"We are beginning to see some early, yet encouraging, recoverysignals, as the manufacturing sector is improving," says locallybased Craig Meyer, managing director and head of JLL's NorthAmerican Industrial Services team. "The most important growthindicator we're seeing is the bottoming out of packaged goodsinventories," he relates. "The increase in global trade volumes inso far this year is another encouraging signal pointing towardincreasing future demand for industrial property."

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While the industrial sector will recover a few quarters ahead ofthe office sector beginning toward the end of 2010, it will not beimmune to the risks of extensive sublease space, facility closures,consolidations and downsizing that could continue well into 2010and 2011, finds JLL.

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"Even though we expect the industrial market to start itsrecovery in the second half of 2010, a long term and sustainedupswing will take some time," says Meyer.

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And until aggregate industrial occupancy stabilizes, negativenet absorption will continue and asking rents will remaindepressed. According to JLL stats, rental rates will only start toincrease in earnest in 2011. "This year will be the last largewindow of opportunity for savvy industrial tenants as competitionfor those tenants will remain intense and landlords are offering amix of concessions to secure new occupants," Meyer predicts."Occupiers will be able to capitalize on low occupancy costs tore-optimize warehouse/distribution operations and supply chainnetworks."

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Some areas of the country are clearly worse off than others. InCentral and Northern New Jersey, for instance, the market hasbenefited from restructured rents and competitive incentivepackages, but the current lag in demand will make it difficult tooffset additional negative net absorption.

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This year, JLL predicts that rents will continue to drop in thesubmarkets exposed to over-construction, which has led to aroundone million square feet of un-leased spec product. Meanwhile, otherport-centric submarkets are now emerging as distribution hubs,competing with the traditional centers of activity.

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"From a fundamental standpoint, the market is excellent due toits close proximity to Manhattan, the port in Elizabeth and astrong regional distribution market, but I have never seen such aprecipitous drop in rental rates or landlords taking such anaggressive position relative to incentives and free rent," saysHasbrouck Heights, NJ-based Jones Lang LaSalle managing directorRob Kossar.

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"We've seen a lot of tenants in the market recognizing that thisis the time to try and lock in a low rate for an extended period oftime. And while some landlords have pushed back, maybe offering athree-year deal at $2.50 net in a $4 building, many tenants havebeen consistent in trying to get a long-term solution at a reducedrate," he says.

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There is also a large amount of vacant first generation space inthe Garden State. "Although we've seen downward pressure to reducethose rents, the worst is still ahead for some of these propertyowners that have had vacancies for a year or two," says NAI JamesE. Hanson vice president Barry Cohorsky, based in Hackensack, NJ,who believes we won't see a bottoming on the industrial side untillater in 2010.

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The main driver behind declining industrial rents: competitionfrom out of state and within. "Everyone thinks of the competitionas being Pennsylvania's Lehigh Valley, but that's just one piece,"Kossar says. "There's also an entire market down by Exit 7A, whichis actually doing even worse than Exit 8A, with the former postinga 23% vacancy and the latter around 14%, if you discountowner-occupied buildings." However, the 7A assets are newer andlandlords there are being extremely aggressive, which is causing 8Aowners to respond in kind.

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To the north, meanwhile, there is a spate of new industrialbuildings at Exit 12. According to Kossar, tenants who might havetaken space at 8A or Heller's Park in Edison are looking atbuildings closer to the port at Exit 12. "It used to be that ifsomebody needed a new, modern distribution center they had to be inCentral New Jersey, but now there are some options."

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One of the broader challenges for the region, from adistribution standpoint, is accessibility to good labor. "Rightnow, we're jitneying in labor from Perth Amboy or Brooklyn," Kossarexplains. "A mass transit solution here needs to happen. Even ifthe government were to subsidize busing into these areas, thepayback would be obvious and easy in terms of payroll tax."

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Despite current conditions, Kossar is bullish on Central NewJersey. "It's all about location and Central New Jersey has it. Atthe end of the day, the Exit 8A market will continue to be thepreeminent regional distribution market in the Northeast." Butothers aren't quite as optimistic. "We're not seeing many brightspots," Cohorsky says. "Exit 8A is a bloodbath. If you're lookingfor a couple hundred thousand square feet, there are close to 50properties between Exits 10 and 7A. Anyone with a heartbeat canlease space at 7A or 8A where rents are in the $2 range."

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The 8A market is swimming in space, agrees Marcus &Millichap Real Estate Investment Services' senior associate JeffOran, who has seen 200,000-square-foot tenants take space herestarting at less than $1. "To fill these big chunks of space,landlords are offering average rent deals in the $3s over a five to10 year period, which is a significant drop from just one yearago."

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Part of the problem is that New Jersey is a notoriouslyexpensive state in which to operate. "Because of its location, thearea is still viable, but when the market changes and puts pressureon rates, warehouse tenants flee to Pennsylvania where it's mucheasier to do business," Cohorsky says. "A developer can go thereand most likely have a three to six month approval process, asopposed to 18 months to three years in New Jersey."

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And Pennsylvania is not the only state snapping up Garden Statetransplants. Both North and South Carolina have become attractiveoptions. "Those states and their respective Governors haveassembled teams to attract tenants by offering tax incentives andabatements," Cohorsky says. "The reality is that if you're amanufacturer and you have a couple hundred jobs, you can make amuch better deal elsewhere. New Jersey has lost a lot of businessto the Carolinas because of those states' ability to make anattractive deal."

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Speaking of the Keystone State, competitive deal structures inmany class A industrial buildings here are presenting tenants withvalue opportunities. "There are a few major tenants in the marketwith sizable space requirements, each within the CentralPennsylvania region," JLL's Meyer notes. "If these potentialtransactions take place by year-end, it is possible for the regionto absorb up to two million square feet of class A space."Furthersouth, Dallas/Fort Worth will also continue to be a competitivelocation of choice for organizations seeking to relocate.

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According to Meyer, the region is a focal point for expansionsand consolidations as companies shorten their supply chains to becloser to major consumer populations. "Companies currently in themarket are seizing opportunities to rework logistics networks andcapitalize on reduced rents in up-to-date facilities," he relates.In fact, leasing activity and the number of mid-sized to largerequirements gradually picked up in the third quarter of 2009.Similar to New Jersey, Los Angeles is struggling with decreasedtrade flows through the San Pedro ports, which have had a negativeimpact on demand. According to Meyer, rental rate appreciation isnot expected to begin until this trend reverses.

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The market also houses the nation's highest balance ofdelinquent CMBS loans, with $1.7 billion outstanding. Theindustrial sector accounts for 38% of that balance, making LosAngeles extremely attractive for buyers looking to capitalize onproperties in default. Investors would also be wise to look at NewJersey, where the amount of ownership distress is set to grow in2010 as market pricing continues to transition and loans struggleto be refinanced as they approach maturity.

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And while the Inland Empire has low exposure to the troubledCMBS loans plaguing other markets, drastic changes in underwritingcriteria and a sharp drop in effective rental rates could giveinvestors the opportunity to acquire properties at highlydiscounted rates.

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