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Most of us know that the CRE industrial market has been on a tear the last few years, but the hefty rent increases and lofty valuations are becoming very scary. Cap rates for the once sleepy and benign industrial market have compressed to the 3%-4% area from about 7% only five years ago and public industrial REITs are trading at sub-four percent cap rates. According to a first-quarter report from Cushman and Wakefield on the industrial market, asking rents nationally have increased 16% since Q1-21. In some of the hot markets around the country like the Inland Empire of CA, rents have increased 41%, in Orange County up 20%, Boise, ID, up 18% and Miami, FL, up 15%. There are also over 660 million new square feet of industrial space coming to market in 2022, which is a historical amount and 4% of the total inventory of 16 billion square feet. In a normal year, only about 100 million square feet of industrial space is under construction. 

On May 10, 2022, Prologis, the giant public industrial REIT, made an offer to buy another industrial REIT, Duke Realty, for .466 shares of its stock for each share of Duke’s common stock. The offer represented a price for Duke of $61.68/share, a premium of 29% to Duke’s share price and a mind-blowing 3.5% cap rate. This type of outlandish pricing for CRE assets was last seen during the frothy period from 2004 to 2007 and right before the start of the Great Recession in mid-2007. Most investors willing to buy industrial real estate at these low cap rates are relying on 5%-10%+ rent growth, which may or may not happen, and carries significant risk. The formula for the cap rate is the risk-free rate, usually the 10-Year Treasury note, currently 3.0% plus a risk premium, which historically has been between 3% and 10% and today is about 8% less than the growth in rents. A generic cap rate for industrial properties with rent growth of 5% would be 3% plus 8% -5% or 6% and much higher than the 3% cap rates discussed above.

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