The industrial market

Manufacturing's muscular revival of the past two years has been the best possible news for U.S. industrial real estate. Reports from national brokerage firms and trade associations show vacancies in the industrial property sector down about 2% since 1992. The Grubb & Ellis survey, for instance, had industrial vacancy above 13% in 1992, but trending down under 11% by early 1994.

Factory output has hummed along. The most current data available in late October indicated that the Industrial Production Index rose 6.4% for all manufacturing industries during the prior 12 months. Durables were up an even steeper 8.4%, with a gain for soft goods of only 3.7% for reasons discussed in the Economics chapter. The year saw large production increases in industrial machinery and equipment (13.4%), electrical machinery (14.3%) and autos (8%). Capacity utilization for all manufacturing broke above 83%, up from 80.3% in 1993, and a 5% improvement over the recession's level of 78%.

Rousing trade volumes have keyed a demand surge in port cities. Althought the merchandise trade balance has been deteriorating since 1992, after five years of improvement, the total volume of international trade continues to expand. Merchandise trade will total approximately $1.1 trillion, 22% higher than in 1990.

NAFTA certainly hasn't hurt. The North American content provisions of the treaty are forging tighter economic links. Fabrication of components in the U.S. is accelerating as a function of greater Mexican assembly activity. The Texas economy is booming, and an intrastate fracas is brewing over whether a new interstate from the border city of Laredo should be aligned due north toward Dallas, or veer northeast through Houston. In fact, the only "giant sucking sound" heard since NAFTA's passage has been created by the influx of investment dollars into the Lone Star State. Landauer's transaction database identified approximately 240 major industrial property sales in the past year -- one out of every six in Texas.

The attraction for industrials is a combination of strengthening demand, low prices and a modest amount of construction. Midyear NCREIF data showed a total return for warehouses of 2.7%, with income levels at 9.5% of appraised value, the highest level ever recorded for warehouse assets.

Nationally, we find some intriguing trends. Owner/users are frequent purchasers. Retailers, especially power center players, are well represented among the buyers. More traditional retailers are in the market, too. Manufacturers and freight companies are acquiring existing industrial properties, as the surging economy strains capacity and development is sparse.

Pension funds, through their advisors, have also been prominent buyers, as have REITs. Generally, both seek larger assets than owner/users. Properties over 250,000 square feet at prices above $10 million are less than 20% of the industrial deals, but are trendsetters for the market. More typical are deals in the $3-$7 million range, with prices from $20 to $40 per square foot.

New development is taking the form of build-to-suit projects. Department of Commerce data showed an annualized $17.8 billion in new construction in July, 1994, up 8.6% from 1993, but only 83.4% of 1990's volume.

Market activity, therefore, appears to be responding to the improving conditions suggested by the rise registered in Landauer's last two years' Industrial Market Power Ratings. We expect to see the results in capital appreciation figures soon.

The current Power Ratings are rising significantly across the board and are approaching previous peak levels. Industrial Market Power Ratings carry a maximum score of 1000, measuring a variety of factors for each market and specific industrial property type including vacancy, employment trends, wage rates, rents and relevant local conditions such as transportation infrastructure, major corporations and proximity to end markets.

The warehouse/distribution category remains the bellwether for industrial properties, with the average Power Rating up to 612 from 1994's mean of 583. Dallas, whose vacancy rate has dipped back into single digits, leads the list at 814. Houston (7th) and San Antonio (11th) also rose.

Port cities continue to do well. Seattle and Portland rank 2nd and 4th, respectively. Portland was an active investment market last year, largely for 100,000-200,000-square-foot warehouses. Both markets now enjoy industrial occupancies above 96%, according to CB Commericial.

Miami and Tampa again rank in the top ten. While vacancies are slightly higher here, both cities are well positioned for growth, with rapid demographic gains and strengthening Latin American trade forecast.

Ebullient economies throughout the Southeast mean that Atlanta and Charlotte should maintain the solid performances indicated by their respective Power Ratings of 731 and 730. Charlotte actually has a much lower existing vacancy rate - 3.6% vs 9.7% in the CB Commercial survey - but Atlanta has greater access to the southeastern markets, a larger local population base and the boost of the 1996 Olympics fueling activity.

Rounding out the warehouse leaders are Salt Lake City (6th place, 745 points) and Minneapolis (10th place, 723 points). Salt Lake is the fastest growing of the nation's 50 largest MSAs, and distances in the West are so vast that there is no competitive distribution hub within 350 miles. Minneapolis has seen its occupancy soar to 97%. The Twin Cities are an active market for warehouses priced in the $3-$7 million range, especially for REITs.

Light manufacturing and assembly leaders once again cluster in the South, since the combination of low taxes, labor costs and other business expenses are viewed as vital in keeping the prices of goods competitive. The stellar performance of the auto industry and the region's attractiveness to overseas manufacturing firms are also key factors this year.

Nashville's constellation of auto plants - with Saturn in Spring Hill and Nissan in Smyrna, TN - sparked a network of suppliers and serivce providers. As production steps up, just-in-time inventory practices are keeping suppliers hopping. A similar story can be told in Greenville, SC, where BMW has sited its North American production facility.

The furniture industry has been a prime beneficiary of the surge in household durables consumption. Industry specialization has catapulted Greensboro, NC to the top of the Light Assembly Power Ratings, with a score of 655.

Florida, with one of the lowest wage structures for production workers in the nation, places four markets in the top ten, led by Tampa (618 points) and Jacksonville (596 points).

Research and Development properties have long been the most problematic industrials. This year, R&D markets neared a historic high in their average Power Ratings, attaining a mean of 456 points. The list of best rated tech/flex markets is geographically dispersed, and features the return of many recently distressed metro areas.

Universities are key locational determinants of research spending by the Federal government and industry alike. The list of top research grants recipients includes Stanford, MIT, the University of Washington, UC-San Francisco, UC-San Diego, Harvard and the University of Minnesota. No wonder, then, that Seattle, Boston, Minneapolis, San Francisco and San Diego appear on our top ten R&D Power Rating list.

Washington, D.C. is ranked first in this category, scoring 637 points. Despite steep cuts in defense spending, suburban R&D markets have prospered, both in NIH lab work and in highly technical research for the CIA and the NSA. Chantilly and McLean, VA and the Maryland suburbs from Bethesda to Gaithers-burg are prime locales for tech space.

California accounts for 21% of all R&D spending, according to a 1992 study by the National Science Foundation. The statewide economic slump has eroded this large share, but California remains unquestionably the sector's national leader.

Increasingly, oil company profits are coming from their petrochemical divisions, which convert petroleum products into plastics, synthetic rubber, and derivatives like polyethlyne and polystyrene. The chemical industry budget for R&D amounts to 5.7% of its net sales, one of the highest ratios of all industries, supporting a considerable amount of demand in the key Texas markets of Houston and Dallas.

Landauer continues to believe that a manufacturing revival will be the engine for overall U.S. economic recovery. This is clearly occurring, and favorable investment opportunities should be spreading in the next year or two. There are, of course, weaker areas, as indicated by Power Rating averages below 500 for Assembly and R&D. New competition can arise quite suddenly: there is an abundance of appropriately zoned land and tilt-up construction is a very rapid building technique. Industrials are perhaps the most sensitive of all real estate to fluctuations in the business cycle, and just-in-time management has only heightened its volatility. So, while painting an appropriately positive picture, we encourage real care in investigating the specifics. From experience, investors should know how complex this propety type can be.

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