Industrial giant ProLogis is boosting its exposure to Nevada’s growing market for distribution space. On Thursday, the Denver-based REIT (NYSE: PLD) spent $1.85 billion for a portfolio of 114 industrial properties with approximately 25 million sq. ft. of distribution space.

Roughly 65% of the entire portfolio is located in Reno and Las Vegas, two major Nevada cities divided by 345 miles of desert. The balance of the portfolio is divided up between eastern Pennsylvania, Chicago and Southern California.

ProLogis formed a new North American property fund (N.A. Property Fund III) to acquire the portfolio from Dermody Properties and California State Teachers Retirement System (CalSTERS). At the end of March, ProLogis owned and managed roughly 436.9 million sq. ft. of distribution facilities across North America, Europe and Asia.

“This deal propels us to the number one position in both Las Vegas and Reno,” says ProLogis managing director Larry Harmsen. “Las Vegas has one of the fastest growing economies in the nation, and both Las Vegas and Reno are land-constrained.” The average size of the portfolio’s Nevada distribution facilities is roughly 160,000 sq. ft.

Merrill Lynch analyst Steve Sakwa, who has a “buy” rating on ProLogis, wrote in a recent note that much of the deal’s embedded value is in the land: “The value-add proposition of this transaction will be the land, which could result in an additional $175 million in value once fully built out.”

The Las Vegas and Reno portfolios include roughly 182 acres of potential development sites. According to CoStar data, the entire 90% leased portfolio is generating average effective rents of roughly $4.25 per sq. ft.

Based on these rents, according to Merrill Lynch, ProLogis accepted a low- to mid-5% capitalization rate on the deal. The low yield came as no surprise: Harmsen says that there was strong competition for the portfolio given the weight of capital that continues to pour into the market. He also sees the Nevada component of the portfolio as a critical expansion of ProLogis’ existing empire of U.S. properties.

“Nevada is a much less expensive alternative to California,” he says, adding that many industrial users have crossed the border from California into Nevada seeking competitively priced space. “A city like Reno is also strategically located on I-80 with direct access to points west or due north and south along the coast.”

Industrial vacancy in Reno was just 6.1% at the end of March, reports Colliers International, and that was down from 7.15% at the end of 2006. Compared with the national industrial vacancy rate, which stood at 8.3% at the end of 2006, Reno is pretty tight. Las Vegas was just 6.2% vacant at the end of last year.

New supply is ramping up in many markets. Industrial completions on a national basis should hit 144 million sq. ft. this year, reports Grubb & Ellis, down moderately from 153 million sq. ft. in 2006. But Las Vegas has roughly 4.2 million sq. ft. of new industrial supply underway at the end of March, and that represented a steep 4.5% of its total inventory.

In the smaller Reno market, however, the percentage of new supply relative to inventory was just 0.5% at that time, which suggests that most industrial developers in Nevada are focusing their efforts on Las Vegas.

“There are certainly pockets of the market where new supply is going to be felt more than others,” says Harmsen of ProLogis. “But we believe that [Las Vegas and Reno] are both strategically located for added logistics activity in the future.”