As the 1991 recession was unwinding, Landauer advised investors that industrial real estate would be early in the queue of recovering property types. Four years ago we noted that "an investment strategy stressing industrial acquisitions in 1992 could be remunerative indeed." In 1995, the forecasted returns began flowing at double-digit rates to purchasers following that strategy. The NCREIF Classic Index reported a year-over-year 12.7% total return on pension fund warehouse investments for the Second Quarter 1995.This was the best-ever return for the sector, roughly comparable to the excellent results of the mid-'80s. Research and development properties produced a total return of 7.6%, not yet back to peak levels but trending sharply upward.

Industrial REITs registered a 12 month total return of 17.7% (11% appreciation and a 6.7% dividend return). They have been on a buying binge, with over 75 deals booked in the first half of 1995 alone. Wall Street appears determined to increase the share of securitized equity in warehouses, light industrials and self-storage facilities, which had a total market capitalization of $6.7 billion, or 13.4% of all equity REITs as of September 30. This compares to allocations of 23% for apartment and 28.5% for retail REITs.

But a closer look at the real estate market activities of the REITs should give the industry pause. About one-third of the deals by industrial REITs involve development. While most of them are expansions, build-to-suits, or projects with significant pre-leasing, there is enough speculative development for concern. If it were only the securitized players, the impact on the market would not be enough to unsettle recovery. But Landauer's look at industrial development over 60 markets shows that the construction curve is again rising steeply. Warehouse starts in 1995 will be virtually identical to the 1990 total of 65 million square feet, and will be up 28% from 1994.

Clearly, pressure is starting to mount. Financing is affordable, with mortgages at 8.4% from the life companies at midyear, down from 9.5% at the end of 1994. Underwriting terms are also easier than for other commercial property types. Loan-to-value ratios are a generous 73.7%, debt service coverage ratios are down to 1.37, and cap rates have fallen 30 basis points in a year to 9.8%. In the past year, ACLI reporting lenders issued $1.8 billion in new mortgages secured by industrial property, with 99 deals totaling $589 million in this sector during the Second Quarter 1995 alone.

The recent improvements in market conditions, and the near-term prospects argue that the good feelings permeating the industrial property market are justifiable. The average vacancy in the 60 markets we review is down to 7%, compared with 8.4% a year ago. Spot shortages appear to necessitate spec development. And national brokerages are reporting 10% rent increases in the past year.

Yet, we wonder. As the business cycle ages, the manufacturing sector should cool off considerably during the next two years. As indicated in the Retail chapter, we are expecting only limited improvement in consumption growth over the same period. Net exports should improve, buoying markets linked to the international economy. But even these cities face uncertainties such as the timing and extent of a Japanese rebound and the sorting out of NAFTA issues.

It should be remembered that industrial properties are extremely sensitive to swings in GDP. If we see another recession before 2000 - and the odds must be considered higher than 50/50 that we will - this property type will hit a major pothole. For the time being, we see room for moderate improvement in supply/ demand fundamentals and additional gains in rents and values. In 1997, however, the positive curve will begin to fatten and the "hot money," could head elsewhere in a flash.

This analysis is-reflected in the spotty improvement in the Power Rating scores calculated in our market-by-market analysis. The top ten markets in the warehouse, assembly, and R&D subgroups can be found in the graph on page 21.

Slow-growth demographics and an aging stock of industrial properties handicap the Northeast metropolitan areas. Only Boston finds a place in our top R&D rankings. But even this is a victory over the naysayers who predicted an irreversible decline in the wake of the mini-computer debacle. At $5 psf, R&D effective rents are competitive with other technology centers across the U.S., and tenant demand is forecast to be brisk.

The South Atlantic states are amply represented on our top market lists. High-tech facilities in the Washington, D.C. metro area should see continuing demand. R&D space in Rockville, for example, has a limited 7.5% vacancy rate, and flex space around the District shows average rents of $6.70 psf Northern Virginia also boasts a concentration of technology parks. Warehouse space generally is in short supply, with industrial facilities in the 1-270 corridor at 96.5% occupancy. This area continues to be a population magnet and, governmental contraction notwithstanding, its sphere of influence is already spreading across the West Virginia border.

In North Carolina, Greensboro and Charlotte are benefiting from nearly full employment, with the jobless rate at 3.7% in both markets as of July. REITs have been active both on the acquisition and development fronts, and industrial construction is rising.This is clearly a bet on future growth, as vacancies stand at 8% - 9%. Greensboro's strength is in its cadre of blue collar workers and low local business costs. Charlotte, of course, has become a star and is attracting considerable corporate relocation traffic, with 1,300 manufacturing jobs created since our last Forecast.

There has been no industrial market more active than Atlanta in the past year. Year-end 1995 warehouse construction totals should be 5.5 million square feet, up 15% from 1994. Manufacturing job gains are robust at 7,200 last year. Though the MSA is likely to see a post-Olympics slowdown, we expect the Games to stimulate even further interest on the part of foreign firms. As the hub of the Southeast, Atlanta should continue to prosper as the region's major distribution center.

A steady population influx and a deepening economic base account for the presence of Orlando, Tampa and West Palm Beach on our top ten lists. Industrial vacancies are trending downward since the early '90s, but there is not much in the way of new supply to meet the fresh demand. It is in assembly, rather than pure warehousing, that these cities make their mark this year. Tampa is well established as a corporate relocation destination, with semiconductor manufacturer Repton Electronics a headlined addition. Orlando is also competing for the semiconductor and computer chip industry, and West Palm Beach has a book of financial incentives for business attraction that has netted a reported 3,500 new jobs since early 1994. Low wages, cheap taxes and the vaunted Florida sunshine have proved a potent combination in bringing employers to the state.

Nashville, with a 4.2% industrial vacancy rate, and Memphis, at 6.1%, lead the Midsouth markets. Just-in-time manufacturing in the auto industry is driving suppliers into a tighter ring around the Saturn and Nissan plants near Nashville, and Memphis, thriving air cargo hub is encouraging manufacturing firms to set up shop nearby, taking advantage of the FedEx overnight delivery system.

Despite the unsettling effects of the Mexican peso crisis on NAFTA-related businesses, Texas is still well-represented among the top industrial markets. Austin leads all our top markets this year, with a 7% gain in manufacturing jobs, almost all in computer-related industries, reflected in its high ranking in both R&D and assembly facilities. High-tech rents, at $7.80 psf, are among the highest in the nation. Dallas is in the midst of explosive construction activity, driving vacancies up to 10%. The Metroplex is established as a telecommunications center, and can be seen as the implementation center for the technology coming out of Austin. REITs, however, are reportedly starting to bring on spec industrial because they cannot find enough product to buy.

San Antonio has a major effort underway to lure manufacturers, with tax abatement packages supplementing some of the lowest utility costs in the U.S. Early results are promising, and there has been little new construction to impede further downward movement in vacancies. Rents are still quite affordable at $3.25 psf If NAFTA fulfills its potential in the coming years, there should be robust industrial demand here.

Minneapolis again holds top ten positions in both the R&D and distribution categories. Construction in the Twin Cities is a steady million square feet a year, modest indeed when compared with the 5,400 manufacturing jobs generated here in 1995. CB Commercial pegs the industrial vacancy rate in the MSA at 4.2%. Computer services and engineering are among the area's employment engines.

Denver's industrial demand revival, especially for flex space in the Boulder submarkets, has driven occupancy to 95%. Effective warehouse rents are up to $4 psf and R&D space is commanding $5.20. Construction activity is quiet for the time being, but developers will be quick to recognize opportunities. Denver should be very active for all forms of industrial real estate investment in 1996. A 4% gain in manufacturing employment, representing 3,400 new jobs, again places Salt Lake City prominently in our top ten lists. Industrial property availabilities have virtually disappeared. The high-tech sector is nicknamed the "Bionic Valley" by local boosters, and further stimulus is expected by the city's selection as the Winter Olympics venue for 2002.

Since the California economy bottomed out in 1994, several industrial markets have made significant progress. But only Sacramento earned a score sufficient to rank it on our lists of leading markets, owing to its remarkable addition of 3,000 manufacturing jobs - a one-year leap of 8.2% . The high-tech sector is burgeoning, driving R&D rents up to $6 psf.

Riverside/San Bernardino and San Diego have posted encouraging vacancy declines and will be among the places leading the statewide rebound. The Inland Empire will find industrial demand energized by population growth as the suburbs migrate east. San Diego is one of the locations most advanced in the process of technology transfer from defense to civilian applications. With its orientation to the Mexican markets and its excellent port, we expect its return to top market status shortly.

Seattle and Portland are becoming accustomed to their exalted rankings in our Power Rating scale. Import/ export volumes are still rising substantially, and Russian trade is now being booked in major amounts. Names like Microsoft, Nintendo and Intel highlight the high quality jobs being generated here. Industrial occupancies are in the mid-to-high 90% range. Portland is starting to see development, and Seattle should see warehouse starts rising in the late '90s. But there is little sign of imbalance on the horizon, and we view these distribution markets as the best in the nation through the year 2000.