Life used to be a breeze for Michael W. Brennan, president and chief executive of First Industrial Realty Trust Inc. From 1996 through 1999, the company's revenue surged 250%, and net income tripled. Why the windfall? While First Industrial was serving the growing needs of its traditional manufacturing and distribution tenants, a swell of e-tailers and their behind-the-scenes suppliers swept into the market.
In 1999, this wave boosted the Chicago-based real estate investment trust to the top of the U.S. industrial-properties market. Its holdings now span 25 states, and its tenant roster includes everyone from dot-coms such as Amazon.com (AMZN) to the nation's biggest logistics companies to blue chips such as General Electric (GE), General Motors (GM), and Procter & Gamble (PG).
The question now is whether First Industrial's rise will continue through 2001. Revenue edged up 3% in 2000, to a record $386 million, but net income slid 7%, to $85 million. Other indicators also suggest harder times ahead. The trust's overall occupancy rate remains historically high but slipped to 94% at the end of the first quarter, down 1 1/2 points from the prior period. Same-property rental rates, meanwhile, have stalled.
Yet Brennan remains optimistic. First Industrial was able to hike rents by an average of 8.9% on the leases it re-signed in the first quarter. Further, he says, his company is still getting orders for new facilities and purchase offers on existing buildings, with deals worth $400 million in the pipeline. Who's still shopping in today's downturn? P&G, for one. First Industrial is wrapping up a $53 million deal with the consumer-goods giant for a 1.7 million-square-foot paper-goods distribution center near Scranton, Pa.
Besides, the 44-year-old exec asserts, given how fragmented the market is, there's plenty of room to grow simply through consolidation. While it may be king of the hill, First National's 994 buildings contain just 68.1 million sq. ft.--less than 1% of the nation's 20 billion-sq.-ft. supply of industrial and warehousing space. Sitting in his 40th-floor corner office in Chicago's Loop, Brennan recently talked shop with correspondent Michael Arndt. An edited transcript of their conversation follows:
Q: Last year, of course, we had dot-com mania. This year, that's all gone. What do you see happening now in that part of the industrial market?
A: Demand related to technology has dried up. But we think the impact is minimal. The reason is that they didn't absorb that much industrial space to begin with. Let's go back to 1999. Companies such as Amazon.com Inc. and eToys Inc. (ETYS) and their brethren that marketed goods over the Internet probably took 20 million sq. ft. in the aggregate. Amazon led the way, with about 3.5 million. But in 2000, the dot-coms picked up just 3 million sq. ft. of new property.
Q: Where do you think it will be this year?
A: The total capacity for the dot-com sector will shrink by 3 million sq. ft. in 2001. EToys has given back a facility, putting it on the sublease market. Amazon.com is in the process of giving a few facilities back. And you'll also see fulfillment companies such as Fingerhut Cos. and [Hanover Direct's] Keystone that will probably lose a couple of Internet companies. Having said that, however, we do believe that over the long term, the use of the Internet to order goods will lead to more efficient fulfillment and that more traditional companies will get involved in the process.
For instance, we built a building for General Motors Corp. of about 350,000 sq. ft. in Indianapolis. It is the distribution site for dealer-parts inventories that are ordered electronically, and then the individual orders are fulfilled out of that location. The building's purpose is to help dealers lower inventory costs by providing them with just-in-time shipping. That is just one example of how the Dow Jones industrials, when they begin to harness the power of the Internet, will come into this arena that once held such promise for dot-com retailers.
Q: We're also seeing traditional manufacturers--such as the car industry and appliance makers--getting hit hard. What impact is that having on warehouses and factories?
A: Very little. The reason is that with manufacturing buildings, when business gets bad, you go from three shifts to two. And if it gets really bad, you go from two shifts to one. So, there's not a regurgitation of facilities. They merely reduce capacity, but they keep the facilities. It works the other way, too: It takes a prolonged economic expansion to cause new manufacturing buildings to be built.
Q: So if this turns out to be a six-month or one-year downturn, the effect is what?
A: It means we won't be building new manufacturing buildings--but current occupancy rates will be generally unaffected.
There's another issue that's changing demand for industrial property: the supply-chain revolution. It's an effort by companies to reorganize their network of buildings to get the best positioning in terms of costs for labor, freight, and material-handling. That process will accelerate in a downturn as companies look for ways to improve their bottom line.
Q: What about the big picture? Are there any parts of the U.S. that are looking weak in terms of industrial-property demand?
A: Yes. You have to understand that what's weak for us is viewed positively by a tenant. From a landlord's perspective, the markets we find unsuitable for investment are San Francisco and Northern California. Demand is in a free fall, not only because of dot-coms but because of power problems. Columbus, Ohio, is another unsatisfactory market for us. We continue to see fairly healthy absorption rates, but because land is so cheap and so ample, rental-rate growth there is flat to negative. The same is true of Memphis.
Q: What about by industry--which are weakest?
A: There's overcapacity in the third-party-logistics area. These are companies you probably never heard of--local companies that do public warehousing for a variety of small companies. There's significant weakness in the trucking business. Also, the technology area. Although we're not seeing big tech companies going bankrupt, we're seeing a drop-off in demand by tech companies and their suppliers.
Q: And conversely, who's strong?
A: No one comes to mind. Nobody's taking gargantuan amounts of space today.
Q: If the industrial marketplace typically grows at 1% to 2% a year, what are you expecting for this year?
A: I think it will be about 1%. I think we'll see about 200 million sq. ft. come on line, and you'll see most of that absorbed, though the rate of absorption will be less than in 2000. That will result in vacancies moving up toward 7%, with 93% occupied. But a rate in the sevens is still a phenomenally good year when you look at the industry historically.
Q: Are you seeing anything that suggests that we've hit bottom?
A: I am optimistic that we've seen the worst or close to the worst. The early evidence was in the first quarter: When everybody was experiencing trouble, First Industrial rolls in with an 8.9% rent increase--the highest in our history, going back to 1994. We have also seen a 30% increase for requests for project proposals vs. last year. And we're looking at occupancy rates not getting any less and maybe getting better. If we're any barometer of the economy, there's reason to be cautiously optimistic.