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In for the long haul

Industrial landlords are struggling, but their ten-year leases make them better positioned than commerical property owners to survive a slowdown.

Industrial landlords are struggling, but their ten-year leases make them better positioned than commerical property owners to survive a slowdown.

By Kerry Hannon
September 2001
Institutional Investor Magazine

As technology companies close up shop and abandon their once-bustling warehouses, landlords of industrial space have had to cope with an unexpected rush of vacancies. With growth slowing elsewhere in the economy, there aren't a lot of new renters jumping in.

Still, industrial real estate investment trusts are in better shape than some of their counterparts. "While there has been a big spike in vacancy on the office side, particularly in northern California," says Cohen & Steers Capital Management vice president Greg Brooks, "industrial REITs have not been dramatically impacted." Occupancy rates are down 1 to 2 percent, according to Brooks, whose New York-based firm manages $5 billion in REIT mutual funds and separate accounts.

As a group, office-industrial REITs posted a total return of 3.73 percent through August 6, after a whopping 33.4 percent return in 2000 - clearly a banner year for REITs. Overall, REITs returned 25.9 percent in 2000 and 12.4 percent through August 6. That compares with a decline of 9.07 percent for the Standard & Poor's 500 index.

Struggling industrial REITs are faring better than their office counterparts, whose tenants include many ailing technology and telecommunications companies, because leases tend to be longer (five to ten years, versus five to six years for most commercial space). This helps cash flow. The relative scarcity of space in most parts of the country further aids the industrial REITs. Says Lehman Brothers analyst Stuart Axelrod, "Industrial REITs are in a better position to weather the storm than office REITs."

For landlords of industrial space, vacancies are up from about 6.7 percent at the end of the second quarter of 2000, to 8.1 percent this year. By contrast, vacancies in the national office market increased from 8.1 percent to 10.8 percent over the same period. A recent report by Arlington, Virginia-based Friedman, Billings, Ramsey & Co., an institutional brokerage, concludes that industrial REITs offer moderate growth prospects and attractive yields.

Says David Loeb, a managing director of the firm, "Growth rates of between 7 percent and 9 percent over the next 12 months are not unreasonable."

Many analysts recommend the stock of ProLogis Trust, a Denver- based industrial real estate firm that has 1,700 distribution facilities, owned or under development, with 197 million square feet in 98 markets through North America and Europe. Its holdings are 93.8 percent leased, which is about average for the category. Revenue grew at an impressive 30 percent average annual clip in the past three years, largely through overseas expansion. "There's no other U.S. industrial REIT operating in Europe," says Cohen & Steers' Brooks.

ProLogis Trust shares recently traded at $22, the midrange for the past year. The stock sells at a 9.1 multiple, versus 9.4 for the average industrial REIT.

Taking a different tack is San Francisco-based AMB Property, which locates its warehouses near airports and seaports in 27 U.S. cities, including Chicago, New York, Miami and Dallas. It owns or manages 93 million square feet. Brooks predicts that AMB will have a growth rate of 10 to 12 percent this year. AMB shares recently sold at $25.80, a 10 percent multiple, despite the $6.3 million write-down on its investment in online grocer Webvan, which recently filed for Chapter 11 bankruptcy protection. All told, AMB took $16 million in write-offs in the second quarter, most of them tech-related.

Industrial REITs may be sorry to lose their dot-com leases, but landlords with good locations and steady business strategies are keeping a tight rein on supply and sticking to their long-term business models. In short, they're finding a way to hold their own.