Cap Rates Plummet on Chicago Warehouses

Two big industrial deals show how strong demand for stabilized properties is pushing down capitalization rates in the Chicago area, a trend that could spur investors to pursue value-added plays to capture higher yields.

Heitman is paying about $140 million to buy seven fully leased warehouses totaling 2.3 million square feet from developer Northern Builders. Meanwhile, Industrial Income Trust has agreed to pay HSA Commercial Real Estate just over $100 million for a 1.4 million-sf portfolio that is 87% leased. Colliers International brokered both deals.

The price paid by Heitman, equal to about $61/sf, indicates an initial annual yield of 6%. The stabilized cap rate will be 6.5%, because a major tenant has a rent bump in the second year. Industrial Income, which is paying $71/sf, anticipates a yield just below 6%. By comparison, the average cap rate for Chicago warehouses last year was 8.4%.

Market players said an enormous amount of core capital is chasing well-leased Class-A industrial properties nationwide. But many investors are getting priced out of the hottest market — Southern California, where capitalization rates are hovering at 5%. “Everyone wants to be in Southern California, but there’s not enough product and pricing is super-aggressive,” said one Chicago industrial broker.

As a result, the recovery is gaining steam in other regions — including Chicago, which has always been a liquid market offering geographic diversification to core investors with exposure to the East and West Coasts.

Leasing demand is improving. The Chicago area’s 1.2 billion-sf of industrial space is 90.5% occupied. There was 4.9 million sf of positive absorption in the first quarter.

Rents, meanwhile, are averaging 35% below their 2006 peak but are expected to rise, so property buyers can expect their returns to increase, said Mike Caprile, a vice chairman of CB Richard Ellis. “These cap rates sound crazy, but you are capitalizing low rents,” he said. “When you really peel back the onion and see the reasons, you say, ‘I get it.’ ”

Area brokers expect the declining cap rates to spark listings of value-added properties.

“Going forward, it’s our view that the investment market will now broaden to include Class-B assets as well as properties with lease rollover and vacancy, as investors become more comfortable underwriting risk and seek higher yields,” said Jim Carpenter, senior director of Cushman & Wakefield’s capital markets group.

In one current value-added listing, Manulife Financial is shopping seven warehouses in northwest Chicago totaling 757,000 sf that are 84% leased. It could fetch $30 million, or about $40/sf, giving a buyer an initial annual yield of about 8%. Cushman is advising Toronto-based Manulife.

Chicago-based Heitman is acquiring six single-tenant buildings and one building with two tenants from Northern Builders, of Schiller Park, Ill. The portfolio’s weighted average remaining lease term is 10 years.

The package Industrial Income is buying from Chicago-based HSA consists of nine buildings. The Denver nontraded REIT’s projected cap rate once vacant space is leased up is about 6.3%.

The pattern of big Chicago trades at low cap rates started with a deal that was struck in February and closed last week: Stockbridge Capital’s acquisition of 2.1 million sf for about $130 million. At $61/sf, the San Francisco investment advisor’s initial annual yield will be about 6.5%. Cushman advised the seller, a partnership between Towne Investments of Milwaukee and Interstate Partners of Schaumburg, Ill.

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