The recession delivers a new industrial market.
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
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.
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
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.
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
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
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.
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.
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.
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.
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
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.
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.
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.
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.
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.
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
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.
is senior vice president and chief investment officer for Industrial
Developments International headquartered in Atlanta. Contact him at