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Is Spec space back?

It's the talk of the real-estate industry. National experts are saying the country is poised for a major surge in speculative office and industrial construction. Times are good and money is plentiful.

Does this signal a return to the boom of the '80s? Is Indiana keeping up with the trend? It depends on where you look. Hoosier developers are approaching speculative development with the same conservatism that spared them most of the pain when the '80s boom went bust.

Certainly, Indiana saw some overbuilding in the '80s but didn't experience the crash felt so dramatically in such places as Texas and California. Indiana did, however, share in one of the consequences - a dramatic lender pullout from further speculative office and industrial construction financing. Lenders demanded that new developments be almost completely preleased before allowing the first shovel of dirt to turn. "Build-to-suit" became the new development philosophy of choice.

Today, the high vacancies caused by too much spec building are fading into the past. According to the 1998 edition of "Comparative Statistics of Industrial and Office Real Estate Markets" - a detailed, 350-plus page annual economic report published jointly by Landauer Associates and the Society of Industrial and Office Realtors - office property markets in 1997 experienced an overall national vacancy rate in the single digits (9.6 percent) for the first time in a decade. Some 130 major markets were analyzed, encompassing a total inventory of 3.5 billion square feet of space under roof.

The industrial markets - where more than 10.5 billion square feet were surveyed - were even stronger, with vacancies averaging only 7.1 percent. The absorption rate during 1997 also was strong, helping support a 17 percent increase in new construction. Indiana's numbers compare favorably with national averages.

Such numbers suggest there should be a strong market for speculative development, and indeed, some is under way in Indiana. But Hoosier developers are taking a go-slow approach thus far, limiting much of the spec work to the outskirts of Indianapolis, surrounding counties and to a limited extent Fort Wayne and South Bend.

"At this point, I continue to stay focused on those individual buildings that I feel are competitive," says Dave Arnold, president of the Fort Wayne operation of Miller-Valentine Group, which has been doing speculative building in the Fort Wayne area on a building-by-building basis. After one building fills, another is launched. "I consider this a growing market, but not booming. We're realistic about that."

Miller-Valentine completed Expressport, a 112,000-square-foot industrial building in Fort Wayne, in January of 1998, and so far 16,000 square feet has been leased to a record-keeping firm. The company's 60,000-square-foot Crown Pointe office building, which broke ground May 19 and will be completed by January 1999, has just 15,000 square feet available for lease.

Arnold says there's still a lot more caution in the air than in the past. "I think the lesson that both developers and lenders learned from the '80s is still with us today," he says. "It can be seen in evaluation methods, loan-to-value ratios and debt-service coverages. We're still not in a lending environment like we had before."

The lending environment depends a lot on the type of development, observes Gary Howlett, senior vice president and manager of the Commercial Banking Group at the Citizens National Bank of Evansville. "In terms of speculative office space, I think there's limited need in Southern Indiana and Evansville. There's probably more room for general purpose, light manufacturing, warehouse/distribution space here. I think we, as well as other lenders, would consider both build-to-suit and speculative of that type," he says. "The financial climate is as good as Evansville has seen since the 1950s. Money is available, but it's also very competitive."

The story is the same in Lafayette. There's no shortage of financing available, but very little of it is going into speculative projects as of yet. "We have more of a build-to-suit atmosphere here," says Todd Burklow, vice president of commercial lending at Citizens Bank of Western Indiana. "You may have 15 to 20 percent of a project that's speculative, but that's filled pretty quickly."

Some speculative office space has gone up in South Bend, reports one large developer, but lead tenants typically still are in place before construction begins. The industrial market, on the other hand, remains strictly build-to-suit.

Yet while such traditional lenders as banks still call a lot of the shots in development financing, an increasing amount of capital is coming from other sources. Most notably, real estate investment trusts, or REITs for short, have been the vanguard of speculation across the country. REITs, whose money comes from stock investment, are able to avoid the normal ebb and flow of traditional capital resources. Evidence of their influence in Indiana is especially apparent in the Indianapolis suburbs, including Plainfield and Lebanon.

But even REITs don't develop with reckless abandon. "You hear arguments that it'll be different this time because of the capital coming from the REITs," says Dr. Jeffrey D. Fisher, director of the Center for Real Estate Studies at Indiana University. "But real estate analysts follow that market pretty closely, and if they see signs of trouble, they'll stop recommending the stock, which in turn will cause the stock to go down and the REIT won't be able to raise money." Rather like water seeking its own level, a built-in control against overbuilding.

One major REIT, Indianapolis-based Duke Realty Investments, isn't about to follow past industry mistakes. "What we're doing, and I presume others are also, is simply to not build new speculative space until what we have already put in service is well leased," says Phil Wegele, vice president and general manager of Duke's Indiana Industrial Group. "I would say we would not even consider starting another speculative industrial building unless we're at least 50 percent leased. But that figure could be 80 to 90 percent, depending on our sense of the market at the time."

Since there has been a fairly steady demand for warehouse/distribution space, some of that demand may stem from a change in distribution trends, such as "just-in-time" delivery requirements, as well as the need for technologically updated structures.

"There is definitely more sophistication on the logistics side," Wegele says. "The distribution requirements are the biggest share of the new construction demand. Users want higher clear heights, wider bay widths, flatter floors, more docks, more trailer parking, EFSR sprinkler systems and energy-efficient, high-output lighting. It's a different market even from that of five years ago."

Immediacy is another significant driving force among today's buyers. "They're saying, 'I need it, and I need it now!'" says Trent Bennett, development manager for The Holladay Group, which is developing the 1,500-acre Ameriplex on the southwest side of Indianapolis. "They're saying, 'I can't wait six to eight months for you to build it; I need to move in now.' That's the reason we've seen a lot of speculative industrial/distribution construction," he says.

"We are just wrapping up a medium distribution building," Bennett continues. "We built it 100 percent spec; it's now 100 percent leased." Such quick turnaround is just what institutions willing to lend for spec projects are looking for.

Holladay's Ameriplex development has shown such promise that the company is thinking of expanding elsewhere. "We are also looking in the Chicago area on the Indiana side to possibly do something along the lines of another Ameriplex, only a little smaller," says Bennett.

One market that Holladay has already tested is South Bend. The company started building a 100,000-square foot building last November 1997 and was able to lease the entire facility by January to a phone-book distributor and a wire respooler. An 80,000-square-foot building is set to start construction this month, with plans for three additional buildings on the site after that building is completed and leased.

Holladay also has an interest in office/flex building. A so-called "bulk" building, which has seen the most activity during the past two to three years, usually has no more than 10 percent dedicated to offices, whereas an office/flex building may have as much as 80 percent of its space devoted to an office/showroom configuration. Holladay Group is presently considering such a project in southwest Indianapolis.

"We're holding off on any more bulk speculation as we assess the market," says Bennett. "Right now, we think there's too much bulk space empty. There's a lot out there. There are several developers in the Plainfield area, and they're all saying the same thing."

If much of the speculative industrial market is on the southwest side of Indianapolis, the office market has been centered on the suburban north side.

Duke Realty led the way into the spec office market with its Parkwood III building, which was so successful that the company quickly began work on the 130,000-square-foot Parkwood IV, scheduled for a September opening. It was started as 100 percent speculative.

Several other projects on the north side of Indianapolis have added fuel to the speculative office market. Developer The Precedent plans a 180,000-square-foot building in its self-named park just east of Keystone Avenue and north of Interstate 465. Lake Pointe Center 4 by Edgeworth Lasky Properties will add an additional 85,000 square feet of office space to Allison Pointe Office Park. One River Crossing by PK Partners and Gibraltar Properties is to be a 125,000-square-foot office building located northeast of the Fashion Mall at Keystone at the Crossing. And Eaton & Lauth's 186,000-square-foot building in College Park Business Park should be ready for occupancy in July. Bindley Western Industries Inc. is committed to nearly a third of the building.

Development at this pace worries some in the real-estate business. "In just the past few months, there have been four or five projects announced that are going to add substantial square footage to the marketplace. If you look at our overall absorption rate, it hasn't been sufficient to take up all that space," says Mike Wells, president of REI Investments. "With the influx of dollars available for financing, there is a possibility we could be back where we were a number of years ago. Vacancies in the suburbs had dropped, but now they're already heading back up. Next year they could be in double digits."

According to the 1998 real estate market report from F.C. Tucker Co., suburban Indianapolis class A office vacancy moved from 7.9 percent in 1996 to 9.4 percent in 1997. Though Tucker expects a vacancy spike in 1998, it also suggests that absorption rates could increase to help alleviate the problem, as large blocks of contiguous space become available.
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Title Annotation:industrial and office buildings in Indiana
Author:Dunlap, Phil
Publication:Indiana Business Magazine
Date:Jun 1, 1998
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