Industrial property makes a comeback

Real Estate Weekly, June 21, 1995 by Jean-Marie Murphy

The national appetite for industrial property is largely driven by business cycles and the regional economies. For the past few years, investors have been reluctant to begin speculative development, and construction has been limited to build-to-suit projects. With industrial construction at 0.1 percent of supply in 1994, rental and occupancy rates are on the rise. Speculative construction is expected to reach 0.4 percent of total national supply in 1995 - more than four times last year's level.

The most promising industrial markets in the U.S. include Miami and Tampa - both with strong forecasts for growth related to an increase in Latin American trade; Atlanta and Charlotte - with strong demographics; Salt Lake City - the fastest growing MSA in the country and the only distribution hub within 350 miles; Seattle and Portland - both port locations with growing economies and sub-4 percent vacancy rates; and Minneapolis - with a 3 percent vacancy rate, resulting from its strong manufacturing and wholesale trade sectors and very little new supply over the past 10 years.

Southern California, New Jersey and Columbus have also been cited as very active industrial markets for 1995. According to the National Real Estate Index, speculative industrial space should increase by more than 1 million square feet in a number of major markets, including Atlanta, Charlotte, Chicago, Columbus, Dallas, Grand Rapids, Houston, Los Angeles, Memphis, Miami, Portland, Phoenix, Raleigh and Riverside/San Bernadino.

The strong performance of warehouse properties last year is responsible for renewed interest in developing this asset class in 1995. According to Frank Russell/NCREIF, total return in 1994 was 9.02 percent, with a 10.04 percent annual income component and -0.96 percent appreciation component. This is a remarkable improvement over the three-year return of 1.44 percent and five-year return of 0.97 percent.

In the last quarter of 1994, Grubb & Ellis reported a 3.5 percent rise in rents, while the national vacancy rate was 10.2 percent. The stabilization of property values - which have been decreasing since 1990 - has been a significant factor in augmenting total return on industrial property.

However, industrial property is more volatile than other asset classes because it is sensitive to many factors. Also, supply can change in a short time frame because tilt-up construction - used for bulk warehouse space - takes very little time to complete.

Macroeconomic factors can have both positive and negative effects on warehouse product. Growth in manufacturing and capacity utilization increases demand for warehouse space. Similarly, a weaker dollar leads to more imports and the accompanying demand for warehouse and distribution space.

Conversely, a rise in interest rates translates into a slowdown in manufacturing activity, causing inventories to drop, and warehousing and distribution activity to decline. Higher rates also hurt retail sales, leading to cutbacks in space needed by big-box retailers and wholesalers, which are significant users of warehousing and distribution capacity.

Interest in this property class is currently coming from retailers, pension funds and REITs, and a variety of institutional investors. The most popular properties are warehouse/distribution properties, with R&D and light assembly trailing. We expect the effects of NAFTA and the very low level of new industrial construction over the past several years to cause an increase in the demand and supply of warehouse space in the major distribution centers in the Southwest, especially in the Texas cities of Dallas, Houston and San Antonio. These cities will also benefit from the deregulation of the Texas trucking industry.

In Texas, like much of the country, there will continue to be significant competition between new facilities and older ones with less operating flexibility. Obsolescence is a problem with warehouse space. As distribution systems become more complex, the majority of large users will require at least 24-foot clear ceiling heights, fast response sprinkler systems, the ability to handle sophisticated racking systems, and multiple loading capabilities.

The optimal locations are within a 24-hour drive of a significant population cluster, and have convenient interstate highway access. The more modes of transportation available, the better - highway, class 1 rail, air and ports.

In the future, changes in the trucking and hauling industry will continue to mandate accommodation from warehouse owners. Longer and wider trucks will require a larger turning radius outside of the facility. Also, truck beds will be lowered to allow for trucks with more capacity, and this will require different dock heights. Retrofitted and upgraded rail transportation will also impact warehouse configuration.

A desirable investment property should contain at least 100,000 square feet, have at least 24-foot clear ceiling heights, and be flexible and modern enough to handle the changing needs of a variety of tenants.