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- Camps Bay Power Play - How much can IOS owners push rents?
Camps Bay Power Play - How much can IOS owners push rents?
CAMPS BAY POWER PLAY: HOW MUCH CAN IOS OWNERS PUSH RENTS?
After 111 votes came in, the Camps Bay Power Play has the takeaway for all of the IOS yard dogs. Over the past few weeks, we have been collecting replies from the community on how much of a rent increase would cause a tenant to move out. Bear in mind that these results do not consider specific market conditions like vacancy in the market, current rent levels, tenant financial health, and conditions of IOS assets. Shoutout to Guggan Datta from Open Industrial for suggesting this idea to IOSList and Camps Bay Capital.
Without further ado, we will dive into the results and the key takeaways here. Overall, we found that there seems to be considerable pricing power in favor of IOS owners versus tenants. With national vacancy rates in IOS being tighter than traditional industrial (link), many tenants find themselves searching for requirements for a while. IOS is unique because it is one of the few real estate asset classes with dwindling supply while demand is increasing. Many IOS sites have restrictive zoning and municipalities resistant to new IOS sites due to the inability to create many jobs at sites, the lower tax revenue potential, the environmental concerns, and the aesthetics associated with IOS sites.
Another reason we believe there is considerable pricing power is due to the IOS’ historical ownership structure. By our internal calculations tracking the capital markets, we believe that about ~5% of the $200 billion market (link) is penetrated / earmarked by institutional ownership (REITs, real estate joint ventures, etc.). The remainder of IOS assets are owned by mom-and-pop local owners and owner users. Owner users do not typically charge rent to themselves, and mom-and-pop local owners are more concerned about occupancy and cash flow than IRR. Non-institutional owners typically do not employ aggressive leasing / asset management. As a result of the unsophisticated ownership base, tenants have been signing below market leases as IOS demand has increased while supply has decreased over the years.
The pricing power for ownership can also be traced to the P&L of logistics tenants. A Green Street report lays it out well with the excerpt below (link to article here):
The information is corroborated by analysis done by CBRE on the P&L of logistics tenants. The graphic is laid out below and link here:
In theory, if a logistics tenant’s rent is 3%, a landlord could double the rent and it will still be within the acceptable range for that line-item expense. Many IOS sites are mission-critical, and tenants will likely need to pay increased rent due to limited sites that fit their specific requirements. Additionally, there will be considerable disruption for groups that would need to move their equipment, building supplies, trucks, and other things that require IOS yards. Tenants would likely need to reduce other expenses before moving away from these critical sites.
For trucking tenants, there is considerable imbalance between available parking and truckers. There are 11 truck drivers per 1 parking space in the United States, and truck drivers waste considerable time trying to find available parking. Besides time lost finding parking, many truck drivers face fines and dangerous conditions by parking / idling on the sides of highways (link).
Tying all this back to the capital markets, LP equity investors typically seek IOS assets without in-place vacancy and want to mark rents to market upon lease expirations. It is important to provide strong leasing data to get investors excited about IOS deals while under contract. Many investors prefer to see tenant inquiries as well as leasing LOIs that prove tenant demand and underwritten rent levels. Especially in the current high interest rate environment, there is more sensitivity to negative leverage. Unless there is short in-place WALT or a clear leasing story with active tenant leasing discussions, many investors are unwilling to wait more than a year for neutral to positive leverage.
In conclusion, we believe that operators and investors should realize that there is considerable pricing power with IOS owners even in the face of macro headwinds including higher interest rates, trucking company bankruptcies, and slower leasing activity. The future of IOS is bright, and Camps Bay Capital sees a lot of equity and debt demand and interest in the space despite transaction volume dropping off in 2023.
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