COVER STORY, OCTOBER 2008

MIDWEST INDUSTRIAL OVERVIEW
Ashley Ball

The general uncertainty plaguing the economy is rearing its head in the Midwest industrial sector. Although fundamentals in the market have remained relatively stable, companies are hesitant to expand and/or commit to new locations, which has undoubtedly slowed the pace for leasing and new development activity in some of the region’s leading industrial markets.

Heartland Real Estate Business recently spoke with two industry professionals to discover just how much the weakening economy is affecting the Midwest industrial market, and more importantly, when will relief come?

Jim Connor serves as executive vice president, Midwest region, for Duke Realty Corporation.

How would you describe the general state of industrial real estate this year in the Midwest?

Connor: I don’t think it will come as a surprise to you that I would say the market has slowed significantly over the last several years. The overall volume of opportunities that we are seeing in the market is down and probably off, 25 to 30 percent. I think the deals that are actually getting done are off as well. So it’s going to have an effect on the overall market this year and going into next year.

Czerwinski: Fundamentals in the Midwest industrial real estate market, like those across most of the major markets in the United States, have been holding their own, with market occupancy levels in the Midwest at approximately 88 percent, according to Torto Wheaton.  First Industrial’s Midwest portfolio has enjoyed above-market occupancy levels of approximately 93 percent for the first half of 2008, and the company leased more than 6 million square feet of space in the Midwest during the period, as compared to approximately 4 million square feet in the first half of 2007.

How has the economic slowdown impacted your ability to lease space to tenants?

Connor: With the number of options that are out there, there’s a lot of competition, so you’re going to continue to see rents and concessions in the tenants’ favor. In these kinds of times, tenants tend to follow the path of least resistance, which most of the time is to renew where they are. A couple years ago, relocation was just a cost of doing business in order to continue to grow. Now, people are saying, ‘We need a good reason to have to expand our business.’ Everybody’s worried about the economy, the state of the capital markets, so the easiest thing to do is to renew a lease for a 3-year term and ride it out.

Rick Czerwinski is the national director, Leasing and Asset Management, for First Industrial Realty Trust.

Czerwinski: Leasing velocity is down from last year’s high levels, but there is still good leasing activity on most vacancies. In some cases, the general economic uncertainty has forced some companies to contemplate supply chain decisions longer before committing to new or expansion space. On the investment side, transaction volumes are down from 2007 record levels, as the well-publicized credit crunch has impacted some buyers’ ability to finance transactions, particularly highly leveraged buyers. However, industrial, due to its more stable investment profile when compared to many other real estate sectors, continues to see demand from pension funds, insurance companies and local private investors, as well as corporate users that prefer to own their own facilities.

How has the current state of the economy affected new deals?

Connor: I think activity as it relates to new deals, new leasing, going into new buildings, or moving and leasing new space in existing buildings is off a lot, as much as 25 to 30 percent in certain submarkets in cities. But there are a few bright spots. The Chicago market has performed pretty well, as well as the Indianapolis market. Columbus is really just starting to slow down and we’ve had some decent activity earlier in the year. They all differ a little bit but on par, when you look at all the different cities, you would say activity is off.

Czerwinski: On the development side, speculative construction throughout the Midwest has dramatically slowed.  Many small developers are out of the market due to the lack of availability of capital as a result of the credit crunch, as well as the impact of higher construction prices. Much of the ongoing speculative activity is larger developers building at existing, high-occupancy business parks in infill locations. Additionally, with new speculative construction constrained, there has been a pick-up in interest for build-to-suits from corporate customers.

What are the new or emerging trends?

Connor: We have seen a dramatic falloff in what we call “the really big deals.” The last 5 years we have started to see a good number of 800,000-, 900,000- or 1 million-square-foot spec buildings. And we’ve seen those deals just literally fall off the table. Nothing going on with those to the point that, when we’re now building new buildings, we’re seeing more deals in that 300,000- to 500,000-square-foot range.

Czerwinski: The trend towards environmentally friendly industrial buildings is continuing. As the rest of the development market slows, these LEED projects represent a greater proportion of the space under construction, and record levels of industrial square footage have been registered with the United States Green Building Council.

How do you feel the industrial market will perform moving forward into 2009?

Connor: I think it’s going to be very slow. It will continue much like it has this year. And I think with the election coming in November, I don’t think you’re going to see any broad significant changes that will affect the economy until early 2009. We’ll continue to see and monitor the state of the capital markets. We still have a lot of bad loans to work through, so I don’t think you’re going to see a lot of overnight health and increased activity in the capital market-side for some time. It will be well into 2009 before some of those things start to get back in balance, which means it could be well into 2010 before we started to really see things improve in our business. Once we work our way through this, I think we are liable to see some fairly significant price increases on industrial real estate.

Czerwinski: We anticipate that Midwest market fundamentals to be a bit challenged as we head into 2009, but are hopeful the markets will begin to show improvement in the back half of the year.  A key factor for the health of the market going forward is that new supply has been restrained. An improvement in the credit markets, and the levels of business and consumer confidence in the economic outlook, would only further help demand for Midwest industrial real estate.

AllPoints Midwest II Plainfield, Indiana Duke Realty Corporation AllPoints Midwest II Browning Investments and Duke Realty Corporation have begun development of a 533,520-square-foot bulk distribution warehouse facility within AllPoints Midwest in Plainfield. The building is expandable to more than one million square feet. The newest facility in AllPoints Midwest will be located just off the Ronald Reagan Parkway north of County Road 200 South, providing unparalleled access to I-70, I-465 and I-65, the CSX intermodal rail facility and the Indianapolis International Airport. The cross-docked facility will include approximately 54 dock doors with levelers and seals, 176 parking spaces for cars, 54 truck parking spaces, a 140-foot truck court and 60-foot staging bays. Completion of the facility is scheduled for the fourth quarter of the year.

First Park Lakeville Lakeville, Minnesota First Industrial Realty Trust First Park Lakeville First Park Lakeville is a new 1.4 million square-foot industrial park in the Minneapolis market. On behalf of Uponor North America — a leading supplier of PEX-a plumbing, fire safety, and radiant heating and cooling systems for the residential and commercial building markets across North America and Europe — First Industrial has begun developing a new 285,000-square-foot build-to-suit distribution center. Additionally, First Industrial is developing a 282,000-square-foot spec distribution center within the park. Both of these facilities will be designated as Leadership in Energy and Environmental Design (LEED) projects. LEED certification will be accomplished through energy optimization, water efficiency, drought tolerant landscaping, and efficient storm water treatment, filtration processes and rain gardens. In addition, the use of alternative modes of transportation will be encouraged by providing bicycle racks and preferred parking for carpoolers. The project will be developed through First Industrial’s Development and Repositioning Joint Venture with the CalSTRS, the second largest public pension fund in the United States with a portfolio of $162 billion.

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