New Jersey’s industrial market has long been a favorite for its proximity to ports, airports and major highway system. But vigorous interest rate hikes, inflation and softening valuations mean lenders and borrowers are rethinking their strategies to pivot toward niches within the sector, with the thesis that these opportunities can be easier to finance and offer diversification.
Greek Development, an East Brunswick, New Jersey-based manager, is one such player looking to increase its focus on niche sectors. It is considering cold storage, pharmaceutical warehouses, and properties where there is a chance to remediate an environmental problem.
“In this environment, capital markets have been fluctuating causing a lot of nervousness, especially in the lending community for construction debt,” says managing partner David Greek. “Last year, there was certainly a record level – some might even call it a euphoric level – of investor interest in the industrial space, especially in development projects.”
This year, that interest has been moderated due to concerns over the macro economy, inflation and rising interest rates.
“This is resulting in short-term volatility with industrial deals trading for about 3 percent cap rates,” Greek says. “[Combine this with] the cost of debt being significantly higher than 3 percent, and that has caused people to rethink pricing on assets, especially larger assets, where debt is required. There is a direct correlation between the price of an asset and the cost of debt.”
According to mid-year data from MSCI, US transaction volume in the industrial sector fell 63 percent year-over-year from August 2021.
But cold storage is a niche within the broader industrial sector increasingly entering investors’ radars. Earlier this month, UBS Asset Management and PGGM teamed up to build a $700 million cold storage build-to-suit platform. The venture will target the development of state-of-the-art cold storage facilities, focusing on major food and transportation centers across the US.
In addition to obsolescence of existing facilities, occupancy metrics in the sector back this thesis. Mid-year data from JLL reported an average vacancy of 3.5 percent for cold storage space, with limited new supply coming online.
“This has been a fast-growing segment of the industrial space,” says Greek. “This is especially the case in central and southern New Jersey, where cold storage requirements have been soaring.”
Greek Development has invested in several cold storage developments across the state. Most recently, it secured $227 million in financing from Wells Fargo spread across two loans for two separate projects in Linden and Logan Township in partnership with property developer Advance Realty Investors .
New Jersey’s industrial sector is not only renowned for its resilience during market downturns, regular cashflows and attractive returns but is seen as a strong hub to access the Tri-State market and many heavily populated areas across the Northeast.
“The long entitlement process and evolution of last-mile distribution has led to limited supply in these high demand markets,” says Brad Ross, managing director and head of originations at Los Angeles-based direct private lender Parkview Financial.
Specializing in ground up commercial and residential real estate financing, Parkview is in a good seat for observing industrial trends. It- is witnessing an increase in speculative development in the region from developers that have created value by converting former agricultural sites to industrial development opportunities.
Sponsors are seeking high leverage debt, which matches the residual value of their potential industrial developments at a high LTC ratio, explains Ross, driving activity in the market. “This is due to the value-add story,” he says.
But the sector is not immune to current unstable market conditions.
“There has been a softening in the industrial markets over the past few months,” says Ross, citing the news of Amazon delaying or cancelling up to 50 potential contracts for various industrial developments across the US.
Parkview has witnessed some New Jersey sites trading for low values.
“We see a decrease in valuations across product types, including industrial, due to higher spreads required to attract investors, and decreased borrowing power across the industry,” says Ross. “Those that have created real value and have balance sheets to weather this inflationary environment will perform strongly when the yield curve eventually flattens.”
In situations when properties are developed, leased and sold, the story supports high residual land values.
“Many lenders are making the bet that values are real and here to stay, but in these instances, lenders must be comfortable with imputed value and low sponsor cash equity into a project,” he adds.
Pharma space and beyond
Another niche sector on real estate debt investors’ minds is pharmaceutical manufacturing warehouses.
“Whether it’s for the production of supplements or prescription medicine, the build outs for these assets are typically very similar, and with New Jersey being very dense with pharmaceutical companies, there is more demand [for such developments],” Greek said.
The third trend is toward infill redevelopment opportunities with environmental challenges. “This could be older, environmentally contaminated facilities or perhaps with a dysfunctional design – if they are in excellent locations, we are betting that they stay excellent for a long time,” Greek adds.
There continues to be a positive outlook for the sector – but there will be market players approaching opportunities with more caution.
“Certain lenders, and definitely equity investors, are being significantly more cautious than they were a year ago – not because of lack of liquidity, but because there is uncertainty about what’s going to happen over the next six months to a year,” says Greek.
The firm does not believe there is a liquidity crisis, compared with the GFC.
“We don’t think that’s what’s happening out there in the market,” says Greek. “[Market players] are adopting this wait-and-see approach as they’re waiting for some good economic news and the right trajectory to make investors more comfortable jumping back into the market.”