IOS Activity In DFW Slows As Stormy Economy Spins Sector Off Course
Demand for industrial outdoor storage in DFW continues at a rapid clip, but challenges on the financing side are keeping momentum at bay.
The number of properties trading hands has plummeted over the last several months as IOS investors struggle to transact. Firms remain bullish on North Texas due to its centralized location and booming industrial market, yet a lack of liquidity and rising interest rates are stemming the flow of deals.
“Folks in this space all understand that the underlying fundamentals are still pretty good,” Timber Hill Group Vice President of Capital Markets Marty Siegel said. “This is strictly a capital markets issue, and until there’s some stability in the capital markets, there will be some inactivity.”
The Federal Reserve’s campaign to drive down inflation through a series of interest rate hikes has done a number on commercial real estate across the board. Lending from banks has all but dried up, and while industrial and IOS are viewed more favorably than other asset types, investors still struggle to source capital for acquisitions and new development.
Those challenges have translated to a dramatic decline in IOS acquisitions. Roughly 55 local IOS sites were sold in 2022, while only 21 have changed hands so far this year, according to data from Davidson Bogel Real Estate.
“A lot of the lenders that are very active in the space are on the sides,” Timber Hill partner and co-founder Ryan Battistoni said. “So by default, is that putting buyers on the sidelines? Of course, it is, whether it’s by their choice or not.”
The divide between what sellers are willing to accept for their properties and what buyers are willing to pay is also stalling deals. Pricing IOS is more difficult than other asset types due to the small number of comps and variability in site size and coverage, said Romit Cheema, founding partner and CEO of CanTex Capital.
“It’s hard to properly value IOS with confidence,” Cheema said in an email. “Now, with the cloudiness of the broader economy and fluctuation in demand, valuation becomes ever more difficult.”
The drop-off in transactions is hardly an indicator of demand, said David Guinn, director of industrial at Davidson Bogel. There are upward of 50 prospective tenants in the market and plenty of investment groups eager to deploy capital in the space.
“We’re still tracking a lot of people out there looking,” he said. “There just seems to be four more layers of analysis that goes into signing any lease right now.”
There are 25 DFW sites on the market for lease, ranging from 2 to 65 acres. About 18 lease agreements have been completed for sites larger than 3 acres so far this year, with the Metroplex on track to see up to 25 leases finalized by year’s end.
Last year, Davidson Bogel recorded 37 total leases.
Rental rate growth has yet to be impacted by the slowdown in leasing velocity, said Scott Arnoldy, founder and managing partner of Triten Real Estate Partners, which owns 29 IOS properties in DFW totaling more than 402 acres.
Average IOS rents in DFW ranged from $3.5K to $6.5K per acre per month in mid-2022, but Guinn is seeing prices today at the top of that range. Brokers expect those costs to continue creeping up as supply continues to dwindle.
“Rents have at least doubled from where they were a couple of years ago,” Arnoldy said. “While the fundamentals are not quite as hot as they were when it was red-hot, they’re still healthy, and we are still getting leases done.”
After picking up 27 properties between 2021 and 2022, Triten has completed only two DFW acquisitions so far this year. Uncertainty around what the Fed might do next has prompted the firm to hedge its interest rate exposure on new deals, and Arnoldy said less available debt requires a greater infusion of equity.
“You might have to absorb a little bit of negative leverage, but it’s not like we haven’t been able to find [capital],” Arrnoldy said. “We’ve gotten multiple financings closed within the IOS space in the last six months.”
Chicago-based Timber Hill Group is in the same boat. The private equity firm owns five IOS assets in DFW but has yet to pick up a new property this year.
Despite the drop-off, the long-term prospects of DFW remain strong, and while most of IOS construction is happening on a build-to-suit basis, Battistoni said Timber Hill plans to continue building spec.
“There are tens of millions of square feet being built in industrial, but we could probably count on one hand the number of IOS sites that are being built that aren’t build-to-suits,” he said. “There’s a pretty strong argument that could be made that the development of IOS is not keeping up with industrial, which is further increasing demand.”
Finding sites remains extremely difficult, and what is available tends to be quickly snatched up by industrial developers looking to maximize the value of the land. That typically means building on as much acreage as possible, said Allison Johnston Frizzo, co-founder and managing partner at Hart Commercial.
“In most industrial markets, land has been gobbled up,” she said. “It’s hard to justify the low return you’d get for not going vertical.”
Trucking giant Yellow is looking to back out of dozens of leases, which could unlock some local supply. But even more impactful is the ripple effect the company’s bankruptcy has had on the borrowing environment, Siegel said.
“The biggest outcome from the Yellow story is we’ve had to answer more questions to lenders,” he said. “It has made lenders nervous [because they think] if it happened to them, it can happen to anybody.”
Raising capital to go after IOS in a big way was extremely difficult when Triten first started buying IOS properties in 2018. The property segment is highly nuanced compared to traditional industrial, and Arnoldy said many investors were hesitant to take the leap.
Fast-forward to today, and while IOS is still considered niche, more investors are recognizing its value, especially as the nation’s industrial sector has boomed.
Though many institutional groups have been sidelined by the rate environment, industry players said that segment of IOS ownership is poised to grow dramatically in the coming years.
“It is for sure on most major institutional capital investors’ radar and priority list,” Arnoldy said. “We are getting a lot of inbounds, and I do think it’s going to become an established property type in the coming years.”
Pent-up demand could unleash a tsunami of new IOS development and acquisition activity once lending resumes. Until then, firms that are able to deploy capital are poised to benefit greatly from the dearth of new supply.
“The lack of new industrial Class-A development that will be delivered over the next three years is going to cause companies to get creative on how they store their equipment,” Guinn said.