”

Furthermore, with credit spreads remaining relatively constant over the last few months, many commercial real estate loans are now passing the 5.00 percent threshold, a level not seen consistently since early 2012, Avison Young noted. “It remains to be seen if this overall increase in borrowing costs translates into a bid-ask spread between buyers and sellers and therefore lower sales volume, or if the abundance of capital looking to be deployed into the commercial real estate sector will accept lower yields in order to be put to use,” the firm’s Commercial Real Estate Debt Market Snapshot report said.

Looking ahead, Avison Young predicted debt capital will be “plentiful” going into 2019 as most market participants expect lenders will continue to increase their allocations over 2018 levels. “However, there is also a feeling that lenders have already cut their credit spreads to razor-thin levels, meaning that as the underlying interest rate indices continue to rise, the all-in interest rates for commercial real estate loans will continue to rise over the coming months,” the report said.

Krasnoff said after extended speculation, the long-predicted increase in interest rates seems to have arrived. “Among the investors, developers and operators we’re speaking to, the general consensus seems to be that commercial real estate interest rates are going up–it’s reality after many months of anticipation,” he said. “Many investors are moving quickly to lock in today’s still historically low long-term interest rates before it’s too late.”

But rising interest rates alone should not be a reason for alarm because rates are still near historical lows, the report said. “Furthermore, with strong underlying real estate fundamentals, as well as a healthy amount of debt capital chasing deals, the industrial sector is poised to remain a favorite asset type for lenders into 2019.”