Investors and developers aren't exactly pushing the panic button in the wake of a few soft years in the industrial real estate market. Space absorption is on the upswing nationally, the perennially strong markets of Los Angeles, Chicago and New Jersey are getting even stronger, and money continues to pour into the vast industrial-property reservoir.
Some observers are confident that those long-sidelined corporate real estate decision makers will soon bolt into action. A burst of activity in late 2003 helped push the industrial sector out of a rut nationally with a modest net absorption of 12.9 million sq. ft. — an encouraging performance after two years of negative absorption (2 million sq. ft. in 2002 and 20.4 million in 2001), reports CoStar Group.
Why the Renewed Optimism?
While it's still apparent that U.S. firms are seeking manufacturing cost savings overseas, several economic indicators speak well for domestic growth in the sector. In February, U.S. manufacturing activity grew for the ninth consecutive month and the overall economy grew for the 28th consecutive month, according to the Institute for Supply Management (ISM).
While new orders and production decelerated somewhat in February, they were still at very positive levels, says Norbert J. Ore, chairman of ISM's Manufacturing Business Survey Committee. All 20 manufacturing industries reported growth, he says, and the sector appears to have “sustainable momentum at this point.”
John Seiple, president of the North American division of Aurora, Colo.-based industrial developer ProLogis, says gains in the industrial market historically lag such positive ISM data by a year or so. “We're (already) seeing improvement in most markets after 24 months of softness.”
Industrial real estate, Seiple says, really never fell out of favor. “In bad times, occupancy is still in the high 80s [percentile], and in good times it is in the mid-90s. Unlike office, where you are spending $10 to $15 per sq. ft. for a new customer (finish-out), you're spending $1 in industrial.”
A U-Shaped Recovery
Undoubtedly, there's still some bumpy ground to navigate this year. Year-end 2003 vacancy rates of 11.6% are expected to jump to 12.2% in 2004 before leveling off to 11.8% in 2005, according to projections from Boston-based Torto Wheaton Research.
“There is a lot of overhang in the market,” explains Jon Southard, vice president and chief economist for the firm. “Warehouses face the risk of a lot of competition, and we see that persisting through 2004. Even in the early 1990s, we really didn't see demand contract quite like this.”
One positive development is that construction activity is slowing. Some 89.4 million sq. ft. of new industrial space came on the market in 2003, but just 61.78 million sq. ft. is planned for 2004, according to CoStar.
Deutsche Bank analyst Lou Taylor, who covers real estate investment trusts (REITs), says leasing velocity increased in the third quarter “and we saw confirmation of it in the fourth quarter. I think the recovery has begun and we should see slow, steady occupancy increases over the next three to four years.”
REITs are giving the category a vote of confidence, as well. They acquired more than $2.5 billion of industrial properties in 2003, a 75% increase over 2002, according to Real Capital Analytics.
San Francisco-based AMB Property Corp. has been especially active, buying a 3.4 million sq. ft. portfolio of 37 air-freight buildings near seven international airports for $481 million. That reflects an investment trend in airport-adjacent distribution property, driven by the growing need to provide facilities for customers with business tied to global trade, says AMB spokesperson Lauren Barr.
Large Appetite For Product
Leading the list of the top 10 industrial buyers in 2003 was CB Richard Ellis Investors, spending in excess of $800 million in 100-plus transactions, according to Real Capital Analytics. HRPT Properties Trust followed with more than $450 million in deals, while Keystone Properties Trust and AMB each bought more than $350 million in industrial real estate.
Although a large volume of industrial assets is changing hands, that's not an accurate indicator of how well industrial is performing, cautions Taylor of Deutsche Bank. “It just tells you that people who accumulated them want to cash out.”
Still, the conventional wisdom among investors is that the industrial market is relatively stable. In fact, historically conservative pension funds have been the most aggressive in pursuing industrial investment in recent months, says Taylor. “(They) have been chronically underweighted in industrial,” and are now trying to achieve a balance to buffer volatility in office and apartment investments.
| Quoted | Vacancy Rate | YTD Net Absorption | Under Construction Sq. Ft. | Rental Rates |
|---|---|---|---|---|
| Atlanta | 14.1% | -1.1 million | 1.7 million | $4.27 |
| Dallas/Ft Worth | 11.9% | -2.5 million | 5.9 million | $4.62 |
| Chicago | 11.3% | 4.7 million | 5.1 million | $5.06 |
| Northern New Jersey | 7.3% | 10.6 million | 2.5 million | $6.10 |
| Los Angeles | 4.5% | 8.9 million | 4.8 million | $7.20 |
| Source: CoStar Group Inc. | ||||
Several commingled funds are in the rare position of not being able to accept new investors because they are fully subscribed, notes Real Capital Analytics. They now have waiting lists.
Significant Transactions
Manufacturing, while soft domestically, accounted for some of the biggest deals in recent memory. Toyota opted for San Antonio last year as the home for a planned 2,000-acre truck manufacturing complex, slated to begin production in 2006. Meanwhile, rival DaimlerChrysler announced plans for a 450,000 sq. ft. plant on 260 acres in the 700-acre Village Industrial Park in Dundee, Mich., with a 2005 debut.
In another major deal, Pfizer Inc. chose New York City for a $560 million business consolidation/manufacturing expansion that will create 2,000 new jobs and retain the 5,500 workers employed in the area.
Still, domestic manufacturing remains the big question mark for the industry, says John Porter, senior vice president of the Global Logistics Group at CB Richard Ellis. “The whole Asian and Indian manufacturing situations are affecting the equation. Right now, their labor is less than a dollar an hour and their technology is better.” Porter believes U.S. Rust Belt cities will “eventually catch up with them in technology and be much more competitive.”
Regional Winners and Losers
The overseas manufacturing shift in recent years has actually kept many traditional port-side markets thriving, such as the nation's two largest industrial centers, Los Angeles and Northern New Jersey, as well as Chicago. In turn, it has softened activity in “inland ports” such as Atlanta and Dallas, say developers.
Michael Morris, vice president of Newport Beach, Calif.-based commercial developer Lennar Partners, says “there is more money chasing deals in Southern California than there are deals.” His firm is redeveloping the former March Air Force Base in Riverside County into the 1,000-acre, 16 million sq. ft. Meridian Business Park. The firm also is planning the 4.5 million sq. ft., 200-acre Sierra Business Park in nearby Fontana.
While the inland markets are soft overall, inland business parks with intermodal yards and Foreign Trade Zones are picking up a solid share of inbound products from overseas, says Bill Burton, senior vice president of Hillwood Properties, developer of Ross Perot Jr.'s AllianceTexas business park in Fort Worth. Hillwood completed deals with General Mills (670,000 sq. ft.) and Bridgestone/Firestone (680,000 sq. ft.) in 2003.
Reassuring Signs
Industrial sales prices seem to be heading northward. The average price of a warehouse property rose by $3 to $42 per sq. ft. in 2003 while prices of flex properties rose by $3 to $86 per sq. ft, according to Real Capital Analytics.
Asking rents in the nation's 11.4 billion sq. ft. industrial market also rose to $5.90 per sq. ft. in 2003 from $5.47 the previous year. That means leasing rates are now at the same level as they were in 2001, according to CoStar.
Porter characterized the industrial market as “either at the very bottom, or on the way up.”
Several national companies have been window shopping for space the past two to three years, waiting for widespread signs of an economic recovery, and this year's elections may finally help force the hands of corporate decision makers, Porter says. “It comes to a point where you've got to move forward with your plans to be able to compete with those who have already gone forward.”
Joel Hoiland, president and CEO of the International Warehouse Logistics Association, also believes the industry “will see a steady increase in vital signs in the next two years, but a recovery will take a little longer to hit outlying markets.”
While companies may expand profitably in 2004, “we think it won't be until 2005 that we see enough demand to fill the [vacant] space,” adds economist Southard of Torto Wheaton Research. With building availability rates high, “there'll be very little upward rent traction” in the next 21 months, he says. “And without that, we see value taken away from income return.”
That translates to cash-on-cash returns — unleveraged returns from income and appreciation — between zero to -0.2 this year and next, Torto Wheaton estimates.
One trend in the market continues to be space consolidation by both manufacturers and distributors, says AMB's Barr. Many national companies are merging smaller, older regional distribution and sub-distribution centers into a few “mega centers” to capture transportation and labor efficiencies and to simplify their supply chain, she says (please see related story below).
Even with the market running relatively flat, Prologis has maintained an inventory of about 2,000 acres in the U.S. “that's entitled and ready to go,” Seiple says. He believes some markets will even start gearing up for speculative construction again.
Ultimately, the most sustainable U.S. growth markets through the rest of the decade, says Burton of AllianceTexas, “will have a good balance of outbound and inbound trade and a large surrounding population.”
Steve McLinden is an Arlington, Texas-based writer.
Logistically Speaking
Supply-chain science drives the industrial engine.
When is a warehouse not a warehouse? When it's a logistics facility, the latest evolutionary link in Corporate America's increasingly sophisticated supply-chain strategy.
“Logistics,” which straddles transportation, storage and inventory management, accounts for a warehouse-sized share of the U.S. economy. In 2003, it measured $910 billion in gross expenditures by manufacturers and distributors, or 8.7% of the nominal gross domestic product, the Council of Logistics Management estimates.
That tally is about $93 billion shy of a “pre-freight-recession” total in 2000, but should be back on the upswing by next year, according to the council.
Driving the efficiencies are changes in consumption habits. Demand for lightning-quick delivery of products is forcing companies to find new ways to fine-tune distribution channels.
Warehouse ‘Track Meets’
Expensive new distribution centers are now built with ultra-high ceilings, wider truck courts and more “cross-dock” doors to help workers quickly move greater volumes of goods in one side and out the other.
“We call them track-meet buildings because they're built for speed,” says John Porter, senior vice president of the Global Logistics Group at CB Richard Ellis. “Some of these 700,000 sq. ft. buildings fill up overnight, and the next morning everything will be gone. Then it starts again.”
But greater efficiency can mean less square footage, especially as companies consolidate scattered satellite warehouses into central ones, says Jon Southard, vice president and chief economist for Boston-based Torto Wheaton Research.
“In a sense, this new logistics technology is driving some warehouses out of business,” he explains. “It reduces the amount of space they need, which adds strength to the headwind that has swept the market downward.”
The difference between the tall, new models and their predecessors — even facilities built as late as the mid 1990s — is vast and has quickly made millions of square feet of space functionally obsolete to many prospective tenants, say developers and leasing agents.
“Subassembly” areas, where last-minute customization is applied before products are packed into trucks, has replaced less-useful space, shifting a layer of labor from manufacturing plants to the less salary-intensive distribution arena.
Streamlining the industry further will be new Radio Frequency Identification (RFID) technology, which enables companies to pinpoint any pallet of goods, any time, via satellite. Wal-Mart is championing the technology and will eventually require suppliers and freight contractors to update their systems, too, says Joel Hoiland, president and CEO of the International Warehouse Logistics Association (IWLA). “The software and tags are very expensive,” he says. “But the end result will be a 7.5% savings in labor costs for them, plus theft reduction.”
Surge of the ‘3PL’
The most voracious users of new distribution boxes are third-party logistics firms, or 3PLs, which handle outsourced distribution functions such as warehousing, inventory and traffic coordination for clients.
As companies have opted out of owning some of the industrial venues they use, logistics outsourcing has grown — 15% annually the past two years, according to the IWLA.
General Motors, one of the largest outsourcers in the world, incorporates numerous contract firms, including 3PLs, into its elaborate manufacturing mechanism. Company assembly lines receive vehicle components on a “just-in-time” basis from such part suppliers/warehousers as TDS Automotive and Leer Corp. that set up plants nearby — a strategy that allows manufacturers to focus more on their core strength, say logistics experts.
“We don't tell them they have to build next to us. We tell them where we'll be and they make that decision,” says GM spokesman Tom Hill, whose firm has 5,300 different suppliers.
“Instead of a vendor dictating the terms of distribution, the client is now dictating what it wants to its vendors,” says Kevin Higgins, senior vice president of Voit Commercial, which is marketing a new 2 million sq. ft. industrial park in Las Vegas that will be used by several 3PLs. Voit Commercial Brokerage, which has multiple U.S. offices, has facilitated sale and lease transactions in excess of $10 billion.
In the past five years, as traditional public warehousing declined by 19%, contract distribution increased 126%, according to an IWLA survey. “Many organizations don't view logistics as their core activity, yet they're seeing the value of it increasingly,” says Marv Larger, senior vice president of commercial services for Great Britain-based Exel Logistics. “As they grow through various mergers and acquisitions, they haven't necessarily adjusted their supply chains. That's where we come in.”
Money not spent on building maintenance, trucks and fork lifts goes right to the bottom line, says Larger, whose firm operates 63 million sq. ft. of leased and owned space in America.
3PLs have become prime business prospects for real estate developers and investors because of their growing need for space, says Lauren Barr, a spokesperson for San Francisco-based AMB Property Corp.
The Institute for Supply Management reports that users of third-party logistics services should spend an average of one-third of their total logistics budgets on 3PL services by 2005, compared with 20% today.
— Steve McLinden