Industrial Sector Turns a Corner

Stirrings of manufacturing expansion and job growth are bound to give the lackluster industrial market a much-needed kick-start. In May, manufacturing activity expanded for the 12th consecutive month, according to the Institute for Supply Management, and employment growth continued with the addition of 248,000 jobs.

These leading indicators are expected to translate into more demand for space. Grubb & Ellis predicts that vacancies will decline by 50 to 75 basis points by year's end, to between 9% and 9.3%.

That's welcome news for owners and developers. The industrial market has been in a monotonous mode over the past year. Vacancy rates and construction levels have remained virtually unchanged. The national vacancy rate peaked at 10.06% during the first quarter of 2003, and has hovered around 9.8% for the last three quarters, reports Grubb & Ellis. In the first quarter, 59.6 million sq. ft. of industrial space was under construction, about the same as was under way each of the last four quarters.

“We are more optimistic than we were a year ago,” says Guy Jaquier, chief investment officer for San Francisco-based AMB Property Corp. “We are buying more than selling right now because we have seen indications of an uptick in fundamentals.”

AMB expects to spend $1.05 billion at home and abroad on acquisitions and development in 2004. A large chunk of that capital will be spent on the purchase of a $481 million package of properties from International Airport Centers.

Investors Scouring for Deals

AMB is not alone in its quest for industrial acquisitions. “There is still a ton of money out there looking for investments,” Jaquier says. About $15 billion in industrial properties traded hands in 2003 with another $4.8 billion in sales taking place during the first five months of 2004, reports Real Capital Analytics, which tracks deals $5 million and higher.

Competition for properties has kept the pressure on sale prices despite lower occupancies and rents. Asking rental rates for available warehouse-distribution space ended the first quarter at $4.39 per sq. ft. per year triple net and $9.47 for R&D-flex space. Since peaking in 2001, asking rents have fallen by 12.1% for warehouse-distribution space and 18.2% for R&D-flex space, according to Grubb & Ellis.

At the same time, cap rates have dropped about 90 basis points in the last 18 months to an average of 8.8%, reports Real Capital Analytics. For properties in hot markets such as Los Angeles, cap rates have even dipped below 7%.

Companies that have been quietly riding out the recession are beginning to stir with new space needs. “As the economy has picked up over the last couple of years, so have our national numbers,” says Dave Riefe, vice president of real estate at Opus North Corp. in Chicago. In 2003, the Opus Group reported 12.1 million sq. ft. of industrial space developed or under construction compared with 11.6 million sq. ft. in 2002 and 10.9 million sq. ft. in 2001.

Indianapolis-based Duke Realty Corp. also has recorded a spike in its development activity with 4.2 million sq. ft. developed or under construction in 2003 compared with 1.9 million sq. ft. in 2002.

“Inventories are at all-time highs, so you can't wring any more efficiency out of these systems,” says Bob Chapman, senior executive vice president with Duke. “That means companies are going to need to take more space to expand.”

Build-to-Suit Activity Booms

Industrial developers can thank Corporate America for keeping them busy over the last two years, despite the sluggish economy. “Most of our construction and development has been on build-to-suits,” Chapman says. For example, Duke recently completed a 1 million sq. ft. headquarters and distribution center in Dallas for the Container Store.

Ironically, companies have been commissioning new projects as a means to cut costs. Some are opting to build more cost-efficient facilities that are better equipped to handle new technologies, while others are consolidating multiple distribution hubs into a single facility. Opus completed a 741,000 sq. ft. distribution facility for Brylane in Plainfield, Ind. The New York-based catalog retailer had consolidated two facilities in Plainfield totaling about 500,000 sq. ft. into one larger facility to accommodate growth and improve efficiencies.

Another cause for optimism is that the industrial market faces a relatively short climb out of the doldrums. “I don't think the valley was that low,” Riefe says. “We're seeing vacancy rates at or under 10%, which spells a relatively healthy market.”

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