It's hardly multifamily, but industrial real estate has emergedas somewhat of a darling in its own right as the economy continuesstrengthening and performance drives up property values. Indeed,industrial markets around the country are bouncing back—and someare preparing for a bona fide boom.

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The industrial landscape is being redefined by surging demandfrom e-commerce, traditional retailers, the manufacturing sectorand third-party logistics providers, according to Marcus &Millichap's National Industrial Research Report for the first halfof 2014. Beyond ports and intermodal hubs, market dynamics arepushing industrial real estate to secondary markets and eventertiary metros as US exports blow past their 2008 peak. US exportstotaled $2.3 trillion in 2013, according to the US Department ofCommerce.

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A quick look at market stats magnifies the opportunities inindustrial. MMI predicts about 120 million square feet of newsupply is set to come on line in 2014. That's a whopping 61%increase over 2013. The good news is most of the product haspre-committed leases or is build-to-suit. And even with all the newsupply, MMI expects the national vacancy to hit a cyclical 7.1% lowby year-end with 239 million feet absorbed. Meanwhile, asking rentsrose by an average of 5.1% and concessions started melting away inthe first half of 2014.

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“The industrial capital markets continue to be on fire,” saysBill Waxman, EVP of CBRE's Global Port Logistics Group. “Investorsare no longer looking at industrial as a stepchild but, rather, asthe white night. Capitalization rates across the country aredeclining and, as a result, we're seeing a huge amount of demandfor a less-than-huge amount of supply. There's great competitionamong global, national and local investors for the same rareproduct.”

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THE STATE OF THE MARKET

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Robust net absorption of industrial space should continuethroughout 2014 and 2015, with 211 million and 205 million squarefeet, respectively, NAIOP predicted in an August report authored byDr. Hany Guirguis and Dr. Joshua Harris. Those figures are about100% above numbers posted 2011 and 2012 as the industrial marketsees a full-swing recovery.

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“Industrial demand remains hot for all types of industrialspace—fulfillment/distribution center, warehouse, manufacturing andflex,” says Thomas Bisacquino, president and CEO of NAIOP. “Aunique area of potential growth for industrial is in energyproduction and transport, as the nation has a renewed focus ondomestic energy resources, and the possibility that the US maybegin exporting natural gas to Europe. These activities will likelygenerate increased industrial demand in port cities with highconcentrations of energy production and supply chainactivities.”

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Dwight Hotchkiss, president of brokerage services for ColliersInternational, points to a solid uptick in manufacturing activityas a strong driver. The Institution of Supply Management'sPurchasing Managers Index (PMI) reveals economic activity in themanufacturing sector expanded in August 2014 for the 15thconsecutive month. Seventeen of the 18 manufacturing industries arereporting growth. With economists agreeing that manufacturing'sback on track, overbuilding is not on the lips of industrial realestate industry watchers. In fact, Waxman says development demandis strong.

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“In every major and secondary market, there continues to be newdevelopment—there's currently more than 11 million square feetunder development in New Jersey alone—and this is the right amountof development,” Waxman says. “Markets won't see an oversupply butwill eventually reach equilibrium. This new development is directlyin response to a healthy demand for leasing nationally and thecontinual activity on both fronts is bound to progress toproductivity.”

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IDENTIFYING THE HOT SPOTS

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Even in a white hot industrial real estate industry, somelocations are still hotter than others. Atlanta is one of theundisputed bright spots, according to Doug Smith, SVP of SeefriedIndustrial Properties. He says Atlanta industrial is as healthy asit was in the mid-2000s.

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“Couple that with a continued drought of new construction, andwe are approaching historically low vacancy rates in certainsubmarket and product types,” Smith says. “All of that leads torising rental rates and overall property values. Currently, thereis minimal construction activity for speculative product in theAtlanta market, while at the same time the region has enjoyednearly 20 million square feet of absorption since the beginning of2013.”

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From an investment perspective, Smith continues, Atlanta remainsa “must have” market for most institutional buyers, but there isnot enough supply out there for the level of investment demand. Theresult: recent buildings have traded at record low cap rates forthese product types and the threshold in cap rates between class Aand class B product is approaching an all-time low for the firsttime in many years.

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Meanwhile, Hotchkiss points to the Inland Empire as a perennialhot spot. Although this area has been strong for some time, itcontinues to thrive thanks to its location next to the Port of LongBeach. But he notes plenty of other cities are also witnessing asignificant industrial uptick.

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“Dallas has seen tremendous activity the past four quarters butis showing some signs of slowing down,” Hotchkiss says. “Chicagoand Atlanta, top five markets in size and importance, have seen astrong pickup in activity. Charleston and Greenville, SC areshowing strength, with car manufacturers like BMW setting upproduction. Other cities within the Southeast and Mid-Atlantic areanticipated to show strong gains due to the growth of East Coastports to service the re-opened Panama Canal.”

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The auto industry is certainly driving gains. Jim Holleman, aprincipal at Cushman & Wakefield | Cornerstone, reportsactivity in East Tennessee among automotive manufacturers andsuppliers. Recent announcements of expansions at the Volkswagenplant in Chattanooga, which will add 2,000 jobs, and SL AmericaCorp. in Clinton, adding 1,000 jobs, are just two examples of thistrend.

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“Areas that benefit from strong transportation and logisticsinfrastructure and close proximity to large population centers areseeing some strong wins among distribution prospects,” Hollemansays.

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Of course, all industrial markets with a port and well-connectedtransportation are reflecting improved activity. Monte Merritt,senior director with Franklin Street in Jacksonville, notes firmswant to move and expand in cities where they can move their goodseasily and quickly.

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“In the state of Florida, Miami and Jacksonville are the portsshowing the strongest improvement,” Merritt says. “Going up theEast Coast, Savannah and Charleston along with New York's harborare improving as well. As far as industrial sectors, distributionwarehousing is still a top area to watch within the industrialmarket. Manufacturing continues to improve as well. In June 2013,NAIOP projected that 20 million new industrial-related jobs will becreated between 2013 and 2020—halting a decades-long trend of jobshredding in the industry.”

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KEEPING AN EYE ON CHALLENGES

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E-commerce is a hot topic in the industrial market, but, asnoted, vehicle sales have also played a key role in the industrialrebound over the past 18 months. Doug Fura, vice president of NAIFarbman, reports a new challenge emerging as a result: securingquality buildings for users in larger size ranges.

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“Several million square feet of buildings were demolished overthe last several years and speculative construction has not yettruly commenced,” Fura says. “We are therefore seeing a lowinventory of larger facilities. This is ultimately a good challengefor real estate developers as it will force companies to considerbuild to suit options. Corporations in need of industrial space arerising from a period of quiet to a high volume but came out of thelast cycle being more meticulous in their real estate duediligence.”

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Waxman is concerned about the “last mile.” Last Christmas, UPSand FedEx were overwhelmed by the huge demand from companies likeAmazon and Target and, as a result, weren't able to deliverpackages on time. Consumers, however, are demanding quick andreliable service. Although that's an occupier issue, it tricklesdown to developers. The good news is, developers areresponding.

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“Developers and owners have done a good job of taking olderbuildings and converting them to meet the standards needed to be akey player in the e-commerce world,” Waxman says. “Similarly, newbuildings that are being constructed are thought of in terms ofe-commerce capabilities. In this day and age, development is notjust about bricks and mortar, but also about how the building andlayout will 'perform' for different types of users.”

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Environmental concerns are also among the discussions amongindustrial real estate watchers. Andrew Maguire, an attorney inMcCausland Keen & Buckman's real estate group, points to aheightened sensitivity to environmental matters in industrialdeals, particularly when the seller has manufactured or storedhazardous materials on the property.

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“Uncorrected violations of environmental laws can be asignificant impediment to industrial transactions—the costs anduncertainties associated with remediation can deter prospectivebuyers,” Maguire says. “It can also be very expensive for owners ofaging, outmoded industrial properties to keep their buildingscode-compliant and compatible with the expectations of prospectivetenants.”

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THE REAL PANAMAX IMPACT

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The heated disagreement about how the expansion of the PanamaCanal will ultimately play and who will benefit in the years aheadis alive and well. Some may be growing tired of the Panamax impactdiscussion but talk won't die down until well after the project iscomplete in early to mid-2016. Although the debate continues,Merritt sees it as an area that could spark “tremendous growth” forFlorida.

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“The Miami port is ready now for the Panamax ships andJacksonville has received all approvals necessary for the requireddredging and is currently working on its funding for this work,”Merritt says. “ The impact of allowing these ships istremendous.”

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Merritt points to Hanjin Shipping Co., Korea's largest and oneof the world's top 10 container carriers. The company pulled out ofits decision to build a $300-million container shipping terminal atthe Port of Jacksonville in 2013 because the current port could notsupport its shipping needs. JAXPORT officials had previouslyreported that the Hanjin terminal would have brought the city morethan 5,600 jobs and nearly $1 billion in annual impact. Storieslike these are causing cities to scramble toward the opportunity.Still, some are skeptical about the impact.

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“I think that the issue of the Panamax can be compared to all ofthe 'what ifs' of Y2K back at the start of the century,” Waxmansays. “There are a lot of unknowns and all of this planning andplotting is definitely valuable, but at the end of the day I thinkwe'll see the same number of TEUs [20-foot equivalent units] comingto the East Coast ports. However, we'll also see more containers onone ship and fewer ships overall. This will reduce the ton-milecost of each individual product and, in turn, reduce the costs oftransportation and goods.”

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LOOKING AHEAD

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With most predicting the economy likely should continue a slowto moderate growth trend in terms of GDP and employment growth,NAIOP researchers Harris and Guirguis forecast the same forindustrial space demand.

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“While we are encouraged by this positive growth in industrial,it is important to recognize that the same demand isn't beingexperienced across the industry,” says Bisacquino. “The commercialreal estate industry as a whole has yet to reach its fullpotential, due to uncertainties about fiscal policy and an unsteadyeconomy.”

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From Merritt's point of view, industrial markets will seeexpansion in new construction and tenants. After some months ofpositive improvement it seems our economy will continue to reboundas the economy continues to improve and the vacancy rate continues.But he offers an important “however, if.”

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“However, if construction stays dormant, as it has in some areaslike Jacksonville, absorption will continue to increase andlandlords will be able to include rental rate increases,” he says.“Overall, the industrial market seems to be correcting itself,absorption is stabilizing, lease rates for the best part are heldin check and are holding developers off. As a result, I'moptimistic the industrial market will continue to improve, slow butsteady. Time will tell.”

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Even with the predicted slowing in 2015, the keyword amongindustrial industry watchers is bullish. Waxman calls this anexciting time for industry and looks forward to seeing the impactof changes on several fronts.

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“The changes in the logistics world upset the status quo and Ithink that the real estate industry has done a great job ofreacting to it and will continue to do so,” he concludes. “In theforeseeable future, I think we'll see continued strong activity,new construction and re-adaptation and should expect to reachequilibrium within the next year.”

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