Industrial Market Goes Great Guns

March 1, 1996

In wine parlance, 1995 was a very good year for the industrial real estate market. And many practitioners are anticipating a 1996 that at least matches---and may even improve on---their 1995.

What made 1995 so strong? The vacancy rate declined to 9.1 percent in 1995 from 10.2 percent in 1994, the strongest decline in 10 years. More important, effective lease rates surged by 4.1 percent in one year, the largest yearly increase in effective lease rates for all three product categories---office, retail, and industrial---during any year between 1988 and 1995. And upward pressure should continue on effective lease rates this year, especially in markets poised to take advantage of new technologies and relaxed trade regulations.

How Did It Happen?

The boom market was due in great part to the low level of construction during the 1990s. From 1992 to 1995, the level of construction was less than 1 percent of inventory. In fact, the 1992-95 level of absorption was 57 percent higher than the level of new construction. The pace of new construction increased by 6.7 percent from 1994 to 1995. However, the construction level during 1995 was less than half that of any year from 1986 to 1989.

In 1995, of the 48 markets surveyed by REIS Reports Inc., a New York City--based company that publishes commercial market data, 27 experienced a yearly increase in lease rates of more than 4 percent. A total of 13 markets, over one-quarter of the surveyed markets, experienced an effective lease rate spike of 6 percent or more. The sharp rise in the national effective lease rate was due to the increase in those markets.

Run for the Border: Many Companies Are

If you're wondering what to expect in your market in the coming year, pay close attention to employment growth (see "What Makes This Market Tick?"). And two other factors are making their mark on industrial real estate these days---the lifting of trade barriers and technology.

The North American Free Trade Agreement (NAFTA) has begun to impact transportation and manufacturing patterns dramatically. Texas and Arizona markets near the Mexican border have seen a dramatic increase in manufacturing and distribution activity. Companies, including many auto and computer manufacturers, are putting manufacturing facilities in markets with strong rail and road links to Mexico. Raw materials and subassembly products are shipped from Mexico to plants in the United States, where the assembly process is completed. The trend has exacerbated the decline in manufacturing employment in the Northeast.

Structural and technological changes have prompted the rapid evolution of warehouse and distribution facilities. Those changes include increased computerization of inventory systems, greater reliance on automation, and use of intermodel containers (containers that can be transported by ship, truck, or rail). Newly constructed warehouse and distribution space will require infrastructure that will meet today's requirements---high ceilings for efficient freight movement, satellite uplinks, fiber optic cabling for computer networks, and placement of the building so that ample berth is provided for today's larger trucks that need more room to turn.

Changes in consumer goods packaging are also affecting the demand for warehouse and distribution facilities. Over the last several years, the package size of many products has shrunk. For example, highly concentrated laundry soaps require a fraction of the storage space of nonconcentrated soaps. More concentrated packaging of consumer goods will slow demand for warehouse and distribution space.

New transportation patterns spawned by NAFTA and new technologies will reduce demand for warehouse and distribution space in some markets but will be a boon for others. The passage of the General Agreement on Tariffs and Trade (GATT), which formed the World Trade Organization, will cause more changes.

Experts anticipate that GATT will boost worldwide trade. So demand for warehouse distribution space in coastal markets with international ports should increase. West Coast ports that serve Asian markets will be one of the primary beneficiaries, as well as ports along the Gulf of Mexico that trade with the Americas.

Markets that could support industrial development during 1996 include Fort Lauderdale, Jacksonville, Miami, Palm Beach, and Tampa-St. Petersburg, Fla.; Nashville, Tenn.; Oklahoma City; Raleigh-Durham, N.C.; Denver; Phoenix; Portland, Ore.; Salt Lake City; and Seattle.

What Makes This Market Tick?

The industrial market can be divided into three general categories, each affected by changes in specific employment sectors.

1. Research and development (R&D) and flex space---Light and high-tech manufacturing facilities that usually require 20 percent to 50 percent office buildout. Demand is fueled by increases in manufacturing and service employment. In 1996, continued strong service employment growth should help strengthen the R&D and flex space market, which was severely overbuilt in the late 1980s and early 1990s.

2. Manufacturing and production---Facilities that typically feature assembly areas and require less than 20 percent office buildout. You guessed it---manufacturing jobs are good news for this category.

3. Warehouse and distribution---"Large box" buildings that are devoted almost exclusively to storage. To gauge demand for distribution and warehouse space, look at trade employment. (Unlike service employment, which includes office functions such as customer service and bookkeeping, trade employment generally refers to building or distribution of goods.)

George Green is a senior economist with the NATIONAL ASSOCIATION OF REALTORS®.

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