For both institutional and private investors, determining where the next 10 to 20 years of market activity will occur is one of the most important elements to identifying good speculative real estate investments. By anticipating this correctly and acting ahead of the curve, one can take advantage of enormous increases in property value as the surrounding area grows. As such, it is no surprise that this is one of the most common questions I am asked when speaking with investors. In many market areas around the country this question can be answered fairly well by looking at an aerial image of the city, county, or region. It is easy enough to visually identify logical areas that are mostly flat, well served by the highway system, and currently mostly undeveloped. As long as they are within a reasonable distance of a city with strong growth prospects, it is fairly likely that development will occur there in the future.
Applying this sort of visual inspection of the Puget Sound region, it quickly becomes clear that the logical industrial development centers have already been heavily tapped. Zooming out, small industrial pockets can be seen popping up in the surrounding areas well outside of the immediate Seattle/Tacoma area, as far South as Dupont and Frederickson and as far North as Marysville. While there has been some interest level in these fringe markets, the appetite for vacant land there has not experience anything near the type of growth that the early investors in these areas expected, nor have the large development projects that did get started been able to attract much leasing activity. This is well evidenced in the Dupont Corporate Center, a 370,000 sf industrial development completed in 1996 that has consistently seen long running vacancy despite the fantastic building features and substantially lower lease rates than core markets. Even more extreme is the nearby Hawks Prairie development site in Lacey that has been on the market for industrial build-to-suite opportunities for nearly 9 years with little activity. Meanwhile, raw land prices in the Kent Valley have more than doubled over the last two business cycles. In the Seattle core markets raw land has more than quadrupled in value over the last decade.
I had the pleasure of sitting down with Patrick Gemma and Justin Carlucci of DCT industrial Trust recently and the topic of future development locations came up. Patrick and Justin echoed the same predictions that I have heard from nearly all of the major developers in recent months, the fringe markets have lost their flare. Institutional developers have been targeting smaller and smaller properties during recent years and as the inventory of raw land dwindles the effect has only become greater. Prologis and Terreno have both acquired buildings as small as 19,000-30,000 sf and pieces of land as small as 2-3 acres in the last 12 months. Other investors such as IPT and Clarion have recently purchased low-quality buildings that are in need of updating or full replacement to the surprise of many. This is a major indication of where these groups see the greatest opportunity, and any speculative real estate investors should take note.
The industrial markets of the Kent Valley saw massive booms in construction in the 70’s and 80’s, which means many of the buildings are reaching the age that they begin to either deteriorate or slowly transition into functional obsolescence. Many of the investors and developers I have spoken to recently have said that this is where they see the real opportunity. I expect to see many more investors buying up old metal and masonry buildings that are sitting on prime real estate purely for the sake of the real estate. The old construction looses value over time, while raw land costs increase as the supply shrinks. For many of the older buildings in the Kent Valley these two trend lines are coming very near an intersection point where the economics pencil out nearly identically for raw land versus a previously developed site that needs to be torn down for redevelopment. If sites such as these are lumped together with the remaining pieces of raw land, the existing inventory suddenly becomes sufficient to easily support 2 to 3 more business cycles of development without leaving the established market areas. As those opportunities are absorbed every other developed property is continuing to age, thus adding to the potential inventory of redevelopment opportunity. It is not unlikely that we are reaching somewhat of an equilibrium in the geographic spread of industrial development. This theory is bolstered by the increasing regulations and bureaucracy associated with new development. Every political barrier to new construction makes it even more likely that investors will be seeking previously developed sites where they can count on a more streamlined process. After all, we are all human and that means we typically follow the path of least resistance to at least some degree.
This equilibrium theory is nothing new, it can be seen in the Puget Sound region dating back well into the 80’s. During that industrial boom the dwindling inventory of land became a well-known topic in development discussions, and it has been an issue ever since. Yet throughout the years plenty of “land” opportunities have been created by rezoning, demolition, and redevelopment. The very land that my office sits on is a great example of this. In the early 90’s Boeing operated a massive research facility in the Kent Valley, complete with a full airstrip and the Space Center testing facility. At that time people assumed that the land was taken and it was never considered as available inventory. As land prices rose though and Boeing consolidated their operations, suddenly the airstrip was no longer necessary and the land was spun off. By the early 2000’s the various parcels were all bought up and a handful of buildings came out of the ground in its place. The Space Center testing facility was not part of this process though, it remained standing and was considered by most to be unusable land. Again, prices climbed higher and the existing inventory continued to shrink until 2013 when the entire testing center was sold and demolished, creating the real estate to build Stryker Business Center that now houses Amazon’s fulfillment center.
Similar redevelopments can be found all around the valley, and have been occurring with an increasing frequency over the last decade. In addition to redevelopments like this, major land holdings are occasionally put on the market that substantially change the calculations of available land inventory. The sale of the 425 acre Weyerhaeuser Campus in Federal Way earlier this year is a great example of this. Los Angeles based Industrial Realty Group has made it clear that they plan on spinning off large chunks of this for industrial development, delivering hundreds of new acres of land inventory that previously was never included in anyone’s calculations.
To my own enjoyment, this equilibrium theory was reinforced earlier this week at the Titans of the Valley NAIOP Breakfast in which John Pietromonaco, Larry Benaroya, and John Teutsch discussed their combined 100+ years of development experience in the Puget Sound region. Teutsch in particular offered an interesting perspective, as he is the owner of the Hawks Prairie project in Lacey and said outright that if he knew then what he knew now, he would not have made that particular land play.
In conclusion, when asked where industrial development and strong market activity is going to occur in the next 10-30 years my answer is not some piece of land well outside of the core market areas. Instead, I point clients toward the existing aging industrial centers. Rather than acquiring swaths of land outside of the high demand areas it is always my recommendation that the target be a building that has a successful industrial history that looks like it is nearing the end of its functional lifespan. There is a chance that you can make it big with a land play in Lacey, but there is also a chance that the increased drive-time and lack of skilled workforce in the immediate surroundings will put a choke-hold on your profit potential. A smart buy in the middle of the Kent Valley on the other hand all but guarantees you lasting profit potential.
If you would like to discuss what smart buys currently exist in industrial real estate investment please contact us. I am happy to share every opportunity currently on the market, or include you on my mailing list for any future opportunities that surface.