financial crisis hits warehouse, DC markets

Until now, the industrial real estate market has been relatively untouched by the financial brushfire that has torched segments of the residential and commercial real estate sectors. But a September study of the nation's top 30 real estate markets by ProLogis, an owner and developer of distribution facilities, reported a sharp contraction in construction activity through mid-year. New starts of bulk distribution and warehouse projects fell to 16 million square feet in the second quarter of 2008, down from 29 million square feet in the first quarter and 40 million in the fourth quarter of 2007. New starts for all of 2008 will likely come in somewhere between 65 million and 70 million square feet, about half the total for 2007, the report predicts.

Project completions in the first half of this year continued to rise relative to 2007's second half, the study said. That may not be as positive as it sounds, however. Because completions lag starts by six to nine months, there is likely to be a sharp drop in project completions in the second half. Through the end of June 2008, 72 million square feet of new space were at various stages of completion; ProLogis expects about three-fourths of that total will be delivered during the second half of the year.

When it comes to demand for new construction, the Chicago area and the New York-New Jersey-eastern Pennsylvania corridor are holding up fairly well, while Atlanta, Las Vegas, Phoenix, and California's Inland Empire are all struggling, says Leonard Sahling, first vice president of the company's research arm and the study's author.

Stuck in a holding pattern
Curtis Spencer, president of IMS Worldwide Inc., a Houston-based firm that specializes in industrial properties for logistics operations, says the crisis in the capital markets is affecting nearly all industrial and commercial real estate activity. New transactions have virtually ground to a halt, with most deals involving consolidations among small to midsized players who may have entered the down cycle financially overleveraged. "Everyone is pretty much holding what they have," he says.

The exceptions are cities like Houston that are supported by significant export-related demand. Areas that depend on imports are less fortunate: In the South Bay area near the ports of Los Angeles and Long Beach, vacancy rates for industrial property have risen to 3.5 percent from 1.3 percent in the past six to eight months, Spencer says. The vacancy rate for the entire Los Angeles basin has doubled during that same time.

Nevertheless, Spencer says, demand for warehousing and DC space could get at least a temporary boost from importers who are worried about complying with the U.S. government's new "10 + 2" rule. That rule, which requires importers to collect 12 data elements and transmit them to U.S. Customs and Border Protection at least 24 hours before ocean shipments are loaded onto vessels at foreign ports, may increase total transit times. That could lead importers to increase safety stocks by an estimated 10 to 20 percent to ensure that goods are available near the point of consumption.

Sahling and Spencer agree that the near-term future of the industrial real estate market will rest in part on the success of legislation to resolve the current financial crisis. If a bill is passed and is perceived to be an effective solution, "we will pretty much be where we are now," says Spencer. If not, demand for warehousing space is almost certain to slip even further.