How Debt Costs Will Affect Industrial Demand This Year

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Although supply-and-demand dynamics in the industrial real estate sector can perhaps be broadly foreseen over the rest of this year, “higher debt costs and tighter credit conditions are causing companies with maturing corporate loans to reevaluate capital spending decisions, including allocations for industrial real estate,” Newmark cautions in a new report, “Debt Dilemmas: Record Corporate Maturities May Impact Industrial Demand.”

While demand for industrial space remains “remarkably healthy,” the report notes that it’s also slowing. The approximately 65 million square feet absorbed in the first quarter was exceptional relative to before the pandemic, yet that figure is 40 percent below the fourth quarter of last year; a typical drop as a new year begins is only 5 to 10 percent.

READ ALSO: Industrial Sector Fundamentals Remain Solid

Newmark anticipates that quarterly absorption this year will stabilize at about that 65 million square foot figure, “a return to pre-pandemic levels of demand.” However, a record amount of industrial space—138 million square feet—delivered in the first quarter.

The result, according to the report, is that “Many markets will encounter rising vacancy as the pipeline delivers into an environment of normalized demand, with an attendant increase in sublease availability.” Nonetheless, there are indications that new construction starts will slow, with vacancies tightening in some markets beginning next year.

Still, while market fundamentals could normalize, this isn’t 2020, and “debt costs have markedly increased,” Newmark points out.

The report warns that the largest amount of real estate backed mortgage debt in history is maturing between 2023 and 2024, and most of these loans were originally issued since 2020 at record low interest rates, which could potentially impact some industrial property values as debt comes due.

Most loans from 2020 and earlier “have organically deleveraged,” in part because of steady net operating income growth, so owners with no need to sell or reposition will likely be fine.

Other owners, however, such as those in markets with less-stable fundamentals, will have to consider their options. Newmark notes: “There is a great deal of bridge capital available that, while expensive, may be used by owners that can withstand a short period of negative leverage while debt markets begin re-pricing.”

Corporate debt

An even larger impact on the overall industrial market might be maturing corporate debt that was sourced since 2020 and is now facing very different lending conditions. Companies will likely focus on expending capital to pay down that debt, repurchase stock, or pursue avenues other than real estate, according to Newmark.

Anecdotal observations suggest that many major occupiers are pausing and reevaluating leasing decisions.

The exception is an extraordinary volume of expenditures going into the construction of new manufacturing facilities, particularly in the EV, battery and chip sectors, Newmark observes, though these are often heavily subsidized at the federal and/or state levels.