The King of Industrial Real Estate

First Industrial Realty is tops in factory and warehouse space. Despite the slump, CEO Michael Brennan sees plenty of room to grow

In late 1999, Warren Buffett auctioned off his 20-year-old wallet at a fund-raiser for an Omaha (Neb.) charity. Inside, the billionaire investor had tucked a stock tip: First Industrial Realty Trust (FR ). The tip was classic Buffett. Even as the overall stock market tumbled in 2000, First Industrial shares gained 34%, as old-line manufacturing and distribution tenants and a wave of e-tailers and their suppliers turned to First Industrial for factory and warehouse space.

This year hasn't been as easy, however. First Industrial's stock price in 2001 is off almost 9%, to $31.02 on May 8. While revenue edged up 3% in 2000, to a record $386.1 million, net income tailed off as 2000 progressed. Other benchmarks also point to harder times. The company's overall occupancy rate, for instance, slipped to 94% at the end of the first quarter, from nearly 95.5% just three months earlier, hurt by rising vacancies in 13 of its 30 metro markets, including Atlanta, Cincinnati, and Phoenix. Same-property rental rates, meanwhile, have stalled. But Michael W. Brennan, president and chief executive of Chicago-based First Industrial, argues that 2001 is only a temporary rough stretch on the road to success. He notes that the company hiked rents by 8.9% in the 175 leases it re-signed in the first quarter. Further, he says, his company is getting more orders for new facilities and purchase offers on existing buildings than ever before.

Who's still shopping in today's downturn? Procter & Gamble 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 executive asserts, there's plenty of room to grow through consolidation. The U.S. contains roughly 20 billion square feet of manufacturing and distribution space today and adds 200 million to 400 million square feet every year -- the office-space equivalent of a new Manhattan. Today, First Industrial is the nation's largest industrial landlord. But its 994 buildings contain just 68.1 million square feet, less than 1% of the industry total. Sitting in his 40th-floor corner office in Chicago's Loop, Brennan recently talked shop with BusinessWeek 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?


Well, demand related to technology has significantly dried up. But we think the impact is minimal, and the reason is that [the dot-coms] didn't absorb that much industrial space to begin with. Let's go back to 1999. Born-on-the-Web companies, such as and eToys and their brethren that marketed goods over the Internet, probably in the aggregate took 20 million square feet in 1999. Amazon led the way, with about 3.5 million square feet. In 2000, that demand [for dot-coms] dropped to about 3 million square feet for new warehouse properties.

Q: Where do you think it will be this year?


Negative 3 million square feet, meaning these companies will be giving back space they had previously leased. eToys has given back a facility, putting it on the sublease market. Amazon is in the process of giving a few facilities back. And you'll also see fulfillment firms like Fingerhut 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. We built, for instance, a building for General Motors of about 350,000 square feet 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 to dealers. The purpose of that building and that initiative is to help dealers maintain lower inventory costs and provide them with just-in-time shipping. That is just one example of how the Dow industrials, when they begin to harness the power of technology, will come into this arena that once held such promise for the Internet retailers.

Q: We're also seeing traditional manufacturers -- the car industry, the appliance makers, the Rust Belt, if you will -- getting hit hard today. What kind of impact is that having on industrial properties, such as warehouses and factories?


Again, very little. And 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. That's why it takes a prolonged economic expansion to cause new manufacturing buildings to be built. But conversely, it requires a prolonged economic contraction before you begin to see existing manufacturing buildings come back on the market.

Q: So if this turns out to be a six-month downturn or a one-year downturn, the effect is what?


It means we won't be building new manufacturing buildings for people. But the current occupancy would be generally unaffected. There's another issue I'd like to get into: Aside from the economic expansion and contraction, there's a new phenomenon, and that's the supply-chain revolution. It's an effort by companies to move the network of their buildings around, really the way you would on a Monopoly board, to get the best positioning in terms of labor costs, freight costs, material-handling costs, so that the overall delivery costs of a company are lower. And that process will accelerate when you have economic adversity, as companies look for ways to improve their bottom line.

Q: Let me ask your big-picture view on a couple of things: Geographically, are there any parts of the U.S. that are looking weak in terms of industrial-property demand?


Yes, there are. You have to understand that what's weak for us is viewed positively by a tenant. I'll tell you from a landlord's perspective which markets we find unsuitable for investment: San Francisco and Northern California. We think 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? Who's weakest today?


There's overcapacity in the third-party logistics area. These are companies you probably never heard of -- local companies that did 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 major technology companies going bankrupt, we're seeing a dropoff in demand by tech companies and suppliers to tech companies.

Q: And conversely, who's strong?


[No one] comes to mind. Nobody is taking gargantuan amounts of space today.

Edited by Douglas Harbrecht