Developers still gung-ho about industrial property

Like a freight train on a fast track, the nation's industrial real estate sector continues full steam ahead. With demand remaining consistent and tenants chasing space in major markets, the industry remains one of the most vibrant.

Fueled by increased demand in the logistics business and strong retail activity, industrial real estate continues on the upward path it has been on for the past five years.

Supply vs. demand While there may be some pockets of overbuilding, the sector has remained healthy. "What's happened to industrial real estate during the past five years is that discipline has been introduced into the development community," says Bill Linville, executive vice president/Midwest industrial division of Indianapolis-based Duke-Weeks Realty Corp. "Supply has not been out of control because there has been a self-imposed governor on the supply."

Bud Lyons III, president of Aurora, Colo.-based ProLogis Trust, says supply and demand are definitely in equilibrium. "Regionally, the West is doing extremely well. The California market is very tight and experiencing record numbers," says Lyons. "There's also increased demand in key regional markets like Atlanta; Dallas; northern New Jersey; Memphis, Tenn.; and Louisville, Ky. But there are some soft spots such as Orlando [Fla.], Houston and Indianapolis."

The advantages "The positive for industrial is that there is not as much risk in overbuilding as there is in office or retail," says Doug Herzbrun, managing director of Los Angeles-based CB Richard Ellis Investors LLC. "The vacancy rate for industrial has been stable the past five years, as have the rates of return. We are seeing absorption outpace supply, particularly when compared with the office market."

Investors believe this property type will benefit from the megatrends like globalization, technology impact and increased trade. Thus, a number of companies, such as Houston-based Weingarten Realty Inc.(WRI), have increased their purchase of industrial properties the past several years. WRI, which has 50 industrial projects totaling some 6.3 million sq. ft., chose this acquisition route even though it sold an 80% interest in more than 2 million sq. ft. of industrial building area to Galveston, Texas-based American National Insurance Co. (ANICO) in 1999.

"We intend to grow through acquisitions," says Rick Hollingsworth, director of business development at WRI. "We're looking at buying in cities like Houston, Dallas, Las Vegas, and Memphis, Tenn. We will continue to look at good portfolio investments in markets where occupancy rates are very favorable."

One of the reasons industrial real estate is the favored product type among investors is stability, says Michael Brennan, CEO of Chicago-based First Industrial Realty Trust Inc. "Industrial continues to demonstrate stability and performance. It also has the highest returns among any commercial property type on a risk-adjusted basis."

Brennan notes that last year's absorption, due to e-fulfillment centers, accounted for 20 million of the 175 million sq. ft. of industrial space absorbed nationwide. "The vast majority of these e-fulfillment centers were taken by traditional companies. Only a small portion came from new start-up dot.coms," he says.

What's important for industrial? "The problem facing investors in the industrial sector is lack of product," says Brennan. "If you talk pensionfunds, they say they love industrial and apartments, but the problem with industrial is there are no big packages available."

Carl Panattoni, president and CEO of Sacramento, Calif.-based Panattoni Development Co., says industrial will remain the preferred product for institutional investors. "Irrational capital is no longer changing real estate," he explains. "Instead, it's changing new economic companies."

Panattoni notes that size and flexibility of industrial space will continue to be important in the years ahead. "Today's large warehouses require two things - strong floors for greater weight loads, and flat floors for better balance because of higher racking. Many users are also putting semi-office, manufacturing or call center uses into their industrial buildings," he adds.

Another important factor in new industrial developments is more electrical power for office, manufacturing and assembly operations. "There's mechanical picking equipment that's as expensive as the building," Panattoni adds. "Fiber optics have also become very important. Before, you wouldn't think about fiber optics, but with larger facilities, fiber optics have become a huge demand."

Panattoni says his company is extremely busy, with about 40% of new construction pure build-to-suit, 30% spec build-to-suit and the remainder spec construction. "In active markets, you need to have a pad up and a building started in order to have tenants coming in," says Panattoni.

Panattoni adds that he doesn't see a lot of overbuilding occurring throughout the country because demand is high and vacancy rates are low. "Most places are reasonably healthy. We're not on the same page we were 10 years ago when overbuilding was horrendous."

What companies are investing in New York-based Ashley Capital has focused on bulk distribution warehouse space in excess of 250,000 to 1 million sq. ft. "The bulk distribution business continues to produce great opportunities for corporate America to apply increased efficiencies to the entire supply-chain management process," says Paul Rubacha, principal at Ashley. "There's continued evolution in both the software that manages the information, hardware and equipment used within warehouses."

Rubacha notes that there's a fair amount of space being built, but there seems to be a balance between absorption and supply coming on the market. "Without a doubt, markets like Boston, Chicago and Los Angeles are hot," he says. "Today the industrial sector has been left with an absence of peaks and valleys. Valuations remain moderate; therefore, when things get soft there's not a huge decrease in value."

The Chicago area, the largest industrial market in the United States with 14% of all space in the country, has a very healthy set of underlying dynamics. "Vacancies have declined significantly over the past year, and are down 100 basis points, to around 6%," says John Gates, president and CEO of Chicago-based CenterPoint Properties Trust. "When you take out the environmentally tainted properties and unoccupied properties, the vacancy rate is around 4%."

Rental rates are increasing in some submarkets that don't have a significant amount available, Gates continues. "Tenants want to be as close as they can to the dominant forms of transportation," he says. "Tenants are also driven by the availability of labor. Many companies make local decisions based on the price points they can live with."

Those in the industrial real estate sector are also seeing the consolidation of distribution around the major transportation hubs, notes Gates. "Companies that had 30 or 40 warehouses nationwide are now consolidating their holdings to four or five hub warehouses," says Gates.

Steven Podolsky, principal of Chicago-based Podolsky Northstar Realty Partners, notes there is strong demand for big-box warehouse and space in the Midwest. "With space, you're doing rehab with a whole set of different space requirements," he says. "For a company, the building has to be specifically renovated, designed and created for them."

There are a half dozen or more projects - multi-story and older industrial structures - that are being renovated in areas that are not traditional industrial markets. "One of the critical elements in the business is for jobs to be close to young people," says Podolsky. "So, many of these industrial structures are being rehabbed in nontraditional industrial areas - sites that some thought were socially and economically undesirable."

Podolsky states that structures that could have been used for offices or lofts in the past are now being converted into industrial. "The value of property is much higher to the seller if it is multi-story industrial," he continues.

"In some cases the sector has become a sort of a spec build-to-suit market," says Jeanne Rogers, executive vice president of Des Plains, Ill.-based Arthur J. Rogers & Co. "Everybody cautiously goes into ground hoping they can get a tenant. The good build-to-suit and spec companies are reserving spots long before they have deals, thinking they'll have the buildings leased when they are finished."

The present market Developers, investors and brokers in other areas around the country also point out the vibrancy of the industrial market. "The present market is the strongest I've ever seen. There's no chance it will be overbuilt because there is no more land to overbuild," says Donald Rechler, chairman of Melville, N.Y.-based Reckson Associates Realty Corp.

Reckson purchased some land several years ago when prices were depressed and waited until the right time for development, according to Rechler. "There was a big demand for industrial space, but we were unable to get the kind of rents we needed, particularly with today's construction costs," he says. "In the last two years, we've actually built approximately 750,000 to 1 million sq. ft. of new space, and half of that has been rehabbed."

In Orange County, Calif., industrial space is being built at a rapid clip. "To meet the existing demand, The Irvine Co.'s Investment Properties Group has developed more than half of its total industrial property since 1996," says Bob Williams, president of the company. "The group has added more than 7 million sq. ft. of its total 13 million sq. ft. in the last three years. The influx of high-tech, biomedical and automotive companies fueled this increased demand."

Michael Kendall, vice president of development for Newport Beach, Calif.-based Koll Development Co., says his company is extremely bullish on the Southern California market. "Investors are putting Southern California at the top of their list." Demand for industrial space will be strong and will continue, says Kendall. "What will the Internet do to real estate? We may see a slightly different requirement, perhaps the way buildings are designed and built, but the Internet won't affect industrial real estate."

Kendall adds that Koll is participating in a number of conversions of industrial facilities to telecom/Web hosting/data centers. "It's a growing business, and industrial facilities lend themselves to it because of the sheer size of the building," he says.

In Houston, the northwest sector remains the most vibrant submarket, says Hollingsworth of WRI, and much of that activity is driven by vendors for the Houston-based Compaq Computer Co., which are entering the area to support the company. "The economy in Houston remains very strong. It has diversified well in that we are seeing all types of companies continue to expand," he adds. "Overall, Houston is experiencing a 7% vacancy rate."

Hollingsworth says the majority of industrial development in Houston continues to be spec construction. "During the first quarter of this year, about 850,000 sq. ft. of new product was delivered to the marketplace, with over 3 million sq. ft. in the pipeline."

Steven Gordon, presi- dent of Southfield, Mich.-based Signature Associates-ONCOR International, notes that there will be an excellent balance of supply and demand, with continued reasonable absorption in the office and industrial submarkets in the Michigan area. "The strong growth areas and corridors of the last few years will make headlines in the new century," he says. "Overall, as these communities mature and work to round out their balance of property types, developers will be exploring opportunities in 'next-tier' areas like the U.S. 23 corridor between Flint and Ann Arbor, northern Oakland and southern Genesee counties, and the less developed Downriver area."

What does the future hold? In the long term, the feeling is that demand for warehouse space will track growth in GDP, says Lyons of ProLogis. "From a global perspective, we feel very good about industrial real estate, both domestically and internationally," he says. "We're very active in Europe, where we find huge demand for new state-of-the-art facilities. The European Union borders have disappeared, and corporations are viewing Europe as one gigantic market equivalent in buying power to the United States."

Amsterdam is a gateway city that is extremely active, Lyons says. "Other key markets are Paris; London; Birmingham in the United Kingdom; Lyon, France; and Barcelona, Spain."

Linville of Duke-Weeks adds that many in the industry are cautiously sitting back, particularly since the Fed continues to raise interest rates. "Developers are wondering how long it can keep going," he says. No one wants to be overextended with product."

Another element that has people worried is whether the dot.coms are ever going to make money. "Now is not the time to take wild risks, hoping that the institutional market will come along and bail you out," Linville adds.

Podolsky is one of the few industrial specialists who predicts a slowdown in the sector. "We had a tremendous amount of supply and absorption go out to the marketplace," he says. "There is now a general lull, which could be the beginning of a downward slide."

Still, it's easy to become lulled by the phenomenal success industrial real estate has recorded during the past five years. With demand strong, construction measured and new uses for industrial product being invented daily, the industrial market is expected to remain on track for a number of years.

Hide comments


  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.