A distribution and warehouse juggernaut has propelled Louisville's economic growth in recent years, but shaky times are sending a jolt through the city known for the Kentucky Derby, the Louisville Slugger and Jack Daniel's.

Louisville's largest private employer, Atlanta-based United Parcel Service (NYSE: UPS), in mid-June lowered earnings expectations for the second quarter, citing slower economic growth and high fuel costs. The shipping behemoth not only operates its massive Worldport international air freight hub at Louisville International Airport, but it also has established its airline division headquarters in the city. Thus, UPS pilots, executives and managers based in Louisville add to the area's wealth.

UPS is plowing $1 billion into its facilities to expand Worldport by 1.1 million sq. ft., making it a total of 5.1 million sq. ft. But continued pain at the pump and a prolonged slump or recession could lead to job cuts. Customers are increasingly avoiding premium air products, UPS says.

“UPS has been the single largest contributor to the economic health of this region for last 15 or 20 years,” says Paul Coomes, a professor of economics at the University of Louisville. “They're embedded in our economy at all levels, from the high-paying executive jobs down to the college kids unloading packages at 2 a.m. So if the biggest employer sneezes, we all get a cold here.”

Coomes argues that UPS, also known as “Big Brown,” is weathering the economic storm fairly well given the increasing cost pressures on the industry as a whole. In late June, UPS reached a tentative agreement with Bonn, Germany-based DHL in which UPS would take over DHL's air freight and sorting operations in the U.S. at Worldport.

Manufacturing woes

The city's manufacturing base is taking a hit. Dearborn, Mich.-based Ford Motor Co. employs 7,100 in two Louisville plants — one makes the Explorer, the other builds F-Series Super Duty trucks. The carmaker has shut down the truck plant for four weeks in July and slowed production at the Explorer plant in response to lagging sales due to high gas prices.

Meanwhile, Stamford, Conn.-based General Electric announced in May that it would sell or spin off its consumer appliance business. That's putting 5,000 blue- and white-collar workers involved in making or overseeing the manufacturing of GE dishwashers, stoves, refrigerators, washers and dryers in Louisville on edge about their future.

Still, Coomes says, GE employed some 25,000 in the city in the 1970s. “Even if it went away, we're talking about 5,000 jobs out of more than 600,000 in the whole market,” he maintains. “The plant's important to Louisville and brings new dollars to the city, but it's not big enough to cause a collapse in the housing market.”

The sky is not falling

It's not all doom and gloom in the city on the Ohio River across from Indiana. On balance, commercial real estate fundamentals are relatively healthy and the city's diversified corporate base could help dampen the downturn in this market of 1.2 million people.

Local companies or national back-office operations tend to dominate Louisville's business environment, but well-known corporations headquartered in the city include Yum! Brands, Humana, Papa John's International, and Brown-Forman Corp. — the maker of Jack Daniel's, Southern Comfort and other spirits.

Vacancies among the major property types have been on a downward trend since 9/11 and the recession early this decade — retail, office and industrial availability is less than 10% in some pockets of the market. Consequently, landlords have enjoyed modest but steady rent increases. The area's lack of large land tracts, high construction costs, and uncertainty in the debt markets bodes well for supply staying in check and rents rising, most notably in the industrial and office sectors, say local real estate experts.

Such barriers to entry could prove critical as job growth slows and users become more hesitant about absorbing more space. Non-adjusted seasonal unemployment in Louisville climbed to 5.3% in April this year from 4.8% in the same month last year, according to the Bureau of Labor Statistics.

“There are as many active prospects in the market as we've seen over the last three years,” says Kevin Grove, a senior vice president and partner in CB Richard Ellis' industrial services group in Louisville. “But the time it takes them to make a decision has been extended quite a bit.”

Supply chain advantage

The credit market crisis and slowing economy are also straining Louisville's efforts to redevelop its downtown, although the city is moving forward with a plan to build an arena along the riverfront (see sidebar p. 36).

The drama surrounding the central business district's renewal has little to do with Louisville's growing attraction among companies looking for new or expanded supply chain solutions, however. Warehouse landlords are still enjoying a windfall of interest as a result of UPS's Worldport expansion, despite high gas prices that threaten the shipper's profitability.

UPS originally opened the next-day air freight operation in the city in 1982. It's newest expansion will raise Worldport's sorting capacity by 60% to 487,000 packages per hour. “Not everybody needs next-day air service,” Grove says. “But of the majority of leasing transactions we handle, the hub plays some role in the user's supply chain.”

Industrial tenants absorbed 1.7 million sq. ft. in the first quarter of 2008 compared with about 975,000 sq. ft. in the fourth quarter last year, according to CB Richard Ellis, which pegs Louisville's industrial inventory at 100 million sq. ft. across seven submarkets. Vacancies fell nearly one percentage point to 6.8% over the same period, while average asking rents increased 2.5% to $3.24 a sq. ft.

Among some of the big deals, Waltham, Mass.-based defense contractor Raytheon leased 172,500 sq. ft. in southern Jefferson County near the airport. In May, Container & Packaging Supply, a wholesale distributor of shipping materials based in Eagle, Idaho, moved a distribution center from Richmond, Va., to 28,000 sq. ft. in the Bluegrass Research and Industrial Park in suburban Jeffersontown.

Locally based companies in the expansion mode as well as newcomers to the market are driving the leasing activity, according to industrial real estate brokers and developers. As of late spring, users looking for more than 2 million sq. ft. of space were poking around Louisville.

Development bull's eye

More than one-third of the first quarter's leasing activity occurred in Bullitt County, a blossoming suburban submarket south of Jefferson County along Interstate 65. Alliance Entertainment, a subsidiary of publisher and media distributor Source Interlink Cos. in Bonita Springs, Fla., announced in May that it had leased 404,000 sq. ft. in Bullitt County's Cedar Grove Industrial Park with an option to expand by an additional 260,000 sq. ft. in the future.

Developers also are targeting Bullitt County for more growth. More than 70% of the roughly 2.1 million sq. ft. of warehouse and industrial space under construction is occurring in the submarket, according to CB Richard Ellis.

Among other projects, Indianapolis-based developer Lauth Group is nearing completion of a 936,000 sq. ft. bulk warehouse building in Lauth's Salt River Business Park. It's the largest speculative industrial project ever pursued by a developer in the commonwealth, according to Jason Bria, director of office and industrial development in the Midwest and West regions for Lauth.

“We're pretty excited about our position in Louisville,” he says. “We've got the only building that provides users with a large amount of contiguous space.”

Lauth intends to push rents. Newer modern bulk warehouse space is fetching about $3.60 a sq. ft. in the market, and Bria says Lauth is asking for $3.65 a sq. ft. The building was underwritten to accommodate three tenants, but Lauth would prefer to find a single user, Bria adds.

Barriers to entry

Lauth is investigating whether to develop a third building in Salt River and has an option to acquire an additional 180 acres adjacent to the park for expansion. That gives the company a strategic leg-up on other would-be developers in Louisville. The area's rolling hills, few large contiguous land tracts with infrastructure, and limestone challenge developers.

“We could have some issues with a shortage of space in the next 24 months,” says Grove of CB Richard Ellis. “There are a lot of developers that want to come in and participate in what has been a very strong and healthy market, but they don't because it's very difficult.”

While those natural barriers to entry should help maintain rent growth, brokerages and other real estate professionals are increasingly looking across the Ohio River into Indiana for industrial space solutions. CB Richard Ellis, for example, just this year started tracking activity in the submarket, which contains about 12 million sq. ft. of predominantly manufacturing space.

Developers, Indiana towns and economic development organizations are now focusing on marketing ground for bulk warehouse space, particularly in Jeffersonville at the North Port Business Center, Port of Indiana and River Ridge Commerce Center.

“It will be a while before southern Indiana's a hot area for speculative development,” Bria suggests. “But you'll eventually see more because of the lack of land in Louisville.”

Sounding a cautionary note

Louisville experts suggest that the market is getting tighter, but don't expect spec development anytime soon amid high construction prices, scarce capital and a weak economy. But for Humana, poking around for 300,000 sq. ft., the bearish sentiment has virtually stymied activity among users with large requirements.

“Companies have turned cautious with respect to their expansion needs,” says Keith Sant, a local partner in the Midwest group for Studley, a New York-based brokerage firm. “But there aren't a lot of real large blocks of space available, so you could make an argument that there's room for new construction.”

The office vacancy rate in the metro area was pegged at 13% in the first quarter, down from 13.2% in the fourth quarter last year, reports Reis, while asking rents grew 1% to $15.95. Users absorbed only 81,000 sq. ft. in the first quarter, and developers completed only 45,000 sq. ft.

Roughly 350,000 sq. ft. is actively under construction, and the lion's share of the space is spoken for, say real estate experts. Among the key projects, the Federal Bureau of Investigation next year will move into a 120,000 sq. ft. building that's being built in the suburban Blankenbaker Station Business Park in east Louisville.

Office developers have also proposed some 2 million sq. ft. of new office space across the metro area, including two projects downtown that ideally would sign Humana as an anchor — a 25-story, 500,000 sq. ft. tower and two 12-story towers totaling 626,000 sq. ft. Both projects are on the back burner, however.

“You're not going to see a lot of new office construction, and that's going to be a good thing,” says David Fenley, president of Louisville-based office developer Fenley Real Estate.

Fenley has developed some 1.5 million sq. ft. of office space in Louisville and recently refinanced 11 suburban and two downtown office buildings for $110 million with GE Real Estate. “It will help guys like me keep occupancy up and rents relatively stable.”

Louisville has historically been dominated by local developers, but last year Dallas-based Behringer Harvard entered the market when it acquired Toronto-based IPC US REIT in a deal valued at $1.4 billion. The 9.6 million sq. ft. portfolio included 1.2 million sq. ft. in suburban Louisville.

“Louisville is a very stable market and that's one of its biggest attributes,” says Brent Boland, a Behringer Harvard asset manager in Louisville. “It's never very exciting, but it's never very dull either.”

Joe Gose covers finance for NREI.

LOUISVILLE - BY THE NUMBERS

METRO POPULATION:
1.2 million

Source: Greater Louisville Inc.

UNEMPLOYMENT RATE:
5.3%

Source: Kentucky Office of Employment and Training

LARGEST PRIVATE EMPLOYERS:

  1. United Parcel Service
    18,398 employees

  2. Norton Healthcare
    7,783 employees

  3. Ford Motor Co.
    7,100 employees

Source: Greater Louisville Inc., Ford Motor Co.

METRO AREA VITAL SIGNS

Office:

13% vacancy, 1Q 2008

14.9% vacancy, 1Q 2007

$15.95 rent per sq. ft., 1Q 2008

$15.48 rent per sq. ft., 1Q 2007

Source: Reis

Multifamily:

7% vacancy, 1Q 2008

8% vacancy, 1Q 2007

$633 effective rent, 1Q 2008

$608 effective rent, 1Q 2007

Source: Reis

Retail:

8.7% vacancy, 1Q 2008

8.3% vacancy, 1Q 2007

$15.14 rent per sq. ft., 1Q 2008

$15.03 rent per sq. ft., 1Q 2007

Source: Reis

Industrial:

6.8% vacancy, 1Q 2008

5.9% vacancy, 1Q 2007

$3.24 rent per sq. ft., 1Q 2008

$3.00 rent per sq. ft., 1Q 2007

Source: CB Richard Ellis

Hotel:

53.6% occupancy, 1Q 2008

53.6% occupancy, 1Q 2007

$86.71 average daily rate, 1Q 2008

$81.88 average daily rate, 1Q 2007

Source: Smith Travel Research

MAJOR PROJECTS

United Parcel Service: The shipping behemoth is adding 1.1 million sq. ft. to its 4 million sq. ft. air freight hub at Louisville International Airport. The project started in 2006.

Developer: UPS

Completion: 2010

Cost: $1 billion

Louisville Downtown Arena: Revenue bonds totaling $360 million are expected to be sold this month to finance construction of a 22,000-seat arena. The arena will be home to the University of Louisville men's and women's basketball teams and will hold other events.

Developer: Louisville Arena Authority

Completion: 2010

Cost: $250 million

Salt River Two: A 936,000 sq. ft. bulk warehouse building is under construction in the Bullitt County industrial submarket. It is one of the largest speculative warehouse projects ever developed in the state.

Developer: Lauth

Completion: Fall 2008

Cost: Approximately $29 million

CITY REVIEW-LOUISVILLE

Credit crisis impedes downtown's progress

Like other metropolitan areas pining for downtown redevelopment, Louisville has pushed for renewal by spearheading large public improvement projects and establishing tax incentives to attract private investment.

Government and civic leaders in Louisville and Kentucky have sparked some $135 million in investment over the last decade to create two key anchors: an 85-acre park along the Ohio River waterfront, now in its third and final phase of development, and Louisville Slugger Field, a 13,131-seat minor league baseball stadium that opened in 2000.

Those projects have helped ignite interest among private developers, who have proposed some $2 billion worth of housing, office, hotel and entertainment projects across several blocks downtown. But the upheaval in the credit markets is delaying several components, including the ambitious $490 million Museum Plaza mixed-use condominium, office, hotel and retail project.

The debt market collapse even put a scare into officials pursuing the third downtown anchor: a new 22,000-seat arena to house the University of Louisville men's and women's basketball teams in addition to NCAA championship tournaments, concerts and other community events.

The Louisville Arena Authority earlier this year sought a new insurer for some $360 million in revenue bonds to finance the project after the original bond insurer, Ambac Financial Group, continued to post billion-dollar losses. In May, the authority reached an agreement with bond insurer Bermuda-based Assured Guaranty, and the bond sale is expected to occur this month, says Jim Host, chairman of the arena authority. He anticipates the arena will open by November 2010.

“We got the arena financed in as tough a market as you're going to see,” says Host, referring to the new insurance agreement. “There was no question from Assured Guaranty that downtown Louisville was bustling.”

Among other projects, Baltimore-based Cordish Co. in 2004 completed Fourth Street Live!, a $75 million downtown entertainment district of bars, restaurants and shops over two square blocks. Cordish has also proposed to expand Fourth Street Live! for a price tag of up to $440 million in a redevelopment known as Center City.

Meanwhile, developer Todd Blue anticipates moving forward with his proposed $50 million Iron Quarter mixed-use retail and office development just east of the arena. Blue, who also serves on the arena authority, began assembling land a decade ago amid early progress of Waterfront Park and Louisville Slugger Field, he says. But he also considered the eventual development of an arena as a critical linchpin, and if it fails to proceed Iron Quarter won't materialize, he adds.

“This is an effort to master plan an area over a 10-year period,” Blue says. “To me, minute one in year one of that 10-year master plan hasn't started yet. Minute one in year one starts the day the arena bonds are sold.”
— By Joe Gose