No Worries On Non-Core Industrial Development Spike

Planned development activity in secondary and tertiary industrial markets set a blistering pace in the third quarter with 38.5 million sq. ft. of new construction starts, reports CB Richard Ellis. That was up from only 16 million sq. ft. in the second quarter. What’s more interesting, however, is that a full third of that third quarter activity was initiated in secondary and tertiary industrial markets rather than the major shipping hubs on the west and east coast.

Sources ascribe the trend to increased user demand for build-to-suit warehouse space outside of the major industrial markets, which tend to have the most traffic congestion problems. With supply chain efficiencies in mind, many tenants are seeking the best locations within striking distance of the nation’s largest cities. This, in turn, also has led many developers to build speculative industrial space in order to exploit future leasing demand.

“Many of the top 10 new construction markets aren’t the usual suspects when it comes to new development growth,” says Jim Dieter, executive managing director of CB Richard Ellis’ North American Industrial Group. “And, with few exceptions, most of the new industrial properties are being developed on a speculative basis.”

Not only did industrial starts soar in the third quarter — most active quarter since 1999 — but markets such as Columbus and Cincinnati saw 2 million sq. ft. of new construction initiated during that period. And, if the future resembles the recent past, this shouldn’t be a problem to lease: roughly 95 million sq. ft. of industrial space was leased during the first half of this year, a 12 million sq. ft. increase over the same period in 2004.

“The world of logistics and delivering goods is all about speed these days, and setting up a distribution center in a major market often means dealing with congestion,” says Dieter, adding that key industrial markets like Atlanta are mired in traffic. That eats into a company’s ability to move goods across the country efficiently — and that, according to Dieter, builds on the allure of both secondary and tertiary markets.

But Dieter cites another compelling reason why many peripheral markets are seeing a building boom. That is, users are increasingly seeking build-to-suit warehouse space without the long wait. So, says Dieter, when users announce that they need 800,000 sq. ft. of warehouse space in a secondary market, developers are racing to build it.

“This is also a function of improving the supply chain and making it more efficient by ensuring that your products are delivered faster,” says Dieter, who believes that 2006 will see added demand for both secondary and tertiary industrial space.

If that happens, it will be driven by different circumstances than those behind the coastal boom. In the Los Angeles-area industrial market, for example, much credit goes to the flood of goods across the Pacific from Chinese factories. That port traffic has helped this market to absorb some 15 million sq. ft. of new warehouse supply over the past decade, dropping vacancy into the low single digits by the end of September. If the demand drivers are clear-cut on the west and east coast, they are somewhat less obvious in markets such as Phoenix and Columbus.

“We really are seeing more companies establish logistics hubs in places like Louisville and Kansas City,” says Bob Bach, director of national research at Oakbrook, Ill.-based Grubb & Ellis. Another factor, says Bach, is added demand for airfreight terminals in places like Columbus. A market like Columbus, for example, is central to many large Midwest cities via highways and rail links, making it a popular staging ground for distributing goods.

Bach also notes that occupancy costs are lower in secondary markets — and that allows developers to build at a discount. According to Grubb & Ellis, average asking rents for warehouse-distribution space in Columbus were hovering near $2.59 per sq. ft. at midyear, making it the second cheapest market in the nation after Des Moines.

For that matter, the Indianapolis-based research director isn’t too worried about an industrial supply glut in his backyard, the third most active market for new supply during the third quarter. Still, Bach acknowledges that any giant surge in new supply should be watched closely since supply-driven real estate busts are common.

“We’re still seeing vacancy rates come down across the board in places like Indianapolis where there’s no lack of new supply,” says Bach. “But you have to look at demand and leasing absorption to get the complete picture, which isn’t so bad.”

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