A boom in speculative warehouse development is rippling through secondary markets as tenants seek less congested locations with lower occupancy costs. Construction starts in the third quarter of 2005 totaled 38.5 million sq. ft., with more than one-third of that activity in secondary industrial markets, according to CB Richard Ellis.

“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. “With few exceptions, most of the new industrial properties are being developed on a speculative basis.”

Soaring port traffic through large West Coast hubs is partly to blame. Los Angeles and Long Beach both handle more than one-third of all U.S. imports off container ships, and each is struggling to handle record cargo volume from Asia. That is sending many Asian shipments bound for places like New York through the Panama Canal, which is building an added traffic lane wide enough to accommodate the larger vessels as a result.

However, speculative warehouse development in places like Indianapolis does present risks. To Doug Poutasse, chief investment strategist at Boston-based pension fund advisor AEW Capital Management, the ease of building in these markets is also a liability.

Poutasse acknowledges that many logistics companies now find markets like Chicago and Los Angeles far pricier than secondary markets such as Columbus, Ohio and Savannah, Ga. “A developer can build a warehouse in less than a year in many secondary markets, and the land costs are much cheaper,” he says, noting it could also lead to a supply glut.

Grubb & Ellis data shows that the average asking rents for warehouse-distribution space in Columbus, Ohio were near $2.59 per sq. ft. at mid-year, making it the second cheapest market in the U.S.

With rents that low, many retailers see the value in securing distribution centers within striking distance of large cities. One example is Skokie, Ill.-based industrial developer Alter Group. With speculative projects under way in secondary markets like Phoenix, Indianapolis and Kansas City, Alter Group is targeting overflow demand from primary markets and will begin building a 100,000 sq. ft. warehouse in Indianapolis this spring.

“The port cities along the West Coast are being flooded with cargo, so many tenants see the benefits of leasing large warehouses in secondary locations,” says Patrick Gallagher, senior vice president at Alter Group. “Establishing alternate locations for their distribution centers helps keep the goods moving,” he adds.

Gallagher says that Wal-Mart is a prime example. Earlier this year, the company established a 4 million sq. ft. distribution center in Houston.

It explored hub markets like Los Angeles, but higher occupancy costs and fears of a port workers strike on the West Coast helped the company settle on Texas. Wal-Mart plans to route between 20% and 28% of its container traffic through Houston, making it a significant industrial port.

“A retailer really doesn't want to put the bulk of its distribution points in two or three markets,” Gallagher says, “so establishing many locations in secondary markets can be a much safer play.”

SECONDARY CONSTRUCTION SURGE

In the third quarter of 2005, five of the 10 busiest new construction markets were either secondary or tertiary markets (in red).
Total construction starts (million sq. ft.)* Total Inventory (bldgs 100,000 SF+) (million sq. ft.)
Los Angeles (metro) 11.6 663
Chicago 6.6 645
Indianapolis 3.9 155
Atlanta 3.9 171
Seattle 2.4 137
Columbus 2.0 152
Cincinnati 2.0 47
San Diego 2.0 92
Phoenix 1.3 91
Baltimore 1.2 99
*third-quarter 2005 statistics
Source: CB Richard Ellis