In a World of Fallen Stars, Warehouses Keep on Shining

In the real estate race of the 1990s, smart money may well be placed on the tortoise instead of the hare.

Lenders and investors, convinced that slow and steady can win the race, are increasingly drawn to the most humdrum type of property, the warehouse industrial park.

"It really is the unglamorous part of the real estate market, but it's been the steady part for a number of years," said Gene D. Clark, a senior vice president of First Union Corp., Charlotte, N.C.

Bankers say making a loan to build a warehouse can enhance their overall relationship with a middle-market corporate client. And they say warehouse development is a lending business that small or medium-size institutions can dominate.

A More Stable Market

The market for these mundane facilities, which can include some office space, didn't soar like the markets for offices, shopping centers, or condominiums -- and hasn't crashed nearly as hard.

Part of the reason is the relatively short average construction time, which takes some guesswork out of project finance. A lender on a warehouse needs to look only months into the future, in contrast to a lender on an office, retail, or apartment complex, which may open two years after groundbreaking, according to a research report by Trammell Crow Realty Advisors.

Mr. Clark of First Union and David G. Hansen, a senior vice president of First Bank, , Minneapolis, said they approach warehouse proposals as cautiously as other kinds of real estate, limiting themselves to projects that are preleased. But they also suggested that it is easier to respond to changes in the supply and demand.

Warehouses "are simple studies," Mr. Clark said. "They fulfill a need, and they seem not only to lease up but to stay leased up."

Localized Lending

Moreover, the big banks from out of town aren't prepared to make loans of $3 million to $5 million for warehouses, Mr. Hansen added. "It's a very localized kind of lending."

It is hard to tell how much any one bank has lent on warehouses, but the "industrial" category of bank real estate loans can be a clue. Warehouses are a main component, along with space used for light manufacturing.

At yearend 1990, First Union's outstanding loans on industrial real estate totaled $945 million, or 3.4% of all its loans.

Mr. Clark said he could think of only a couple of nonperforming loans in First Union's warehouse-industrial portfolio.

Among 35 banks followed by Salomon Brothers, only Los Angeles-based Security Pacific Corp. had a higher percentage, 4.8%. Warehouses totaled 1.3% of the Salomon group's loans.

First Bank, which is not among Salomon's 35, illustrates the fact that smaller banks often specialize in warehouses. Warehouse real estate represents more than 10% of all First Bank loans, Mr. Hansen estimated.

Plain-Jane Designs

Design and flexibility are the keys, the bankers said.

"Some of the repayment comes from sale or refinancing of the project," Mr. Hansen noted. For example, cool rooms with reinforced flooring, which are needed by food companies, make buildings too specialized for easy resale, he warned. "We try to make them as plain-Jane as possible."

One of the few mistakes his bank made in the warehouse sector involved an obvious design error, Mr. Clark said. "The loading docks were improperly located and were not the right height," he said. "That created a problem with leasing it."

Still, both bankers said they are more than willing to entertain proposals for warehouse projects, especially if the space is easily reconfigured to suit the changing needs of the marketplace.

Like other property markets, the warehouse market is overbuilt. But the vacancy rate is still only about half as high as that for office space.

Long-Term Balance

Besides, bankers say, the properties are relatively cheap and easy to build, so it is easier to avoid big mistakes in evaluating demand.

"Historically, supply has tracked demand very closely, because warehouses can be constructed in six to nine months," said Michael Wilkinson, analyst for Trammell Crow Realty Advisors.

Trammell Crow Co., the Dallas-based parent, manages 150 million square feet of warehouse space, 92 million of which it owns, Mr. Wilkinson said. Its founder and namesake, Trammell Crow, started modestly as a developer of warehouse space.

Nationally, Mr. Wilkinson said, warehouses have outperformed every other property type, with an annual return on investment averaging 11.26% over the past 13 years. Retail space returned 11.05%, and offices 10.09% in the same period, he said, citing a popular index of real estate investment returns put out by the National Council of Real Estate Investment Fiduciaries.

The future, too, looks enticing. Demand is expected to rise 20% from 1990 to 1995, fueled by imports, exports, and manufacturing output. That's down from 38% growth in 1985-90.

To be sure, credit for industrial space has dried up, as did credit for office and hotel space a few years ago. But experts are convinced that the need for inventory storage will put warehouses in greater demand as the economy recovers.

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