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Development is a key driver of external growth for industrial REITs. Given the challenging transaction markets resulting in historically low cap rates, industrial REITs have focused more on development in the last several years as the main external growth driver, both in the US and abroad. Development yields on average are 200 to 300 basis points higher than acquisition cap rates. Further, redevelopments provide a means for immediately recognizing upside to land value as much of the existing product in the US today is older and in some cases obsolete. This does result in increased risk as much of the new development is being completed on a speculative basis.

ProLogis has the largest development pipeline, as the company estimates it had $4 billion of ’07 development starts and currently has roughly $2.7 billion under development. The Denver-based REIT anticipates no slowdown for ‘08, However, its total development value represents only 9.2% of enterprise value. By contrast, San Francisco-based AMB Property Corp. has more than $1.6 billion under development, representing over 15% of enterprise value.

We believe the recent turmoil in the credit markets, which has led to tightened lending standards, increased financing costs and fewer available lending options will result in a slowdown in larger speculative bulk distribution facilities constructed by private developers. For example, even though its development pipelines remain lively, ProLogis has become somewhat cautious about developments in the US, placing more focus on build-to-suits and slowing down on spec development. This could lead to additional opportunities for REITs to develop or increase occupancy in existing product.

Torto-Wheaton Research projects slowing demand in the industrial sector, resulting in declining occupancy levels. Demand is expected to be negatively impacted by a slowdown in US economic growth and slower employment growth trends. The Boston-based research firm expects net absorption decline. As a result, industrial vacancy is expected to expand 60 basis points to 10%, not reverting to current levels till 2012.

We believe, however, that demand for bulk distribution warehouse space will hold steady as an increase in outsourcing has shifted a significant amount of manufacturing abroad. This shift will likely be a catalyst for global trade. Given the high density of goods being imported to the US, this will likely maintain demand levels above Torto-Wheaton’s projection, at least in ports and airports that receive goods from overseas.

Source: Banc of America Securities LLC

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