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Strong Rent Growth Helping Offset Rising Costs In Mid

Jan 06, 2024

While owners of industrial property in the mid-Atlantic region aren't immune from financial headwinds like rising interest rates and construction costs, experts said they see enough upside in the market's rent growth to make it an attractive asset class for investment.

"Our tenant demand in the last 30 to 60 days, across the markets, is either a strong B to an A-plus ... through this entire cycle, our demand is as strong as it was a year ago," Matan Cos. principal Mark Matan said Thursday at Bisnow's Mid-Atlantic Industrial Summit, held at his firm's 700 Progress Way in Gaithersburg.

Other industrial owners and brokers at the event echoed those sentiments, but they also said factors like inflation, interest rate hikes and a scarcity of developable property complicate deals in the region. Speakers generally defined the region as including Maryland, Virginia, West Virginia and Delaware.

Their optimism follows a relatively sluggish end to 2022 for the region's industrial sector. Industrial leasing volume in the Baltimore area last quarter was 1.3M SF, well below the five-year quarterly average of 3.5M SF, according to CBRE's fourth-quarter market report. But that didn't stop the market from recording year-over-year rent growth of 13.7% in December, CBRE found.

Panelists largely attributed the market's slowdown last year to rising interest rates and tighter lending, particularly by national banks.

Mike Trail, chief investment officer for MCB Real Estate, said interest rates hikes caused a "blip" in the local industrial market.

He said investors want to invest money in industrial and multifamily properties, with retail "creeping in over the last six months." But he said there's "more running room" for rent growth in the industrial sector compared to other asset types.

"If you get a big tenant that comes to you and says 'I need 500K SF,' most of the time, the rent is the last piece of the equation to them," Trail said.

Danielle Schline, senior vice president at industrial giant Prologis, projected the imbalance between supply and demand will spur substantial industrial rent growth in the next 12 to 18 months.

"In the Baltimore-Washington corridor this year, there are zero buildings being delivered. Zero," Schline said. "So if we're at 3% vacancy, that's not going to change and rent is going to continue to grow."

Brookfield Senior Associate Kyle McGrady said rent growth slowed in places like New Jersey, which experienced record-setting demand in recent years.

But he said the mid-Atlantic continues to experience comparatively more robust rent growth, with buildings ranging in size between 30K SF and 400K SF drawing the most substantial tenant interest.

"The mid-Atlantic lagged [industrial rent growth] somewhat. But we are seeing that full push on market rates through even some minor difficult [market conditions]," McGrady said.

JLL Executive Managing Director John Dettleff, a leading industrial broker in the region, said industrial rents in the D.C. metro area have increased by 50% in the last two years. While that is not as strong as markets in Los Angeles or Chicago, he said that may be a good sign because it means there's room for rent to rise.

"Rent growth solves a lot of problems for investors," Dettleff said.

Despite strong market fundamentals in the region, developing the properties remains a more significant challenge than finding tenants.

Drew Enstice, vice president of ARCO Design/Build, said costs associated with building skyrocketed from the start of the pandemic until last summer. Since then, prices have moderated, but they still present a substantial obstacle to meeting demand.

"Costs are not going down at the rate they went up, or the rate people had hoped," Enstice said. "So I think a challenge we have is people hear, 'Hey, the cost of steel is going down' [they] assume that our building will be back down to pre-Covid numbers. Unfortunately, it's not even close to that."

Property owners in the region may also face a decision about whether or not to demolish older industrial space. Nationwide, a significant majority of industrial properties are at least 50 years old, panelists said.

One potential solution is to demolish existing nonindustrial properties with the proper zoning, Entice said. One project Entice's firm is working on is the former Diamond Point Shopping Center in Dundalk, which he called a "disaster" with cats living inside.

"To knock a place like that down and build a warehouse is kind of the same price as building a warehouse from scratch," he said.

However, there's little interest in demolishing older industrial properties to build new industrial assets. Industrial Class-B properties, Schline said, fetch enough rent that demolition isn't an option.

"It doesn't pencil right now," she said. "We've looked at a number of projects where we've had an assemblage of [older] buildings ... It doesn't make sense. These rents have grown 100% as well in the last five years."