Industrial goes back to the basics

Nowhere is the well-worn real estate mantra "location, location, location" more apropos than in today’s industrial market. For the past few years, developers of these properties have focused on several trends: increased ceiling or "clear" heights, flatter concrete floors for more advanced articulating equipment and more amenities, such as architectural features and landscaping.

Client demand drove much of the focus, especially in the build-to-suit area. As a result, many markets have experienced an increase in the amount of flex/warehouse space, where an office component is part of the mix. Many other hybrids also have been created, making it more confusing than ever to identify a true industrial property.

But there is an increasing sense in the industrial community that it’s time to return to the basics of what industrial buildings are designed to do: accommodate the logistical needs of owners and inventory products, and streamline the flow of goods to and from end-users.

Location is key

In good economic times, companies could afford to spend time and money dressing up their buildings. But the declining economy has forced more firms into a slow-growth, and less attention is focused on building aesthetics. The attributes of location now receive the bulk of the attention.

According to John Gates, president and CEO of Chicago-based REIT CenterPoint Properties Trust, the physical characteristics of a building, such as sprinklers to ESFR or wiring, can be retrofitted inexpensively. "You can rebuild an industrial building from the ground up for $12 a sq. ft.," he said. "You can’t repaint your office for $12 a foot!"

In many ways, most industrial buildings readily adapt to customer need. "What can’t be replaced is the locational attributes," said Gates, who lists labor and abundant freight transportation, along with labor, as the most important location attributes.

"Labor is the new one," he continued. "Ten years ago, people didn’t care much about labor. They figured wherever they moved they could find the people necessary to do the job. Today, it’s their primary concern."

Locating near readily accessible transportation has been a key strategy for another major industrial player, San Francisco-based AMB Property Corp., which has adopted the unique approach of locating industrial facilities on the grounds of airports. Why? "Today, location is more important than ever because of the increase of reliance on intermodal transportation for distribution," CEO Hamid Moghadam said.

Location also has a lot to do with who’s actually leasing the space in those buildings. Increasingly, the space is being rented to third-party logistics firms, whose sole function is to help manufacturers and retailers move goods from place to place. "Logistics companies, air cargo carriers and other transportation companies that serve corporate America’s distribution needs are our biggest clients today," noted Moghadam.

For example, San Francisco-based Catellus Development Corp. signed an 86-month lease with Exel PLC, a global supply chain management company based in Berkshire, England, for an 830,000 sq. ft. distribution warehouse at Kaiser Commerce Center in San Bernardino County, Calif. The $22.4 million building is slated for completion in second-quarter 2002. "The combination of truck and freight rail service at this gateway for goods movement is a major advantage of this location," said Nelson C. Rising, chairman and CEO of Catellus.

Improving efficiency

But corporate America also is leasing space for itself. Denver-based ProLogis is active in the build-to-suit area, recently signing Volkswagen of America to a 10-year lease on a 332,095 sq. ft. building in Ontario, Calif. "The sharpened focus of major corporations on improving distribution network efficiency is generating significant requirements for new distribution space," said K. Dane Brooksher, chairman and CEO of ProLogis.

Kurt Rosene, senior vice president of Chicago-based The Alter Group, said the impact of consolidation and the continued importance of logistics companies can be seen clearly in the increasingly large facilities being constructed. "The high-cube nature of these new super-centers also is being driven by the extraordinary ceiling heights required to accommodate high-tech racking systems and the latest lift trucks," he said.

Rosene cited The Alter Group’s 835,000 sq. ft. state-of-the-art office/warehouse facility now under construction in Independence, Ky., for Stamford, Conn.-based Thomson Learning Services. The new building consolidates three separate distribution operations currently located in Florence, Ky.; Hebron, Ky.; and Cincinnati, Ohio. The structure also features a 38-foot ceiling height as opposed to the previous 32-foot standard.

The big slowdown

Overall, demand for any type of industrial space is flat. According to New York-based Cushman & Wakefield, the national vacancy rate for industrial properties registered at about 6.9% at the end of second-quarter 2001, up from 6.5% in the first-quarter 2001 and 5.7% in second-quarter 2000.

Greg Gregory, president of Atlanta-based Industrial Developments International (IDI), said as people evaluate their logistical needs in the light of the current recession, the decision-making process has become very slow. "We can have a lot of conversations, on both our speculative space and on our build-to-suit space, but we’re not doing a heck of a lot of it, comparatively speaking," Gregory said.

He compares IDI, which has developed more than 82 million sq. ft. in 28 states and Mexico, to an automobile. In 1999, the IDI "car" was speeding along at 65 mph. In 2000, the same "car" had accelerated to 75 mph. But right now, Gregory noted that the speed of the "car" has slowed to only 45 mph.

"Both 1999 and 2000, from IDI’s standpoint, were really just unbelievable years. This feels real slow," he said with a laugh. "Luckily we didn’t count on 75 mph for 2001, and we didn’t build to stay at that rate. But I can tell you that we anticipated 55 mph and thought we were being conservative."

According to Gates, the recent terrorist tragedies that hit New York and Washington, D.C., will exacerbate customers’ indecision. "They can’t quite get themselves to make up their mind to do something new, so they hunker down and stick with what they’ve got," he observed.

Customer reluctance is not necessarily a bad thing, he continued, because it has led to a high level of renewals and sales of buildings to their occupants this year. "People feel very happy with where they are," he said, citing low interest rates and longer commercial mortgage amortization schedules. "More than ever, customers have a very large imbedded investment in their building. Even the simplest of distribution buildings have a lot of technology investment by the tenant in it and people don’t like to walk away from that."

Gates also points to the continued importance of labor in the mix. "Labor has become such an issue in recent years and people are loath to move anyway because they risk losing their labor force, which they had a tough time recruiting and spent a fortune training."

New strategies to employ

Given the recent economic slowdown and the impact on their customers’ business, developers continue to look for new growth opportunities, including infill development in urban areas and more speculative building. But neither strategy is designed for long-term success.

According to Gregory, the industrial sector is still a suburban business. "We’ve got some infill sites in Dallas and we do them when we find them and they make sense, when they’ve got good orientation to transportation," he said. "We also are not really in the business of demolishing or renovating large areas to do it. We really have to look for some kind of special situation."

On the speculative side, developers are hamstrung by the same slowdown that has hit their customers. "There have been no spec starts in Chicago since June," said Gates. He said the markets where spec development was a factor have become somewhat overbuilt, reducing the need for that type of space.

But, "I’ve been doing this for 20-odd years and I’ve never seen double-digit vacancy either in metropolitan Chicago or the nation as a whole, and you can’t say that about any other product type," he said. "You’ve seen vacancies creep up from 7% to 8% in metropolitan Chicago and speculative starts have just shut down."

Likewise, Gregory hasn’t seen much new spec in his major markets, which is good news for the supply/demand equation. "Now that demand is down, it’s oversupplied to a certain extent, but we’re not continuing to oversupply the market. All of us seem to be letting supply and demand get to some balanced level."

However, the slowdown may be hurting true developers, striking at the heart of their entrepreneurial souls. "That’s part of the painful thing. We want to develop and we’ve got land to develop on and we continue to buy land," said Gregory, who recently bought land in Atlanta and is also looking at three properties in California. "Where we’ve found ourselves short in the land inventory, we are taking the long view and buying it. We’re in the business for the long term."

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