Modern Logistics

The recession delivers a new industrial market.

The Great Recession jolted real estate markets, which are still feeling the aftershocks. While the industrial real estate market is seeing strong signs of recovery, to understand today’s investing environment, we must look at the changes since 2008.

Post-Crash Update

The U.S. capital markets peaked in 2007, only to see the failures of major U.S. financial institutions over the next year. As is often the case, the real estate markets lagged other capital markets in their response to changes in the economic situation. Despite declining leasing demand for industrial space and high levels of new construction starts, both equity and debt were readily available for industrial real estate investment. Low capitalization rates and high deal volume carried through for most of 2008.

Starting in fourth quarter 2008, capital evaporated and fundamentals further deteriorated, leading to a dramatic downward spiral. Absorption turned negative across most markets and speculative projects started in the prior year were delivered without tenants — driving available inventory to record high levels in 2009 and 2010. Asking rates crumpled as owners desperately tried to preserve occupancy.

Tenants went into a holding pattern as questions swirled about the future of their operations. Many companies and industries downsized and gave space back. Active expansions were put on hold or canceled. The only silver lining for the industrial market — especially developers — was the accelerating trend to consolidate supply chain operations into very large distribution space. This gave rise to the super-bulk distribution centers: modern logistics facilities from 600,000 square feet to more than 1 million sf.

As demand for small buildings declined dramatically, demand for very large spaces held fairly strong as tenants insisted on increased supply chain efficiency. The big buildings filled up, often at market rates higher than smaller spaces. Large build-to-suits were able to capture even higher rents per square foot in many markets.

With the relatively short development cycle, some developers were able to react quickly to a volatile market and changing customer demands. For real estate companies with class A space and readily available land and capital, this created a market advantage.

Today’s Industrial Market

As the recession ended, activity started picking up across a number of markets, led by the western U.S. markets. It should come as no surprise that the Inland Empire of Southern California led the country with high levels of absorption and the return of spec development focused in the super-bulk segment. Since 2010, more than 43 million sf has been absorbed, driving down IE’s vacancy; developers have responded with 9.5 million sf under construction as of the end of first quarter 2013, according to CoStar.

As other markets began to rebound, it became increasingly clear that the industrial real estate marketplace had changed in many ways. First, due to technology innovations, world trade patterns, and supply chain practices, sustained demand for very large distribution centers in the top logistics markets has been clearly established.

Second, proximity to superior logistics infrastructure is driving location selection for industrial tenants, especially for larger operations and e-commerce fulfillment centers. Proximity to ports, freight airports, and intermodal rail yards is clearly driving demand in the top logistics markets.

Third, underwriting industrial leases has become much more complicated than in the past due to a vast range of debt and equity structures available as tenants and investors wrestle with predicting the future of inflation in the current very low yield environment.

Finally, a build-to-suit development for all sizes of industrial properties is even more competitive, much more than during the recession. This has created a market that favors the tenant. Though still profitable, build-to-suit developments often lead to bidding wars for a tenant’s business, but investors that control the best land sites in the top markets have a significant competitive advantage.

Tenant Preferences

Today’s tenants are looking for class A space with modern functionality. These requirements range from higher clear heights, ample trailer and employee parking, energy efficiency, and proximity to logistics infrastructure: air freight, intermodal rail, and seaport. Class B and class C buildings cannot offer these prerequisites and therefore are in much lower demand despite closer proximity to the city center.

Tenants are also looking broadly at a marketplace. Certain markets, such as Memphis, Tenn., Cincinnati, Indianapolis, and Louisville, Ky., have the existing logistics infrastructure needed for efficient distribution centers, including proximity to multi-modal transit — rail, highway, and air freight. This allows tenants to serve a larger percent of their customer base using the most efficient combination of trucks, planes, and trains without being locked into the old paradigm of distribution via truck only with a two-day service window. These markets are also competing directly with each other.

Also occurring is the re-emergence of small to midsize tenants from many different industries including manufacturing and construction. These firms need expansion space, while new businesses are also being formed with a need for light industrial space. As these small to midsize tenants continue to rebound, leasing activity between 25,000 sf and 100,000 sf has followed.

Investment Considerations

There is continued strong investor demand for new investment in modern logistics real estate. Renewed opportunities for the full spectrum of real estate investment capital, including real estate investment trusts, institutional investors, sovereign investors, and private equity, make it a great time to be a seller of class A properties.

It’s still a challenge though to quickly achieve asset allocations in the industrial market. For example, an institutional investor with $1 billion to invest and a 20 percent allocation for industrial real estate will likely have to complete 10 to 20 $10 million to $20 million transactions. The investor can achieve the same 20 percent allocation in the office market by buying just one building. As more capital continues to flow into real estate, expect the industrial investment market to continue to pick up in core, value-add, and development.

As the top markets have strengthened, construction has returned. At the end of 1Q13, about 60 million sf of modern logistics property was under construction nationally, a steady increase from 20 million sf at the end of 2011. Prerecession, the average modern logistics square footage under-construction was about 100 million sf.

While the future of the industrial market looks positive, there are still reasons to be cautious. We cannot overlook how the recession changed the industry. Demand is up and access to capital has improved, but developers, tenants, and investors are being more prudent, which is probably a good thing. Part of this cautious optimism is due to the surge of information and data that is now available to help tenants and investors make better-informed decisions.

Bryan Blasingame is senior vice president and chief investment officer for Industrial Developments International headquartered in Atlanta. Contact him at


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