Guest post by Elise Couston, Senior Managing Director at Newmark Grubb Knight Frank
For this month’s Industrial Insider, we spoke with three top developers, both locally and nationally, to discuss the resurgence of spec building construction in the Chicago area, as well as in certain markets on a national basis.
We appreciate the interesting information provided to us by the following industry leaders: Jim McShane, chief executive officer of The McShane Companies; Tom George, senior vice president and regional managing director at IDI; and, Mike Yungerman, vice president-Real Estate Development, Opus Development Company.
Q. Industrial spec building has returned
to Chicago! Why did your company decide to start building spec this year?
Jim McShane: Conor Commercial Real Estate, one of The McShane Companies, embarked on its first post-recession speculative project during the Fourth Quarter of 2012, when we purchased a 20-acre parcel of land in the Northwest Corporate Center at I-90 and Randall Road in Elgin, Illinois. The vast improvement in market fundamentals created a compelling reason for us to evaluate and move ahead with a new speculative facility in the northwest suburbs of Chicago at that time. Our research indicated that Elgin’s vacancy rate (in modern industrial properties that offered at least 24′ clear height) was less than 5%. That provided the incentive for Conor Commercial and our co-developer, Globe Corporation, to move forward with the speculative industrial development opportunity within this submarket.
Tom George: IDI broke ground last year on a 602,000 square foot speculative building in Bolingbrook because of the improving health of the industrial market, and because we saw a localized shortage of available space in the 200,000 to 600,000 square foot range. The rest of the ingredients (land, money, and a willing investment committee) were available, so we commenced.
Mike Yungerman: Opus entered into a joint venture agreement with USAA last fall, and began construction of I-88 Gateway Logistics Center in October 2013. We will deliver the 604,000 square foot building in early July. Opus has been a believer of the I-88 market since our involvement with Butterfield Business Center in the mid-90’s. Our strategy has been to identify submarkets with low vacancy and good historical absorption; and then try to find a site that can fill a void in the market. This is no easy task. Chicago is a very competitive industrial market with a deep pool of talented developers all pursuing the same opportunities. When Opus decided to move forward with the project, the I-88 corridor had a 2.7% vacancy rate for building 250,000 square feet or greater with no buildings able to provide 400,000 square feet of contiguous space. The corridor has also averaged more than 2.5 million square feet of positive absorption over the past three years.
Q. In your opinion, have the net rents increased sufficiently over the last 12-18 months to warrant new construction? Have your rent expectations been adjusted to address the current timing of the market?
McShane: We are clearly experiencing a much improved market overall and, in particular, within the industrial sector. Rents have slowly risen from the low experienced in 2010, roughly 30% below pre-recession highs, back to their previous 2007 highs in many submarkets throughout Chicago. We actively maintain a careful evaluation of the variances in rents throughout the markets and engineer our rent expectation to both user demand and the modern space that we offer to the end-user.
George: Net rents have increased to a level which supports new construction. However, effective rents may not be all the way there. We are relying on the continued contraction of available space along with the economic and operational benefits of a contemporary building to bridge the remaining gap.
Yungerman: Over the past 18-24 months, most Chicago sub-markets have experienced a significant decrease in vacancy and increase in rental rates, back to pre-recession levels, and perhaps slightly higher rents. The I-88 market fits this description. The lack of available Class A product has forced many companies to make decisions to start build-to-suits which always demand higher rents. I-88 Gateway Logistics Center provides many users with a viable alternative to build-to-suit.
Q. Following up on question #2, what indicators have you seen in the market that convinced you that this is a good time for building new spec product?
McShane: Over the past 18 months, we have been witnessing a significant swing in supply and demand. At the worst of the recession (late 2008 through early 2011), new construction was practically non-existent with the exception of the occasional build-to-suit. The absence of new speculative development allowed for the slow and steady absorption of a significant amount of contemporary space (higher clear height and well-docked properties). This eventually swung market fundamentals positively in favor of new investment.
George: The reasons we have decided to build a spec building include: falling vacancy, spot shortages, increasing number of build-to-suits, rising lease rates and the emergence of pre-leasing.
Yungerman: In addition to increased rents and lower vacancy, the availability of debt and capital is a key factor. Investors who historically were net-lease buyers are now looking at partnering with developers to build spec, allowing them to get into the deal at a lower basis but taking some leasing risk. Exit cap rates remain low, especially for core industrial, and are expected to remain there at least for the balance of the year.
While examining existing sub-market statistics is important, another factor is the status of neighboring feeder sub-markets, from which a high percentage of the potential tenants will come. In 2013, according to the Colliers 2013 Year-End Market Report, the Central DuPage submarket experienced the largest increase in year-over-year net absorption and one of the highest leasing volumes in all of Chicago.
Q. Please talk a little about the building(s) that you are constructing (i.e. location, size, clear height, dock ratio, trailer parking), and how/why you decided to build that particular product.
McShane: For our new speculative project in Elgin, Northwest Pointe, we designed and constructed a 342,620 square foot cross-docked facility. The building offers as many as 68 docks (one for every 5,000 square feet) and can be divided into tenant spaces from 70,000 square feet. We chose a large building (relative to the Elgin market) because the greatest void in that active market area was in larger blocks of space (greater than 250,000 square feet). The Conor Commercial/Globe Corporation speculative industrial building can have several trailer spots added; however, the Elgin market has not traditionally been a heavy trailer storage market like I-80, I-55 and what is occasionally developed within the O’Hare area.
George: We are underway with two buildings and finishing the design on a third. The first is in Bolingbrook, a 602,000 square foot cross-dock facility. The building is 36′ clear, has 60′ wide bays, and can have up to 115 docks and 180 trailers. Our second building is a 290,000 square foot rear-load facility in Rock Run Business Park in Joliet that has a prelease, leaving 75,000 square feet available. The available space is 32′ clear and can have up to 17 docks and 26 trailers. Our final building which should be starting in mid-July will be just off I-94 on Route 173 in the ACC Logistics Park. It will be a 454,000 square foot cross-docked building with 36′ clear height, 60′ wide bays, and up to 120 docks and 115 trailers. The design of the three buildings (including LEED-certification) is meant to address the needs of today’s users and hopefully future users, as well.
Yungerman: I-88 Gateway Logistics Center is strategically located within 1.5 miles of two four way interchanges at the northwest corner of I-88 and Randall Road with 2,350 feet of 1-88 frontage. The building is 604,565 (expandable to over 1M) square feet and is located along the north side of I88 at Randall Road and Orchard Gateway Boulevard in North Aurora. Avison Young’s Brendan Kelly and Todd Heine brought the opportunity to us and are marketing the building. The building is 32′ clear with 60 docks (expandable to 112) and 115 trailer parking stalls (expandable to 160). The building offers car parking for 300 vehicles and can be divided into two tenant spaces, both with Orchard Gateway Boulevard frontage. With any speculative project, flexibility is important. Our building offers the ability to expand the building size, number of docks, number of trailer stalls, and multiple tenant entry points which offer the ability to secure the site for multiple tenants.
Q. Is your company doing industrial spec construction in other markets? If so, where?
McShane: Conor Commercial has been launching speculative industrial properties since the beginning of the economic recovery. We have constructed numerous industrial spec properties within the Inland Empire region of Southern California, as well as within the East Bay industrial corridor in Northern California. The firm’s speculative development activity has also taken place in growth markets throughout Texas, and within many active submarkets in the Chicago and Midwest region.
George: IDI has speculative projects underway in New Jersey, Atlanta, South Florida, Cincinnati, Northern Kentucky, Indianapolis, Memphis, Dallas, Houston, Salt Lake City and Southern California.
Yungerman: Opus currently has over 2.2 million square feet of speculative projects under construction throughout the Midwest. In addition to the 604,000 square foot I-88 Gateway Logistics Center, Opus has 925,000 square feet under construction in suburban Indianapolis, 200,000 square feet in Minneapolis, and just recently started construction on a 485,000 square foot speculative building in Columbus, Ohio.
Q. Please give a brief overview on your predictions for the industrial market in Chicago for 2014.
McShane: Based upon the activity that we continue to enjoy within the industrial market, it is believed that market fundamentals will remain strong throughout the balance of 2014 and well into 2015. Specifically supporting that improvement is the further advent of increasing rents, decreasing tenant concessions, competitively priced land, demand that outpaces supply and interest rates remaining low. These conditions provide access to capital that allows us to continue to pursue new investment and future development activity.
George: It seems like the Chicago market will progress at a reasonable rate, probably again achieving net absorption in the low eight figure range. It will likely continue to lag behind the velocity experienced in the east and west coast markets, Texas, and even other Midwest cities such as Indianapolis and Cincinnati.
Yungerman: Although there has been an increase in speculative starts over the past eight months, we are seeing a significant increase in build-to-suit activity in all sizes. With the interest rate still low, some smaller tenants are making the decision to own vs. lease and are doing so with build-to-suits. Also, many existing spaces cannot meet the tenant demand that requires well above market automobile and trailer parking and the only way this can be accommodated is through build-to-suits. Given the limited supply of Class A product available for investment and the number of active buyers we will continue to see near record cap rate sales for stabilized, core industrial product. Rental rates for newer, efficient buildings will continue to rise as interest rates, construction costs, and land costs climb higher.
A sincere thank you to Jim McShane (The McShane Companies), Tom George (IDI), and Mike Yungerman (Opus) for taking the time to share their insights and thoughts about the resurgence of new industrial spec building construction, which has returned to the Chicago area and other strategic markets nationally, as well as their predictions for the Chicago market in 2014. Please check back for the next Industrial Insider – coming in August!