Leading industrial players are turning to a more traditional model of development and disposition to recycle capital and achieve higher returns.
Early in October, two of the nation's largest industrial real estate companies unveiled extraordinary deals. First, Chicago-based First Industrial Realty Trust announced the sale of its Long Island, N.Y., portfolio totaling 50 buildings with 3.5 million sq. ft. for an undisclosed sum to an undisclosed buyer.
Then only days later, Indianapolis-based Duke-Weeks Realty Corp. announced it had partnered with affiliates of J.P. Morgan Investment Management and General Motors Asset Management to complete a joint venture including 129 buildings with 21.8 million sq. ft. in seven markets worth $789 million. Duke-Weeks owns a 50% interest in the venture.
To be sure, those are big deals, but they are anything but one-offs these days. In fact, the nation's largest industrial real estate companies are focusing on recycling of the most precious resource - their capital.
With the public equity markets all but closed to real estate investment trusts (REITs) and other public companies for secondary stock offerings, the latest buzzword to hit the business is "self funding." In a nutshell, that means money is raised through the traditional real estate cycle - develop a property, then lease or sell it for a tidy profit and move on to the next project.
"[A build/sell strategy] allows you to get much higher returns, maintain a stronger, much more flexible balance sheet and also keeps you relatively independent of the obviously quite volatile capital markets," says John Gates, CEO of Chicago-based CenterPoint Properties Trust.
"We can continue to grow at 13% to 14% a year in terms of funds from operations (FFO) per share without having to sell new common stock and dilute our existing shareholders," Gates says.
In addition to the two deals mentioned, other whoppers back up the recent build/sell trend:
- Cabot Industrial Trust of Boston formed a joint venture with GE Capital Real Estate of Stamford, Conn., to acquire and develop up to $250 million of workspace and multi-tenant industrial properties nationwide.
- Atlanta-based Industrial Developments International is building two buildings totaling 672,700 sq. ft. at Park West International, a 250-acre, 11-building industrial park with more than 4 million sq. ft. near the Cincinnati/Northern Kentucky International Airport.
- Up to 6 million sq. ft. of industrial space is up for sale in Minnesota's Twin Cities area, most of it owned by REITs, including 1.3 million sq. ft. from First Industrial.
- Edison, N.J.-based Whitehall Industrial Properties, an affiliate of Goldman, Sachs Co., bought its first New Jersey property, a 165,000 sq. ft. building in Carlstadt.
- Dallas-based Trammell Crow Co. is planning a $40 million, 68-acre speculative industrial park near Austin, Texas, located near two Dell Computer complexes.
- Ryan Cos. of Phoenix closed on a 56-acre parcel in the suburb of Chandler, Ariz., and is planning a $35 million business park with nine flex/industrial buildings totaling more than 850,000 sq. ft.
- First Industrial is building a 1.7 million sq. ft. distribution facility for Procter & Gamble near Scranton, Pa., one of the largest such buildings in the state.
- Duke-Weeks completed $201 million in dispositions in the third quarter, for a total of $478 million in year-to-date sales at an average cap rate of 9.1%. At the same time, the company broke ground on a 506,700 sq. ft. manufacturing/bulk warehouse worth $25 million in Henry County, Ga., south of Atlanta.
- Keystone Property Trust of West Conshohocken, Pa., which has been in a disposition mode to focus on the Northeast and Midwest, began a major Midwest building push by acquiring chunks of land in both Louisville and Cincinnati.
- Wal-Mart has been busy scouting around Charlotte, N.C., for a site to put a 1.2 million sq. ft., $65 million distribution center.
- AMB Property Corp. of San Francisco has purchased more than 1.2 million sq. ft. of space around the John F. Kennedy Airport in New York. Most of the properties were acquired from J.A. Green Construction in Great Neck, N.Y.
Build/sell cycle takes hold Denver-based ProLogis also has adopted the self-funding strategy. "We're selling assets and redeploying those funds into higher yielding developments," says COO John Seiple. "In 1997 and 1998, the equity markets really shut down. Companies started looking at how we continue to grow without continuing to access the public equity markets."
In October, ProLogis announced the formation of a $230 million fund with the State Teachers Retirement System of Ohio (STRS Ohio), to hold title to a select number of the pension fund's distribution properties in North America. The fund mirrors one that ProLogis set up for its European properties last year.
"The funds are a way to do that [grow] without giving up the customer relationship and the customer contact," Seiple says. "By contributing assets to a fund, we can meet our goal of recycling capital and at the same time meet our goal of maintaining contact with the customer and continuing to serve that customer."
Those types of gyrations signal a definite change in the air, which many in the industry view as a positive.
"Things are always changing, and if you don't change and respond and react, then you're probably going to be left in the dust," says Robert Chapman, executive vice president at Duke-Weeks. "The biggest single change in the industry, particularly in the REIT business, has been the lack of equity capital. The equity doors are just shut. That has forced us to really accelerate and refine a program we already had in place to recycle capital.
"Our goal this year was to dispose of $400 million of assets out of a $6 billion portfolio [less than 10%]," Chapman says. "We've focused on two areas - the bottom 10% of our portfolio that we really didn't want anyway, and secondly, the buildings with long-term leases where we really could extract the highest value by selling them."
But will the newest strategy work? According to a new report penned by Bear Stearns analysts Ross Smotrich and Enid Lloyd of New York, the industrial market is poised for continued growth.
"We believe that changes in supply chain management and in wholesale distribution, facilitated by technology and enhanced by e-commerce, imply growing demand for good industrial space. Industrial space is resilient, less prone to overbuilding, and favored by institutional investors for its consistent returns and relatively modest capital expenditure requirements," say Smotrich and Lloyd.
For true-blue real estate types, the build/sell strategy is a kick. "This is all great stuff, and I'm a big proponent of it," says Chapman. "We're developers. We have a $1 billion development pipeline [office and industrial] in the Midwest and the Southeast. That's where we really create value, where we're getting returns in the teens. Anytime that we can sell a portfolio and liquefy our portfolio and do it again and again, that's really the business that we're in.
"It's been a great discipline for us, and going forward, you will see us continue to take down fairly big land positions to do big industrial and office parks and to develop those buildings," Chapman continues. "That, in turn, gives us double-digit FFO growth [Duke-Weeks has had 20 consecutive quarters of double-digit FFO growth over the prior year]. You can't really do that with a staid portfolio of properties."
So who's buying all of this inventory? "It really varies," says Chapman. "For the triple-net-lease properties, those buyers are a unique segment and are frequently coming out of tax-free exchanges. Or, you'll find institutional investors that like a 10- or 15-year lease with Lucent Technologies or BellSouth or whoever it might be. Then you have the pension funds that are still very active both on the industrial and the office side, particularly in the larger markets. Then you have the local investors who are buying the one-off, smaller deals, maybe a park with two or three buildings."
Locally focused strategy In the Chicagoland area, locally based CenterPoint has found its own unique niche - the globalized container market.
"Globalization is driving very significant trends," Gates says. "One is the huge accelerating increase of containerized shipping due to the fact that more and more goods are coming from offshore and Asia. Vastly increasing rates of those goods are moving in the form of containers.
"Demand for facilities that handle those things, so-called intermodal yards, has accelerated tremendously," Gates says. "And then, as a result, the desire for distribution companies to be near those facilities has accelerated dramatically."
Case in point is CenterPoint's redevelopment of the huge Army arsenal facility in Joliet, Ill., 40 miles from Chicago's downtown Loop. The arsenal property will be anchored by a 620-acre intermodal facility operated by the Burlington Northern and Santa Fe Railway Co., which CenterPoint is building and will lease to the company on a 40-year land lease. When completed, it will be the largest container-handling facility in the world.
Gates also anticipates building 17 million sq. ft. of distribution space adjacent to the intermodal facility in a complex known as Deer Run Industrial Park during the next 10 to 12 years.
"Our contribution to it will be about $650 million," Gates says. "Burlington is putting in $250 to $300 million, and we anticipate that the industrial customers will probably put in at least another $500 million. We're looking at about 8,000 permanent jobs and about 10,000 construction jobs. So what you're really creating is almost a distribution city, anchored by this huge inland container port."
CenterPoint also is building a 1.5 million sq. ft. supplier park for Ford Motor Co.'s tier-one suppliers on the south side of Chicago. Gates says he expects the project to create 1,000 new jobs through a $400 million total investment over three years - $50 million from CenterPoint, $50 million from Ford in the form of the real estate, $100 million from the state and city, and expansion of Ford's existing facilities worth about $200 million.
Another major CenterPoint project is the International Produce Mart near downtown Chicago, which will serve as a distribution point for fresh fruits and vegetables for the Midwest. Plans for the $100 million project call for 750,000 sq. ft. in three buildings. The space will be pre-sold to distributors and vendors as part of an industrial condominium, which is a relatively new concept to the industrial industry.
Consolidation still trends up Without a doubt, the industry continues to feel the impact of consolidation of distribution facilities, as more distribution firms whittle down their many far-flung locations to fewer but larger properties placed in more strategic locations.
"Historically, national distribution companies had operated through a series of 20 or 30 smaller warehouses scattered throughout the country near their principal customers," Gates says. "Today, technology has allowed them to consolidate those into the four or five biggest transportation hubs in the United States and achieve far greater efficiencies as a result. And Chicago is almost always a candidate for those, as are northern New Jersey and northeast Pennsylvania.
"In the South it's usually a choice between Atlanta or Dallas; in the West it's usually a choice between the Bay Area and Los Angeles," Gates continues. "But you have seen a tremendous consolidation of distribution facilities into those marketplaces."
For private firm The Allen Group, Carlsbad, Calif., the consolidation trend has generated something else that's important to just about everyone these days - savings. "Some companies are achieving significant savings by consolidating," says Richard Allen, partner and CEO. "Some of our tenants have said they are realizing significant savings by reducing inventory carry costs."
For example, consolidation can offer significant savings to those companies that can meet their delivery obligations from one central large distribution center as opposed to having several smaller ones closer to their major markets. With fewer but larger facilities, companies achieve an economy of scale in total operations and inventory hold costs.
"This works particularly well when a company is distributing products that have long shelf lives, and there is customer flexibility in arrival times (within the day rather than within the hour)," Allen says. "There are many companies that need to fulfill several times a day. A regional distribution center is basically looking for overnight fulfillment."
The goal is to put the products closer to consumers, according to Tom Bisacquino, president of the Herndon, Va.-based National Association of Industrial and Office Properties (NAIOP). "We're seeing a need for distribution that's closer to the consumer," says Bisacquino. "There is big demand for smaller, more flexible space nearer consumers. More things are happening online, so having a distribution center 90 miles away won't do the deal."
Carl Panattoni, president of Sacramento, Calif.-based Panattoni Development Co., agrees. "REITs are very competitive in large markets where they have been established and have large building or land holdings," he says. "However, many users today want to take advantage of the local and state incentives, in addition to finding affordable and available labor. For this reason, today's user is locating distribution facilities outside the large-market regions. Being an entrepreneurial company, we accommodate the users by developing in marketplaces of all sizes."
Panattoni itself is moving closer to its customers, establishing full-service development offices across the United States. Presently, it has 16 offices, with eight of them opening in just the last two years. "By having local partners we are better able to understand the marketplace and react to a client's needs immediately," says Panattoni.
All aboard the tech train Without question, technology to a large degree has shaped the industrial scene in the past two to three years.
"We find technology playing an increasing role everywhere," says Pam Hinton, president of the Society of Industrial and Office Realtors (SIOR), based in Chicago. "You can consolidate operations into mega-distribution facilities because it is more efficient to have one big warehouse with 400 people than two facilities with 200 people each. The marketplace rewards improving efficiencies and tighter margins.
"All of this changes site selection for distribution and other types of facilities," Hinton continues. "You have the ability to locate dot.com fulfillment centers near the market for the ultimate goods. You can locate call centers near the right people to staff the phones."
NAIOP's Bisacquino agrees. "Clearly the whole tech area is exploding," he says. "We're trying to keep our members educated on who's out there, what's developing and how to make their buildings more attractive to tenants." His goal is to hold two shows next year devoted entirely to technology.
Nelson Rising, chairman and CEO of San Francisco-based Catellus Development Corp., also has a goal to capitalize on technology. "One of the most significant benefits of the technology revolution is in the distribution of goods," he says. "Warehouses can be bigger and more efficient. Firms are going for larger facilities. The consolidation is really the big thing right now, and it's continuing."
Catellus anticipated this emerging trend, according to Rising. "We had lots of good sites located along major distribution corridors, plus we've bought new sites to round that out in Portland, Ore.; Denver; Louisville, Tenn.; Plano, Texas; and suburban Chicago. We want to be in large distribution markets as a continuation of our strategy," he says.
Greg Gregory, CEO of Atlanta-based Industrial Developments International (IDI), is particularly intrigued by the impact of technology. "The continuing trend that has been in place since the early- to mid-1980s is technology's impact on distribution and the type of facilities we build," he says. "More recently, of course, is the e-commerce trend and the use of our facilities for those purposes, such as communication and the ability to keep up with goods in progress and where they are; SKU technology - all of these things."
Being a private company has not hurt IDI's business one bit. It is an active national player, growing its assets from $89 million in 1989 to more than $415 million, with another $404 million in joint venture assets. The company has developed more than 65 million sq. ft. of industrial space worth more than $2 billion.
"In 2000, we have leased or sold some 600,000 sq. ft. of space to technology companies for uses that didn't even exist some two years ago and for which we didn't build the building, such as server hotels or co-location facilities," says Gregory. "Technology continues to have a huge impact on our customers, which impacts our facilities in a positive way. Our facilities continue to be in high demand for a number of reasons and uses."
In the Southeast Michigan area, technology's impact also has been felt. "Starting from the early-1990s, Southeast Michigan has diversified," says Steve Gordon, president of Southfield, Mich.-based Signature Associates. "And although it still maintains very strong ties to the automotive industry, Detroit has embraced other non-automotive users, making it an attractive place to house operations."
"The biggest change in the industry has been the positive insertion of technology," Gordon says. "I feel it has transformed the industry and is making it a user-friendly market with quality product information that has ease of access. There has been a big technology demand, with Internet switch stations and dot.coms upgrading the Southeast Michigan market."
Demand remains strong because fiber-optic lines throughout the market are driving expansion, he adds.
ProLogis, too, has been focused on technology issues since the early '90s. "The two major trends, both technology related, are the broadband-enabling of our industrial facilities and then encouraging the customers in those facilities to utilize technology to make their operations more efficient," Seiple says. "Not only have we embraced technology in general, but our technology related investments total almost $40 million over the past two to three years. That's a little bit more than an embrace, I believe."
All of those moves have at their core the belief that digital transactions are the wave of the future. "It is coming because clients are demanding the use of technology to reduce costs and speed up the process," says SIOR's Hinton. "The digital transaction will become a normal part of operations. How it works is being invented right now, though its shape is still coming into focus."
The competitive landscape With no fewer than seven major public real estate companies and countless large and small private firms, the industrial sector is a competitive hotbed. That explains why differentiation throughout the buy/sell process has become important.
For Duke-Weeks, the competitive difference is lots of land in inventory. The firm is sitting on 3,900 acres of available land with 61 million sq. ft. of potential development for office and industrial use.
"Land is king on the industrial side, particularly if you're going to do office and industrial parks," says Chapman. "The way we look at our business is much the same way a retailer looks at his business. We really pioneered the same-store concept. So when we buy land in a submarket, we look at it as an inventory, and we want to burn through that inventory in three to four years.
"It's the same thing with buildings," Chapman continues. "We really look at recycling and turning over the assets. You want to liquefy this stuff as much as possible. We're really interested in creating value for shareholders. The way we do that is by buying land, building buildings and generating strong FFO growth."
IDI's corporate strategy continues to change as its customers change. "Our strategy is to stay in front of our customers - to meet their needs," Gregory says. "In fact, we spend a lot of time and effort understanding and anticipating what those needs are."
Other firms are staking out claims on turf closer to home. For example, the Central Valley [east of Los Angeles] is attractive because of its location near California's major markets, relatively low land and lease costs and favorable labor conditions.
"The next big industrial play is California's Central Valley," says Allen of The Allen Group. "By being a pioneer, we are positioning ourselves for the long run. Five years ago, we pioneered the San Diego marketplace before the established players stepped up."
CenterPoint remains almost exclusively focused on Chicagoland. "It's the largest industrial market, but also highly diversified, so virtually every significant company in the world has an industrial or distribution facility here," Gates says. "So we see a lot of these trends at a very early stage."
CenterPoint has six full-scale operating regions in the area, which has 24 submarkets. And yet, it still only has a 2.5% market share. "But our brand name and our franchise allow us to see a disproportionately large set of the opportunities that are out there," Gates says. "It means we're a safe alternative for governments and big corporations who are as concerned about their reputation and making sure that all of the promises are fulfilled as they are about the last nickel of economics."
At ProLogis, globalization has been a key focus. "First, if you think about what customers really want, I think they take high-quality real estate as a given," Seiple says. "That's a price of admission to be able to service the customer at all. So I think you have to differentiate through innovation and providing the expanded services and through providing the total solution to the customer.
"We can provide the services and solutions globally," Seiple continues. "And we provide the access to the distribution facility and the services through a single point of contact."
Impact of tech bubble burst: zilch Reviews are in on the impact of this spring's technology bubble burst, and so far the industrial sector is largely unscathed. "It was a little bit of a bubble burst throughout our system, but we established the company policy back from the get-go that we were going to cover our assets," says Chapman of Duke-Weeks. "A year ago, there were just an incredible number of deals, both office and industrial, on telecom and dot.com. We turned away a lot of business, but we made some deals. We're conservative, and we decided from the get-go that we didn't want to be in the venture capital business. It's had minimal impact on the industrial business."
At IDI, Gregory says the dot.com bubble burst has had no impact on his properties. "We have done a number of dot.com deals," he says. "We have been careful in the underwriting, and we are happy with the underwriting. And we're happy with the tenants we have done business with."
Ditto at CenterPoint, says Gates. "There's been very little dot.com activity in the industrial marketplace. The 1.25 billion sq. ft. Chicago market has had probably fewer than a dozen deals to dedicated dot.com companies. In the scheme of this huge market, it's tiny. It's so small it really doesn't register."
What it all means In the end, the ultimate successful strategy, whether for public or private firms, will be unique to each. "Our overall strategy is we want to be as absolutely local as possible, but then bring to bear all of our resources, like our construction company and legal group, to hopefully save money. It's a pretty good formula," says Chapman.
CenterPoint's Gates believes in being nimble and flexible when it comes to the industrial sector. "There will always be changes in our business, both driven by technology and globalization and so forth, but they're also changes driven by the economic cycle," Gates says. "At some point it's better to be a buyer, at other points you can get your highest yield out of development, at other points you're getting your highest yields out of redevelopment."
Adds Gates, "You've got to stay very close to the customer and on the cutting edge of everything that goes on in your industry to know how to deploy your resources to get the best possible yield and minimize your downside."