Strong leasing activity and rising rents are stimulating investment activity.

The industrial market in the San Francisco Bay Area continues to experience unrelenting demand as the explosion of e-commerce has retailers and outside logistics providers fiercely competing for space.

These include highly desirable urban last-mile distribution centers for rapid product delivery and warehouses to store goods to protect against supply chain pushbacks. However, demand far exceeds supply.

The space crisis is exacerbated by department store competition as life sciences and biotech companies expand in search of new R&D and laboratory space. This is creating new demand for industrial space in the Bay Area on an unprecedented scale.

Why is the market so hot?

The main driver of the industrial boom is the region’s access to major ports and airports for domestic and international sales. For example, the Port of Oakland in the East Bay is one of the busiest ports in the United States. In addition, the Bay Area provides access to major thoroughfares in California and the western states, including Highway 101 and Highway 5 and 80.

With fewer options available, companies are competing for existing space. Amazon, FedEx, UPS, Target, Walmart, and other e-commerce operators and logistics service providers consume warehouses and distribution facilities. For example, to meet the growing demand for warehousing/distribution space in the warm East Bay, that submarket will need 13 million square feet of additional inventory, while only 5.7 million square feet are planned, according to JLL’s report.

A market with high barriers to entry hampers development

The Bay Area is a region with high barriers to entry. Land availability is minimal, especially for large lots that would be required to develop large industrial plants. This complicates the development of new products.

There are also regulatory barriers to the development of new industrial sites. In addition, high property values ​​and rising construction costs make new products difficult. These and other factors will somewhat limit development work in the future.

Moderate demand drives prices up further

The vacancy rate is less than 1% in the South Bay and 3.7% in the East Bay industrial market Oakland In San Francisco, the vacancy rate fluctuates around 4%. Tight market conditions are driving rents up and tenants are willing to pay to keep their Bay Area locations.

These solid foundations are attracting investors’ attention. As demand for industrial assets increases, investors are looking to the San Francisco area for real estate, spending millions. Buyers are attracted by higher rents combined with a cap rate squeeze. The combination of these factors has created a high asset value and a strong foundation for investors who believe their value will increase over time.

San Francisco-based private REIT Prologis Inc. and private equity giant Blackstone operate in the Bay Area, as do other public and private REITs, pension funds, private equity, and family offices. Some domestic investors are looking for established assets that are leased and operating.

Creativity from a lack of space

As options dwindle, big players like Prologis are looking for high-rise buildings in tight urban areas so their tenants can get products to consumers quickly. In addition, areas previously used for other purposes were taken over and converted for commercial purposes.

Credit markets are very liquid

Lenders have always been very active in the industrial sector and especially in the post-pandemic world, the industry is considered a safe haven asset for investors and lenders.

In 2020 and 2021, industrial assets made up a significant proportion of many lenders’ portfolios, and this trend will continue in 2022. The most active lenders for medium-sized and institutional products are life insurers and banks. Life insurance companies are highly competitive in industrial assets and can offer long-term fixed-rate financing on attractive terms, including early rate freezes. In today’s volatile interest rate environment, an early freeze on interest rates eliminates the borrower’s interest rate risk for the 60 days until the loan is closed and 5-10 years thereafter, depending on the loan term. Additionally, insurance companies can often offer interest-free periods, whether it’s a few years or just interest-linked terms, which can help the investor earn a return well beyond the life of the loan.

Debt funds are also competitive in this area for value-added acquisitions and business strategies.

Although borrowers have equity, rising interest rates are making themselves felt. Most forecasts assume an extended period of rate hikes. Interestingly, there is often a cap rate adjustment that accompanies an increase in interest rates. But it hasn’t quite worked out in the Bay Area yet. The Bay Area continues to trade with highly compressed industrial sector earnings ranging from the low to mid 3%.

Transactions Illustrate Financing Options and a Competitive Market

Financing options for industrial assets are available and can often be customized to suit investors’ business plans. Northmarq recently closed a portfolio of six 1,000,000-square-foot industrial lots with properties in Arizona, Virginia, Georgia, and Maryland. Fundrise, the largest real estate investment platform aimed directly at US investors, acquired the assets entirely in cash or with short-term debt, allowing the company to quickly close the properties and combine them into a portfolio.

Northmarq has partnered with Fundrise to raise $97.75 million in assets through a portfolio loan. One of Northmarq’s partner life insurance companies offered competitive interest rates with an upfront interest freeze and an attractive structure that allowed flexibility in raising funds over the life of the loan. Asset-as-a-portfolio financing allows both the borrower and the lender to spread the risk across the assets. This transaction structure demonstrates how investors across the country, including the Gulf region, can be competitive in acquisitions while leveraging the debt markets to maximize returns.

In a Bay Area deal in February, Northmarq negotiated a $35 million refinance for a private owner of a seven-building, 337,585 sq. ft. industrial property in San Jose. The multi-tenant property is well located, just off Interstates 101 and 880, with easy access to the San Jose International Airport. The transaction was structured with a 10-year, interest-only term. Northmarq secured the permanent-fixed loan for the borrower through its relationship with a correspondent life insurance company.

Northmarq was able to quickly rate lock while the 10-year Treasury rate was attractively low. This transaction is indicative of how strong market conditions in the Bay Area attract competitive financing options from lenders.

What will drive financing for the remainder of 2022?

For lenders, there is a flight to quality for both assets and sponsors. Lenders will be most competitive on well-located properties that are stabilized and have a solid tenancy. Meanwhile, the sponsor’s track record and experience in the market are very meaningful to lenders, particularly during volatile times. Lenders will be more diligent in considering those two aspects of a given transaction before committing to lending.