As the economy rebounds, more boxes of widgets, gizmos and thing-a-ma-jigs will need to be stored. As a result, we are very optimistic about the industrial sector. The majority of U.S. industrial markets that are tracked by Linneman Associates are expected to strengthen through 2005, as absorption has turned positive due to growing demand and minimal construction. However, it will take time for markets to fully strengthen, resulting in small rental increases until vacancy rates approach 6-7 percent. For the most part, U.S. and Mexican industrial markets have yet to achieve this targeted vacancy rate on a consistent basis.
   The five Canadian markets in this survey are all relatively strong, with vacancy rates no higher than 6 percent. The only cause for concern in Canada is Toronto’s relatively large number of industrial facilities with greater than 100,000 available sq. ft. (93,000 sq. m.). This is a data point we will watch closely in the next installment of the index.
   While the general trends are positive, investors must consider four macro factors that impact specific markets: (i) productivity and (ii) hours worked, which together determine the quantity of “inventory” being created; (iii) labor costs, which can determine production location; and (iv) supply competition, which can emerge more quickly than you might imagine.
   Productivity growth remains strong, running well in excess of 3.5 percent per annum. However, productivity growth will slow as expanding payrolls bring less productive workers back on the job. In addition, emergency workloads will be scaled back to normal. As a result, over the next two years, we expect productivity growth to average 3 percent. Also boding well for North American industrial property markets, the manufacturing sector has seen a notable rebound in hours worked, driven particularly in the United States by the renewed strength of orders for both defense and non-defense goods. A recovery in durable goods demand is under way, with the computer and software sectors experiencing notable increases.
   Mexico still holds the clear advantage from a labor cost perspective at $1-2 per hour versus $10-15 in the United States. Given its lower standard of living, the overall cost of doing business in Mexico is significantly lower than its northern neighbors. Rental rates, however, are generally comparable across borders.
   Finally, investors often lose sight of the fact that replacement costs (at reasonable land values) are the key to acquiring these industrial properties, as it is generally not a complicated product to create. Rental rates fall when markets are oversupplied, but because of the short development cycle for industrial product, supply shortages do not last very long. As a result, industrial property down-cycles tend to last longer than the upcycles.

— Linneman Associates
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