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Real Estate Investors Seek Rising Industrial Strength
Jose Gose | Investors Business Daily


A rendering of the planned Candler Park/Edgewood Transit-Oriented Development. The Columbia Ventures project will feature about 400 apartments, 10,000 square feet of retail and a public park. Construction is expected to begin by early 2016. The development is estimated to generate 387 to 540 new daily transit trips for MARTA.

Rising rents and low vacancies coupled with lagging new supply — and billions of dollars searching for assets — have ignited a booming trade of industrial properties around the U.S.


Despite the country's moribund economic output in the first quarter, overseas buyers looking for safe havens are more aggressively targeting U.S. industrial assets, which include warehouses and "flex" buildings that typically feature offices or showroom areas in addition to warehouse, research and development, or manufacturing space.


Not only are buyers from Asia and Europe displacing Canada as the biggest group of foreign investors in U.S. industrial deals, but cross-border capital generally is also spreading more cash beyond primary and secondary markets, according to a recent report on foreign investment by Chicago-based commercial real estate services firm JLL.

Even with the expected completion of 171 million square feet of new industrial space this year, following 142 million square feet built last year, supply is still below the annual average of 184 million from 2004 through 2008, says JLL.


Additionally, virtually no new industrial space was built from 2011 through 2013, says John Huguenard, international director and head of industrial capital markets for the Americas at JLL.


Building On Spec Returns

Speculative construction has generally composed about half of the new supply over the last several quarters and is concentrated in Dallas, Southern California's Inland Empire and other markets that have a large industrial base, he adds. He estimates that companies are typically leasing 30% to 50% of the space while under construction.


"Developers are really trying to play catch-up more than anything else," Huguenard said. "So we're just not seeing a lot of perceived risk in the system from institutional investors."


U.S. industrial property sales totaled $21 billion in the first quarter, a year-over-year increase of 97%, according to commercial real estate researcher Real Capital Analytics, which tracks individual property and portfolio transactions of $2.5 billion and greater.


New York-based Blackstone's (NYSE: BX) $8.1 billion sale of its IndCor Properties industrial platform to a joint venture between Singapore sovereign wealth fund GIC and Singapore logistics provider Global Logistics Partners was a key contributor to the dollar-volume spike. Blackstone built the 117-million-square-foot portfolio through 18 acquisitions over the last five years.


In April, a joint venture between San Francisco-based real estate investment trust (REIT) Prologis (NYSE: PLD) and equity partner Norges Bank Investment Management, Norway's pension fund, reached an agreement to buy KTR Industrial for $5.9 billion. KTR's portfolio encompasses 322 properties totaling 60 million square feet.


By comparison, Canadian investors plowed only $3.5 billion into industrial properties from 2012 through 2014, according to JLL.


The investment activity helped drive industrial capitalization rates to an average of 6.9% in the first quarter, a year-over-year decline of 30 basis points, according to Real Capital. Capitalization rates represent a property's initial yield and move lower as asset prices increase.


Industrial prices have climbed 12% so far in 2015 and lag last cycle's peak prices in 2007 by only 4%, according to the Real Capital/Moody's Commercial Property Price Index.


Property 'Feeding Frenzy'

What's more, cap rates for newer industrial properties in mature industrial markets, which tend to get the highest rental rates, are in the 4.75% to 5.5% range, says Erik Larson, an executive director at commercial property brokerage Cushman & Wakefield in Los Angeles.


"There's so much capital looking to be placed and so little product that there's a feeding frenzy for buildings that come on the market," he said. "I haven't seen cap rates quite this low before."


Industrial investors are chasing a sector that has enjoyed robust fundamental improvement over the last several quarters. Auto parts distributors, e-commerce retailers, and food distributors and preparers are among some of the more active users of space, observers say.


The average industrial vacancy rate in the U.S. dropped to 7.6% from 8.2% a year earlier, according to Chicago-based commercial property service provider DTZ. The average rent of $5.35 a square foot that landlords sought in the first quarter marked a year-over-year increase of 4%, the firm said, but several markets such as San Francisco, Chicago and Nashville, Tenn., saw double-digit-percentage rent increases.


In California's Inland Empire, near Los Angeles, developers are currently building 17.6 million square feet, which includes a significant share of speculative development, according to Cushman & Wakefield. While the average vacancy rate of 6.1% in the first quarter was flat year-over-year, the average rental rate climbed 7% to $5.28 a square foot.


Considering that industrial users absorbed 9.1 million square feet in the quarter, Larson says, the market isn't too concerned about oversupply. Thanks to healthy real estate values, developers are tearing down old obsolete buildings and replacing them with more desirable modern properties.


Big Deals On Tap

Real Capital notes that large portfolio sales have dominated the landscape recently but typically only average about 29% of activity annually. Subsequently, sales of individual industrial assets, which it considers the "bedrock of the market," were up only 20% year-over-year to $8.9 billion in the first quarter. Yet demand for large portfolios isn't waning.


A handful of landlords such as Denver-based Industrial Income Trust, a nontraded public REIT that owns 57.6 million square feet, are on the market, Huguenard says. All told, in 2015 he expects $60 billion in industrial properties to trade hands, about $10 billion more than what would trade in a typical year.


In some cases the deluge of capital and frothy pricing has tempered investment appetites. On May 1, during the first quarter earnings call for Denver-based DCT Industrial Trust (NYSE: DCT), CEO Philip Hawkins said that the company was reducing its acquisition guidance for the year even though it completed a few deals in the first quarter.


It has become "more and more difficult for our market teams to find acquisitions that make sense from a quality and return perspective," he told analysts.