Despite pockets of speculative building, investors are clamoring to buy industrial properties. The dollar volume of recent deals—with roughly $9 billion worth of industrial properties sold for the year through the end of April--represents a steep 150% increase over the same period in 2004, reports Manhattan-based property research firm Real Capital Analytics (RCA). What’s more, industrial sales volume (on a dollar basis) outperformed all other property classes for the first four months of 2005.

Underscoring this demand, however, are some potentially overbuilt markets. Grubb & Ellis data shows that the industrial pipeline swelled to 88 million sq. ft. at the end of the first quarter, which represents a 4 million sq. ft. gain over the first quarter of 2004.

On a market basis, California’s Inland Empire lead the nation in new supply during the first quarter with 14 million sq. ft. of industrial projects underway. Chicago, Los Angeles, Atlanta, and northern and central New Jersey rounded out that list with construction pipelines ranging from 5 to 9 million sq. ft. Meanwhile, overbuilt markets such as Dallas-FortWorth are still fielding new projects from industrial developers. By comparison, the average vacancy rate of these five markets was only 8.84% at the end of the first quarter, which was slightly less than the average national vacancy rate of 8.9%

These new projects may partly explain why owners of warehouse distribution space are struggling to boost rents. Grubb & Ellis reports that average asking rates at the end of the first quarter were hovering around $4.40 per sq. ft., down by a penny from the end of 2004. The average asking rate for R & D/flex space ended the first quarter at $9.26 per sq. ft., up .27 cents from the end of 2004 but still trailing year-end 2003 by .21 cents. To put that number in perspective, the first three months of the year marked the 13th straight quarter that R & D/flex rates posted a year-over-year decline.

Soft rents and new supply notwithstanding, the heated deal making isn’t likely to slow down this summer. Case in point: there are three times as many industrial offerings now versus one year ago, according to RCA. Why are investors gobbling up industrial properties? One reason may be the historical returns.

“If you study the NCREIF data, industrial returns exceeded office for 11 of the past 15 years,” says Bob Bach, director of national research at Grubb & Ellis. As far as other real estate classes are concerned, retail beat office for 8 of the past 15 years while the apartment sector prevailed over the office market for only 5 of those 15 years.

Adds Bach: “That’s not too bad for a low-risk property type like industrial.”

Institutional buyers agree. According to RCA, the two largest industrial buyers during the first five months of 2005 were ING Clarion Partners and CalEast Industrial Investors. The two spent more than $1.75 billion on industrial properties over that period, and the rest of that list includes many private REITs and TICs. RCA reports that institutional investors have been the most aggressive buyers in major markets. These buyers have favored markets like Atlanta and San Francisco, whereas Los Angeles is fielding demand from all capital sectors.

So given this mixed picture, where does Bach of Grubb & Ellis see the industrial market heading?

“Look for the industrial vacancy rate to continue falling but at a slower pace than the first quarter, ending the year between 8 and 8.5%,” says Bach. Industrial vacancy closed the first quarter at 8.89%, below the end of the first quarter 2004 when it hit 9.82%. He projects that average rental rates will begin a gradual ascent in the second half of 2005.

Top Industrial Market Sales Volume (through April)

Location Volume in millions Average Cap Rate Price per sq. ft.
Los Angeles (Metro) $3,600 7.7% $82
New York City (Metro) $2,499 8.6% $74
Chicago $2,459 8.1% $43

Source: Real Capital Analytics