By Brian A. Lee
Industrial REITs in the Midwest are gaining momentum by building from the ground up.
E-commerce expansion and a highly competitive investment sector are spurring industrial real estate leaders to green light more development projects.
According to JLL, the Midwest has recorded nearly 21.3 million square feet of industrial completions through mid-year with more than 23.5 million square feet currently under construction.
Only the Southwest region exceeded that sum during the same period (25.3 million and 37.3 million square feet, respectively).
“The most significant trend that we need to see in the industrial sector is overall GDP growth that is driving demand for space from a range of tenants across a wide span of industries,” says David Harker, executive vice president at Chicago-based First Industrial Realty Trust. “While growth has been measured, it has been good enough to spur incremental demand that has been exceeding new supply at a pace of about 1.5 times.”
Industrial REITs take a hit on Wall Street. Click to see larger
While shareholders may be less than impressed with total returns this year (see chart), Midwestern industrial REITs continue to post big numbers in other important
investment categories as they aggressively target the region.
“While their current returns are underperforming expectations, most REIT managers remain positive on the outlook for industrial for the rest of the year,” says George Cutro, who recently joined JLL as director of Midwest Industrial Research.
The Second City is second to none in big-box industrial development. Cutro called Chicago’s growth an “explosion in construction starts.”
The majority of development is less than 500,000 square feet, but the following large-scale speculative projects are currently underway in the Land of Lincoln: Hillwood Investment Properties’ 746,800 square feet at Laraway Crossings Business Park in Joliet, Bridge Development Partners’ 626,800 square feet at Bridge Point North in Waukegan and Ridge Development’s 574,900 square feet at RidgePort Logistics Center in Wilmington.
Infill development has also increased, including Bridge Development Partners’ 588,200-square-foot project at Bridge Point Northlake on the former Dominick’s site, DCT Industrial’s 350,000-square-foot build-to-suit lease for CoreCentric Solutions and Panattoni’s nearly completed 316,700-square-foot speculative development in the Windy City.
“Very few industrial markets in the United States cause us much concern. However, a few are starting to show signs of supply outpacing demand,” says Steve Schnur, Duke Realty’s executive vice president for the Central Region.
Despite that concern, CBRE reported the longest streak of flat or declining industrial availability rates — 21 consecutive quarters through mid-year — since the global real estate services firm began tracking the national market in 1989. It also put the spotlight on Chicago as one of four major U.S. markets and the Midwestern leader to outpace the national industrial vacancy rate decrease of 30 basis points in second quarter (to 9.8 percent).
Duke Realty Delivers
Build it and they will come.
Investment returns will come easier, that is.
The majority of industrial capital deployment for Indianapolis-based Duke Realty currently centers on development versus acquisitions.
“The reason for this is that the margins and spreads are much better in development than acquisitions right now,” says Schnur, who adds that most of the REIT’s development activity is build-to-suit and partially pre-leased projects. “The acquisition markets, because of the availability of capital, are very frothy right now.”
Specializing in the ownership, management and development of bulk industrial facilities, Duke Realty employs a growth strategy based on the tried-and-true formula of finding quality real estate and maximizing value for shareholders. Its Midwest portfolio spans 62.2 million square feet of industrial and office assets, including medical office, in six major metropolitan areas.
Currently, e-commerce is the No. 1 driver of Duke Realty’s bulk warehouse business.
In the Columbus, Ohio, MSA, Duke Realty developed a 743,600-square-foot build-to-suit distribution center for Bon-Ton Stores’
e-commerce operations.
“And it’s not just the Amazon.com and Walmarts of the world,” says Schnur. “Nearly every consumer business and many business-to-business suppliers are re-examining their supply chain and logistics strategy to stay in front of e-commerce.”
The 43-year-old REIT recently developed a 743,600-square-foot build-to-suit distribution center for Bon-Ton Stores in the Columbus, Ohio, metro area.
The automated, direct-to-consumer fulfillment center is a key cog in the growing e-commerce operations for the nationwide operator of department stores.
“Relative to transaction terms, we see more customers asking for flexibility today, whether it is assignment flexibility, expansion, contraction options, etc.,” adds Schnur. “Tenants are willing to pay for the flexibility of terms.”
Duke Realty is well proportioned and positioned to continue to ride the industrial momentum in Midwestern markets.
There are no magic tricks, just meticulous execution.
“We pride ourselves on the quality of our portfolio and our tenant base,” says Schnur, who always keeps very close tabs on interest and speculative availability rates. “We will continue to stay disciplined and focus on maximizing value for our shareholders. Commercial real estate is a capital-intensive business, and we think this is a competitive advantage for us as a large public company.”
STAG Recalibrates Strategy
STAG Industrial, which primarily acquires single-tenant industrial buildings across the nation, recently adjusted its investment strategy regarding acquisitions and new development.
“Prior to 2015, STAG’s focus was 100 percent acquisitions of existing buildings,” says Steve Mecke, chief operating officer and head of acquisitions for the Boston-based REIT. “The mix now is roughly 90 percent existing buildings and 10 percent build-to-suit. The company rolled out the build-to-suit initiative at the end of 2013 and has provided forward commitments on three build-to-suit deals that all closed in 2015.”
Having approximately 38 percent of its industrial portfolio in the 10-state Midwest region, STAG targets deals in the $5 million to $50 million range.
Typical industrial transactions for the company are $8 million to $10 million. Usually, that means an approximately 180,000-square-foot single-tenant asset in primary and secondary industrial markets with around five years of lease term remaining.
“STAG focuses on primarily single-tenant real estate assets because the perceived binary risk often makes these assets mispriced,” says Mecke. “By creating a diversified portfolio of these assets we are able to reduce the volatility of the cash flows and mitigate the single-tenant risk. The typical Midwestern deal profile for STAG has not changed that much since the company started investing in 2003.”
To get a window into the health of the economy and specifically the country’s flow of goods and services that ultimately impacts industrial real estate demand, STAG pays close attention to GDP growth, manufacturing and trade inventories and sales, as well as interest rates, of course.
“E-commerce, as well as continued on-shoring of manufacturing, has also increased over the past several years, driving growth in demand for industrial space,” says Mecke.
The company, which plans to acquire more than $450 million of industrial properties nationwide this year, also keeps an eye on product supply. However, STAG has been selectively acquiring vacant industrial buildings in markets where it’s already established “and where we believe the fundamentals support taking on near-term vacancy exposure.”
First Industrial Sees Growth
First Industrial Realty Trust’s main path to a high-quality portfolio and long-term growth in cash flow is through development.
“We can use our platform and talented people to create value for our shareholders through site identification, development execution and finding the right tenants,” says First Industrial’s Harker. “We continue to pursue acquisition opportunities as well, but there is tremendous competition for quality assets, reflected in the low cap rates at which transactions are taking place. That has been the case since we and the industry emerged from the last downturn.”
In Kenosha County, Wisc., First Industrial recently broke ground on First Park 94, which will include this 600,000-square-foot spec distribution facility. Located adjacent to Interstate 94, the building will be completed in summer 2016.
In Somers, Wis., First Industrial has broken ground on First Park 94, which has the capacity for up to 4.6 million square feet and can accommodate build-to-suits from 150,000 square feet to 1.5 million square feet. Located less than an hour from O’Hare International Airport, the development offers immediate access to I-94 and the Canadian Pacific Railway.
“Kenosha County has enjoyed significant growth in demand from e-commerce and other users targeting customers in Chicago, Wisconsin and other nearby markets,” says Harker. “E-commerce has certainly been a secular driver of incremental industrial demand. This has been the case for both large distribution centers as well as more infill distribution buildings as e-commerce providers compete to provide same-day delivery to their end customers.”
For development investments, First Industrial seeks margins of 100 to 150 basis points above market cap rates for comparably leased assets.
On the acquisitions side, the REIT, which achieved its goal of 95 percent portfolio-wide occupancy a whole two quarters ahead of schedule this year, targets bulk and regional distribution facilities in submarkets that can deliver above-average rental rate growth.
“Our foundation is our investment grade-rated balance sheet,” adds Harker, “and we are funding our investments primarily through free cash flow from our existing portfolio and the redeployment of capital from targeted asset sales.”