Costs for owning industrial product are lower than other sectors, says Principal Financial Group, owner of Kyrene & Warner Commerce Center in Tempe, Ariz.
Investors and developers are all smiles when it comes to the state of today's industrial marketplace. Is the end of the good times anywhere in sight? Not soon, according to most observers.
Industrial markets throughout the nation continue to ride the wave created by a strong economy. Demand for industrial space, particularly that of the bread-and-butter, bulk warehouse variety, is strong and coming in large part from large corporate space users that are continually refining their distribution networks. Meanwhile, developers, whether they are public or private, are busily throwing up facilities to meet this demand - and there's plenty of money available to bankroll their efforts.
Investment angles "Investors' love affair with industrial-warehouse investments doesn't miss a beat," according to ERE Yarmouth/ Real Estate Research Corp.'s Emerging Trends in Real Estate 1998. The strong national economy of the past five years is the main reason behind this enduring romance.
"Industrial properties excel in strong economic periods, and the current healthy business climate has been a boon," the report notes, adding that "the formula is simply that businesses manufacture, ship and store more goods when the economy is rolling and customers are buying."
Industrial properties are a long-term favorite among investors, says Greg Gregory, president of Atlanta-based Industrial Developments International. "Of all the real estate investments available, it is generally and accurately felt that industrial is the least volatile," he says.
During the last major downturn in real estate, when the management of many properties wound up the responsibility of the Resolution Trust Corp. (RTC), "The percentage of industrial properties involved was miniscule," says Gregory. "You don't always get 'super' returns when investing in industrial, but it is typically a much surer, more certain category of real estate investment."
A number of factors work together to make industrial the most stable of real estate investments, according to Marty Cropp, director of commercial real estate for the Des Moines, Iowa-based Principal Financial Group, a leading investor in industrial and other real estate product. "Demand for industrial product is driven by population - people always need to eat and consume other basic products, and retailers always need places to store foodstuffs and other goods," he notes.
At the same time, the relatively short time frames involved in developing industrial space allow for more timely response to market conditions, says Cropp. Meanwhile, "The capital costs associated with developing, investing in and owning industrial real estate are much less than those you find with other property types, particularly office."
The price of entry into the industrial property arena may be rising, though, notes Hamid Moghadam, president and CEO of San Francisco-based AMB Property Corp., a REIT with some 70% of its holdings anchored in industrial product. "The market is getting pricier than it has been," he says. "Pricing on some of the available portfolios is being bid upwards to high levels, while some individual assets can be purchased on a much more attractive basis."
Still, he notes, "the industrial investment market never gets as 'frothy' as the office market on the way up, or as depressed on the way down - it is always a very steady performer."
Judging by recent performance indices from the Washington, D.C.-based National Association of Real Estate Investment Trusts (NAREIT), industrial REITs are currently generating returns a cut above the average REIT. Total return for industrial REITs in 1997 was 19.02%, according to NAREIT, compared with an 18.86% return among all REITs for the year. And as of the end of Febr uary 1998, when total return for all REITs was a negative 2.16%, industrial REITs did a bit better in holding the line, keeping their aggregate negative return to 1.60%.
Investor competition for industrial product "is pretty fierce," says Michael Tomasz, president and CEO of First Industrial Realty Trust, a Chicago-based REIT.
"There's an enormous amount of capital on the market, and everyone is chasing deals," he notes. "Although the pricing has gotten tougher, the cost of capital has come down dramatically over the past two years. So, while it may look like we are paying more (for industrial properties), when you look at the actual costs of transactions, we are probably better off than we were two years ago."
REITs are particularly active buyers of industrial product, according to Cushman & Wakefield of Texas Inc. Senior Director Jack Fraker, "and pension fund advisers are right up there as well."
Last year, while marketing packages of industrial properties, "We had some 65% to 70% of all offers coming from the pension fund advisers, with the balance from REITs" he reports. That ratio is closer to 50/50 now, says Fraker. "REITs are making more offers now, but they are not always the ones that pay the most."
The most popular type of industrial product for investors is the big-box bulk warehouse/distribution facility, says Jim Dieter, executive director and head of industrial operations for Insignia/ESG. Speaking from his office in Chicago, he notes that investors, especially those of the institutional ilk, see real advantages toward sinking their dollars in this type of building, "The buildings are big and can often be subdivided, which makes them very flexible - and institutions like flexibility," says Dieter.
At the same time, "most of these buildings are being leased by large, high-credit national tenants, which gives security to the investment," says Dieter, adding that for institutions, particularly REITs, "the appetite for big-box distribution facilities is high in all major markets."
The demand side Businesses are flocking to the marketplace for industrial space. While new construction is taking place in nearly every market in the nation, "industrial space is nearing peak occupancy levels," according to Chicago-based LaSalle Advisors Capital Management Inc.'s 1998 Investment Strategy report.
"Prices have been bid up to replacement costs," the report says, "with few opportunities for significant price increases in the near future." In general, the report continues, "rent levels are expected to remain near inflationary levels."
Meanwhile, "new completions are competing for tenants, but vacancy has not been high enough to affect rents in most markets," says the report.
"Major users are active across the country in all markets, with no exceptions - and big-box distribution buildings are the major focus," says Insignia/ESG's Dieter. Today's major warehouse user is typically consolidating the numbers of its distribution operations, "while the facilities themselves are getting larger and larger," he notes.
Demand for industrial space today is coming from companies reassessing their distribution needs, "and they are largely looking at the big-box facility," says Jack Crocker, president of Opus National LLP, Chicago. "The big, high-cube, straightforward box is the hot product in today's market. This is the product most companies want, particularly as they examine their distribution strategies and consolidate smaller facilities into larger, regional distribution centers."
Finding the right distribution facility in the right place - fast - is a continuing concern for Corporate America, according to John Seiple, managing director of Security Capital Industrial Trust, a REIT with more than 100 million sq. ft. of industrial space worldwide. "Major companies are continually looking at optimizing their distribution networks," he notes from his office in Atlanta. In response, Seiple adds, Security Capital provides a logistics consulting service, utilizing a recently developed software package "to help these companies determine just how many facilities they need and where they should be located."
Today's warehouse/distribution facility user is more inclined to lease speculative space, as opposed to going the build-to-suit route, according to Cushman & Wakefield's Fraker. The fast-paced business style of the 1990s is the reason, he notes. "All major companies have people constantly planning ahead for upcoming distribution needs," he says. "But, no matter how much they try to plan ahead, they inevitably wind up having to make a lot of location decisions within a short time frame."
As a result, the nation's speculative developers of large warehouse projects are meeting with continuing success in leasing, says Fraker. "A typical build-to-suit project may take a year to put together, but a four-month timeframe is often all a company has to work with."
"Things change quickly, and no one has that kind of time to work with," says Fraker, which works to the benefit of the speculative developer "that has the product already in place to do a lease quickly."
The build-to-suit market is not entirely dead, though. "An increasing part of our business is corporate distribution facilities done for a specific customer," says Security Capital's Seiple. And although this type of facility may be done on a lease or sale basis, "We are predominately seeing a preference for leasing, with customers wanting to keep real estate off their balance sheets."
Ownership is still a viable option for many companies, though, according to Harry Henshaw, president of corporate industrial services for Chicago-based LaSalle Partners. "Many users in this market have specialized needs," he notes, "so you'll find that in a significant number of instances, they want to own the asset."
Overbuilt? While demand for industrial space appears to be fairly consistent for now, thanks largely to an expanding economy, some are concerned about the rapid pace of development of new product. "What could upset the current market balance is the supply side," says IDI's Gregory. "There is a huge amount of capital available for industrial space development coming from all kinds of sources - pension funds, banks and, of course, Wall Street."
Markets could become oversupplied, says Gregory, " and that is a real danger we are looking at now."
There's a lot of money available for industrial development, agrees William Linville, executive vice president of Duke Realty Investments, an Indianapolis-based REIT. "The market is definitely good for industrial development - almost too good in some respects," he says.
A lot of new players have been able to enter the development arena lately, notes Linville, "and some markets are starting to look a little overbuilt."
The industrial development market "has been hot for the past several years," says Cliff Aiken, executive vice president of Columbus, Ohio-based Pizzuti. "Last year, it seemed to soften a bit, but this year the market has come back stronger than ever," he notes.
In the various markets in which Pizzuti develops, "vacancies seem to have gone up a bit, just because a lot of new product has come on line," notes Aiken. But, he adds, "this product seems to be getting absorbed, and there doesn't seem to be any real overbuilding as of yet."
"It's been pretty easy to develop in most markets over the past three or four years," says Todd Anderson, executive vice president of Majestic Realty, a big-box developer based in City of Industry, Calif., "but I think things are getting more difficult now."
REITs are developing throughout the country, Anderson notes, while "because of all the capital available, you are seeing a lot of new players, along with developers that have been out of the market for a while, coming up with the money to do new development deals."
As a result, "there is growing competition on the supply side, while the demand side has not changed dramatically," he adds.
"A number of markets are becoming overbuilt," says Opus National's Crocker. "Even though there are deals out there, there is more competition for them," he notes. As a result, "speculative product is taking longer to lease, there is some pressure on rental rates, and there is definitely some pressure being placed on (developer) margins."
Some are more sanguine about the industrial development marketplace. "Markets are very much in equilibrium right now," says First Industrial's Tomasz. "I don't think there is a market out there that is in any serious danger of overdevelopment or declining occupancy."
In general, development has been staying in line with demand, he says, "although some markets, due to the sheer volume of space we're talking about, are a little scary." Atlanta, for example, "is a market that absorbs tremendous amounts of space, which leads to tremendous amounts of development," explains Tomasz. "The good news is that the two have been pretty much in sync for the past three or four years."
Others see no reason for concern at all. "There is no oversupply of industrial real estate," says Fraker. "We are seeing everything that is built getting leased up, if not upon completion, within a short while after."
The current increase in supply in major markets is necessary to meet demand, he notes. "In the early 1990s, due to the national real estate crash, supply didn't increase at all," says Fraker. New industrial construction didn't really resume until 1995, he says, and in the time since then, "the builders are building and the lenders are lending, because buildings are leasing up well and the lenders are recognizing that there is not that much risk involved."
Product perspectives With all the talk about functional, flexible, big-box buildings where you store things to be moved later, you may think that warehouse design and construction must be pretty dull stuff compared with office towers or shopping centers. Think again. "An industrial building takes all the skills that you learn as an architect," says Security Capital senior vice president Don Madsen, an architect responsible for the design and construction of all facilities built by this REIT.
Ceiling height has been one feature of warehouse design that has been changing over the years, according to Madsen. "In 1970, we started hitting 24-foot clear ceilings, and 28 years later, that is still considered a good, utilitarian clear height," he notes.
For buildings 200,000 sq. ft. and larger, Security Capital "has pushed the envelope" up to 30-foot clear ceiling heights, says Madsen. "I really don't know how many users can actually make use of that high a ceiling," he notes, particularly in buildings with cross-dock loading facilities, i.e., loading docks directly opposite each other on both sides of the building, "where product comes in and moves out very quickly."
With users stacking stored product higher and higher, the properties of the warehouse floor become increasingly important - the flatter and more level, the better. The use of "laser screed" technology allows building contractors to achieve extremely flat and level floors, says Madsen. This, combined with newer technology used to finish the concrete comprising the floor, allows for a super-flat/super-level "random access floor" in today's warehouse, he notes, which users can utilize in any direction as they stack and move product within the facility.
Other recent shifts in the design of warehouses include the use of ESFR (Early Suppression/ Fast Response) sprinkler/fire control systems, "which, for the most part, satisfy the needs of most users," says Madsen. And, of course, with the increasing size of truck trailers, larger truck courts are the order of the day, he notes, while enhanced lighting of warehouse facilities and their surroundings is often necessary to accommodate increased evening and nighttime operations.
Service space resurgence It goes by different names in different markets - flex, service, high-tech, R&D - and was egregiously overbuilt in the 1980s. But there's a resurgence of development under way for the industrial product with grade-level loading and high-office finish, although there are some new tweaks in its design and marketing.
With the existing (i.e., ca. 1980s) service product now functionally obsolete, "what you are seeing being developed now is a product more closely akin to true office," says Tom Leiser, managing director of Trammell Crow, Dallas, a developer of bulk-warehouse and service space.
Changes are focused on higher parking ratios and enhanced appearance, he notes. "We think we can appeal to a number of traditional office tenants who find surface parking more appealing than being in a garage structure," says Leiser. On the appearance side, "we won't appeal to the corporate user that wants a corporate image," he notes, but "the service space environment can give a tenant a lot of presence and identity - and there are a lot of users looking for just that."
Trammell Crow is also marketing service space to a larger user than was the case in the 1980s, says Leiser. "We are not building service space with the 2,000 to 5,000 sq. ft. user in mind as before," he notes. "What Crow is doing in Dallas is targeting 20,000 sq. ft. and larger users." Tenants of this size "give a project a much better credit base, which was a big part of the problem with service space the last time around."
"Service space is a very good product type," says Charles Wolcott, president and CEO of Dallas-based American Industrial Properties, a REIT that owns and develops light industrial, flex and service center properties in the South and Southwest. "There is very little institutional ownership in this sector, which means relatively little institutional pricing pressures, resulting in a market where you can buy these properties at prices well below replacement costs."
Service projects located "in the shadows of high-rise suburban office parks" are attractive "because they often have the ability to attract spillover tenants," says Wolcott. The tenant base of these projects is mostly local, he notes. "But you get your Fortune 500 tenants as well, who are attracted by the drive-up parking in a park where customers can find them quickly and easily, more so than if they were located in a multistory building."
Developers and owners can have a hard time profiting from flex space "because it has such a high degree of office finish," says Duke Realty Investments' Linville, "and it tends to be customized for the tenant."
Most of the demand for this kind of space today is due to overflow from the pure-office sector, he notes. "Office users increasingly need more back-office, storage and overflow space for their operations, but they don't want to pay pure-office rental rates to get it."
Outlook "We are extremely bullish" when it comes to the outlook for the nation's industrial marketplace, says Cushman & Wakefield's Fraker. Look for rental rate growth to continue at a moderate pace, albeit slower than that of some previous years, he notes. "Two or three years ago annual rent growth was in the 10% to 12% range, but now that figure is more like 4% or 5%."
Among the nation's major industrial markets, "Los Angeles is very active and balanced, while Chicago may be suffering a bit," says Insignia/ESG's Dieter. Dallas, meanwhile, "is extremely hot, with a possibility of becoming overbuilt."
Overall, "I think we still have a couple of good years ahead of us, particularly in the distribution end of the market," he adds.
Look for a bit of a slowdown in the expansion of the nation's industrial marketplace this year, says LaSalle Partners Senior Vice President Michael Sekerak. "This is not particularly a result of any 'red flag' being waved," he says. "Instead, it is more of a reasoned reaction by the marketplace to what has been happening in Asia and the Middle East."
Changing consumer behavior may have a long-term impact on the warehouse industry, says Principal Financial Group's Cropp, but exactly how things will shake out is hard to predict.
He asks, "As people become more comfortable with shopping via the Internet, will we see a decline in the number of retail outlets that are necessary?" And if this happens, "will we see more products stored in warehouses and distributed to customers via cyberspace?"
Predictions about whether more or fewer warehouse facilities will be needed in a growing on-line retail market vary, notes Cropp, "but it is something we all have to keep an eye on."
Today's industrial market "is as good as it gets," says Tomasz. "I kind of hate to say it, but these are the good old days."
Not that he feels there is a major downturn waiting in the wings. "Year-in and year-out, industrial is the best performer on a total return basis, if not the most glamorous," he adds. "It is a very stable, predictable product sector with no enormous peaks and valleys," he continues, adding that with overall industrial occupancy remaining in the 91% to 96% range during the past 15 years, "this is a hell of a business to be in."