"Both stocks are less susceptible to rising cap rates, are self-funding with less reliance on credit markets and continue to benefit from strong global trade trends, which have resulted in increased demand for bulk distribution space in proximity to key logistics markets," the authors write in the report.
For the sector as a whole, however, Germain and McElroy believe demand will moderate in 2008 because of a slowdown in macro-economic and employment growth trends. They expect the moderation to result in greater vacancies, pointing to the forecast by Boston-based Torto Wheaton Research of a 50 basis point increase in industrial vacancy rates to 9.9% by the end of next year.
While economic growth has been unexpectedly robust, primarily because of increasing exports and a pickup in inventories, the BofA economics team expects growth to moderate in '08, as consumer and business spending slows and production levels decline. They note the factory sector reported five consecutive months of declining growth through November, reflective of a slowing economy. A 12-month downward trend in industrial production provides further evidence of marked weakness, they add.
"Our view is supported by solid global trade trends," says Germain. "Global trade continues to benefit from the weak dollar, robust foreign economies and the globalization of commerce." He notes that trade volumes are expected to rise 6.5% to 7% annually within the next two years, outpacing GDP growth, while air and port volumes are expected to grow 6.1% and 7.2%, respectively. Furthermore, he points out, approximately 40% of S&P 500 sales occur outside the US. Increased outsourcing of manufacturing, inefficient logistics systems and presence of obsolete product should help sustain demand trends in the near-term, he adds.
On the development side, Germain and McElroy report Torto Wheaton is forecasting a 20% increase in development deliveries next year, resulting in an expansion in industrial vacancy levels. Nonetheless, says, Germain, "We continue to believe global trade trends and the maturation of the logistics industry continues to result in a compelling development story within the sector. All six industrial REITs in our coverage universe focus on development as their primary external growth driver as attractive yields and tenant demand has driven growth in development pipelines."
The authors note that large portfolio transactions and institutional investor appetite for yield helped maintain cap rates at compressed levels at the start of this spring's credit crisis, but they believe the absence of highly levered buyers in the industrial sector is likely to result in a less noteworthy increase in cap rates over the next 12 months. "While management teams continue to suggest cap rates will remain flat to slightly up in primary industrial distribution markets, we are expecting a 72 basis point increase from peak pricing levels," says Germain.
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