Property Management: Shifting Gears – A Changing Industrial Landscape Brings Fresh Management Challenges

The industrial sector may seem to lag other property types in glamour, but to those charged with managing distribution centers, research-and-development space and other facilities, it presents a complex, fast-changing landscape.

By Paul Rosta

The industrial sector may seem to lag other property types in glamour, but to those charged with managing distribution centers, research-and-development space and other facilities, it presents a complex, fast-changing landscape. Trade patterns, supply-chain issues, surging interest in sustainability—these and other factors all filter down to the end user’s needs at the property level. A series of recent blockbuster corporate moves will also have closely watched implications. Most notably, the union of AMB Property Corp. and ProLogis under the new Prologis Inc. brand name, which was completed June 1, is influencing the market dynamics of industrial property management.

In November 2010, seven months before that merger, Blackstone Group L.P. paid $1 billion for a 23 million-square-foot, 180-property portfolio of ProLogis properties. The assets formed a significant portion of the 45 million-square-foot portfolio now held by IndCor Properties Inc., a new Blackstone affiliate. IndCor divided property management duties for a 40 million-square-foot portion of the portfolio among three service providers: CBRE Group Inc., Jones Lang LaSalle Inc. and Cassidy Turley.

To be sure, senior executives maintain a realistic view of the sector’s prospects. “Overall, the industrial market is doing about like the economy,” said John Dobrott, president of McShane Development. “The real growth is not as strong as we would like it to be, but it’s heading in the right direction.”

Confirming Dobrott’s analysis, an early November assessment by the NAIOP Research Foundation projected an annualized fourth-quarter growth rate of 1.09 percent. That pace is at the low end of the historical spectrum, but would mark the sixth straight quarter of growth if it holds true. Barring unexpected shocks to the economy, NAIOP researchers said that growth should start picking up speed in 2012.

The industrial sector has proved to be something of a sleeper among property categories. Though the slow pace of growth mirrors the sketchy economic recovery, fundamentals that softened during the recession have now been firming up for more than a year. During the third quarter, availability of industrial properties dropped 20 basis points to 13.7 percent— the fourth consecutive quarter of decline, according to CBRE Econometric Advisors, the research arm of CBRE Group Inc.

Other metrics similarly suggest a tightening market. Of 60 markets surveyed by CBRE, industrial availability fell in 40, increased in 14 and remained unchanged in six, CBRE found. Gradually increasing competition for space could lead to an uptick in pricing, although that has not yet emerged as a widespread trend. For owners and managers alike, the market remains competitive and the priority is keeping the property stable. “Most of us are focused on occupancy: keeping tenants in place and getting new tenants,” reported Jim Connor, senior executive vice president for Duke Realty Corp.’s Midwest region. “The market isn’t so good that you’ve got people beating down the door to take your space.”

Third-quarter absorption trends offer clues to how the evolving supply-demand dynamic will affect the way property managers meet end users’ needs. Through September, leasing activity hit 227.8 million square feet for the year, a nearly 20 percent year-over-year increase compared to the first three quarters of 2010, according to Cushman & Wakefield Inc.

Revealing as these statistics are in many ways, trends that are influencing how property managers meet the needs of end users are hidden between the lines. “There’s starting to be an acute shortage of big-box space—500,000 square feet and up—across all tier one markets,” contended Jim Dieter, executive vice president & head of industrial brokerage for Cushman & Wakefield. He named pivotal markets such as Atlanta, Dallas, New Jersey and Southern California’s Inland Empire as examples of locations experiencing shortfalls.

The most important cause of the big-box squeeze is a trend toward space consolidation. Competitive pressure to deliver goods more efficiently prompts end users to replace multiple midsize distribution centers with a limited number of larger facilities. That issue, plus the aging of existing stock, is causing the stirrings of the first significant new development since the recession took hold.

Duke, to name one leading developer, has a $200 million project pipeline that will extend through 2012. And 33 top industrial markets around the country added 15.5 million square feet of new product through the first three quarters of 2011, with another 16.6 million square feet in the pipeline, according to Cushman & Wakefield.

Votes of Confidence

Major owners are giving the industrial sector a vote of confidence, a trend that bears implications for in-house and third-party real estate managers alike. For Duke, the industrial sector is the anchor of a long-term strategy. At the end of 2010, its nationwide portfolio consisted of 49 percent office properties, 42 percent industrial and 9 percent medical office buildings. By the end of 2013, the REIT wants to make that composition 60 percent industrial, 25 percent office and 15 percent medical office.

Toward that end, Duke is targeting expansion in high-growth industrial markets. During the third quarter, the firm spent $103.5 million on industrial and office properties; most of that total went toward acquiring eight industrial properties in Chicago, Dallas and Raleigh, N.C.

Earlier this year, the company paid $450 million for a 4.9 million-square-foot portfolio made up of 51 distribution buildings and five office buildings in Broward and Palm Beach counties in Florida. And in a step toward the complimentary part of its strategy–trimming its office portfolio—this month the company is scheduled to close the $1.1 billion sale of an 82-property, seven-state suburban office portfolio to Blackstone. Duke self-manages almost all of its industrial properties, but its aggressive expansion plan may yet breed confidence in other investors to buy—and then retain management services for—industrial assets.

As third-party property managers jockey for leadership, some are using transaction services as a launching pad. Jones Lang LaSalle is expanding its property management services through its leasing and investment sales teams, which are introducing the services to their clients. “We want to be involved from cradle to grave,” explained Dan Pufunt, president of Jones Lang LaSalle’s property management business.

At the moment, the company’s industrial property management business focuses much of its energy on eight major industrial markets: Northern California, the Inland Empire, New Jersey, Dallas, Houston, Chicago, Atlanta and Philadelphia. A big win for Jones Lang LaSalle this year was its selection by IndCor to manage a 15.4 million-square-foot portfolio in Pennsylvania, New Jersey, Maryland and Virginia.

What appears to be an industrial market in transition puts a different spin on how owners and managers market properties and serve end users’ needs. Demand will continue to grow for distribution centers that offer up-to-date specifications like 32-foot vertical clear space, crossdock facilities and truck courts sized to permit proper circulation of big rigs.

Another issue on the radar of industrial real estate managers and owners is the changing dynamics between older and newer product. “The biggest challenge of the older stock of buildings today is competition with newer buildings,” contends Dieter.

In a relatively healthy economy, older properties can use price discounts as an effective selling point to help them stay competitive with newer industrial facilities. But a weaker economy like today’s reduces the value of that selling point by shrinking the pricing differential between new and older properties. “That puts extra pressure on older-generation buildings,” Dieter explained.

This generation gap is also reflected in the sustainability movement, which continues to pick up speed in the industrial sector. Industry veterans point out that green features are incorporated more effectively in new development than retrofit older building stock.

Partly because the recession has narrowed the pricing gap between brand-new and older product, owners are often unable to charge a premium rate for newer, greener facilities. But green features can still provide a competitive edge. When a prospective customer has narrowed the choice of a new distribution center to two facilities that are otherwise closely matched, if one of those properties offers up-to- date sustainable features, “it’s a tiebreaker,” Connor observed.

New twists and complications flow into the industrial property sector by the week, yet in the midst of accelerating change, sticking to a few principles will also help property management professionals at all levels steer a successful course. To begin with, Pufunt suggested, try to understand where clients need to be and why— then work backwards to determine the appropriate location.

Raising that deceptively simple question enables property managers to fit together pieces of the puzzle like supply chain, transportation and facility size. And professionals who can answer the question accurately will lead their industrial clients to the most effective and competitive use of space.