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Industrial REITs: Can They Ride Out the Storm?

Given the slowing U.S. economy, reduced consumer demand and lower retail sales, it might not seem intuitive that one sector capable of weathering the pending economic storm would be industrial, but the leading players in the warehouse market have been positioning themselves for just such a downturn for years.

“If the economy remains slow as expected over the next few quarters, it could work to the benefit of the warehouse market for at least a couple of quarters because importers and manufacturers will need to store excess inventories until the inventory/sales ratio returns to balance,” says Robert Bach, senior vice president of research at Grubb & Ellis. The weak dollar is also propping up demand for exports and thus warehouse space.

Industrial vacancies have remained constant for more than a year. Nationally, vacancies held steady at 7.6% in the third quarter of 2007, the latest period for which data is available. Los Angeles had the lowest market vacancy rate at just 1.6%, while the highest was recorded in Memphis at 16.4%.

Solid fundamentals are also at work in the leasing area. Net industrial absorption totaled 45 million sq. ft. nationwide in the quarter, the highest volume for any quarter in 2007. Asking rents were at $4.61 per sq. ft., up 3.6% from the year-earlier period.

“The first half of 2008 will present significant challenges for the industrial market but fundamentals are expected to remain largely unchanged,” says Ross Moore, senior vice president of market and economic research with Colliers International in Boston.

Most of the major industrial REITs have expanded globally as a way of diversifying their operations. Denver-based ProLogis, the world’s largest owner, manager and developer of distribution facilities, adopted a global strategy nearly 10 years ago, and today that drive is paying dividends by most accounts. The company operates in 20 countries including the U.S., Europe and Asia, with $34.4 billion of assets — 483 million sq. ft. —owned, managed or under development.

“From an operational standpoint, we expect to outperform in ’08, given our international platform,” says ProLogis CEO Jeffrey Schwartz.

A majority of the 16 Wall Street analysts covering ProLogis have “buy,” “hold” and “strong hold” recommendations on the stock. Shares of ProLogis closed Friday at $53.37, up $0.17 cents over the day earlier and down from its high of $73.35 set last October. That is when the company announced that it will double its managed portfolio to $60 billion by 2010.

Other leading industrial players are making inroads on the international scene. Earlier this month, Chicago-based First Industrial Realty Trust announced it is teaming with the California State Teachers’ Retirement System (CalSTRS) to form a 10-year, $475 million joint venture to invest in industrial land and buildings in the Netherlands and Belgium.

“That [strategy] is really driven by the growth of our customers due to supply chain reconfiguration that is going on in that part of the world,” says Johannson Yap, First Industrial’s chief investment officer.

Industrial REITs have quickly adopted international capabilities since they often work with global clients. For example, late last year San Francisco-based AMB Property Corp. signed DHL Excel Supply Chain, a Deustche Post company, to 590,000 sq. ft. of space in the U.S., Europe and Asia.

But not everyone is convinced that REITs have truly battened down the hatches. Last week, Citi analyst Jonathan Litt helped initiate a market selloff after issuing a negative report on the REIT sector and downgrading six stocks — but there was not an industrial REIT in the bunch. He did note that office, industrial and apartment stocks would be negatively impacted by the slowed housing market and flagging fundamentals.
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