Industrial Rent Rollover: Threats & Opportunities

How To Map Out a Winning Investment Strategy

September 3, 2013

PPR54 industrial rents are enjoying a period of above-trend growth (3.3% year-over-year, compared to a long-term average of about 1.5% since 1994). While that goes a long way toward regaining lost ground, asking rents remain roughly 5% below their long-term trend, suggesting that more above-trend growth is in store before speculative construction ruins the party.

Investors who are scratching their heads at pricing in the traditional core markets and cannot take on vacancy can find higher in-place yields, and more upside, on buildings with near-term roll. Five-year leases with a couple of years of term remaining are about 2.2% below market rents today. However, if rents perform as anticipated, owners can expect to capture a pop of about 8%-and much more, in some places-as those leases roll to market in mid-2015. 

Since the market, at a minimum, will already have priced in the difference between in-place and market rent, a winning investment strategy will identify where momentum in rents will result in the most upside on lease expiration. 

The chart in Exhibit 1 highlights 10 areas where the difference between in-place and market rents is expected to increase by at least nine percentage points in the next two years (again assuming a five-year lease term). PPR has selected these submarkets based not only on their rent upside potential, but also to demonstrate a diverse mix of geographies representing viable core-plus/value-add investment targets. 

So, for instance, asking rents in the Inland Empire - Airport Area Submarket Group are about 3% above rents on leases signed three years ago in mid-2010, but by the end of a five-year term, market rents would be about 21% higher, a swing of about 18 percentage points. 

We expect similar opportunities over the next two years in traditional core markets such as the Inland Empire, Los Angeles, and Seattle, and in secondary markets such as Nashville, Orlando, and Portland. All have the potential for swings of 10 percentage points or more in the difference between in-place and market rents.

By Shaw Upton
Shaw Upton is Senior Real Estate Economist for CoStar Group.