Industrial Faces an Additional Upcoming Challenge in Overall Corporate Debt

As is true for all commercial real estate, industrial, while still showing strength, does face some struggles common to all CRE property types. However, another one, overall corporate debt maturities, could offer additional headaches, according to Newmark’s latest report on industrial.

Industrial has been doing well. Q1 of 2023 has seen absorption of 65 million square feet, which is the best first quarter compared to pre-pandemic times. But that’s also down 40.4% from 2022’s Q4. Usually, the fall-off from Q4 to the following Q1 is more like 5% to 10%. There are also expansive amounts of new property, 138.0 million square feet in the first quarter.

“Many markets will encounter rising vacancies as the pipeline delivers into an environment of normalized demand, with an attendant increase in sublease availability,” the report said. “However, new construction starts to continue to ease amid further tightening of overall credit conditions as liquidity concerns remain pronounced following the takeover of First Republic Bank in early May 2023.”

Aside from ongoing strong performance, none of this is particularly surprising and other property types face similar issues, though in some cases, like office, with gloomier results.

Another issue is the maturing of debt. “The largest amount of real estate backed mortgage debt in history is maturing between 2023 and 2024, most of which was originally issued since 2020 at record low interest rates, potentially impacting some industrial property values ​​as debt comes due,” the report noted. Though instead of panic over refinancing, large net operating income growth and asset appreciation have effectively already leveraged properties. Owners who do not need to sell or reposition will likely retain their assets. Again, not the case for all property types, with the office facing much larger hurdles to clear.

But where maturing debt may come into play is in more general corporate debt, where a happy confluence of rising rent values ​​may have taken the kettle of disruption off the stove.

Corporate debt could have a broader impact because it can affect how tenants choose to operate. Accounting standards say that leases longer than a year are balance sheet capital obligations and “require further capital investment in equipment to make such spaces operational.” Private capital expenditures on structures and equipment slowed by the end of 2022, suggesting that tenants “are pausing and reevaluating leasing decisions.”

Companies that have maturing debt at low rates that will now shoot up may decide to put extra money into paying down debt rather than other things, like real estate. They might get involved in mergers and acquisition activities that result in reducing overlapping staff and cutting use of space, affecting rent rolls, “a concern for both sublease availability and credit loss via tenant default that may tilt the scale of market vacancies abnormally.”