CoStar's Third Quarter 2008 National Market Reports, which provide comprehensive statistics for national and local retail real estate trends, are now available to subscribers under the Analytics/Market Reports headline on the CoStar Control Panel. Non-subscribers can purchase the reports at CoStar's Yahoo Store.

"This is the most unpredictable and unsetting financial environment in modern history," said Hamid R. Moghadam, CEO of AMB Property Corp. (NYSE: AMB), which has seen shares take a drubbing like most others publicly traded REITs in recent weeks. "Since mid-September, the visibility into the credit markets and the outlook for the global economy has deteriorated dramatically. Decision making on many fronts has ceased and the capital markets are by and large in a frozen state.

"While the recent moves by the Treasury, the Fed and other central banks give us hope for some eventual relief on the capital markets front, we anticipate that the U.S. economy will deteriorate significantly in the coming months."

Still, industrial real estate fundamentals held up "reasonably well" in the third quarter and global leasing activity was slightly ahead of second-quarter levels, Jeffrey Schwartz, CEO of industrial developer ProLogis (NYSE: PLD) told investors last week. The development giant continued to see modest growth in rents and same-store net operating income.

"However, customer demand has begun to moderate in recent weeks, as around the globe, companies are pausing to assess how their businesses might be affected by this turmoil."

Tenants are delaying or canceling relocations or expansions in the uncertain economy. Industrial developers are finding the going particularly rough, with merchant builders opting to play it safe and preserve capital. Developers have delayed or pulled the plug on numerous new projects -- particularly on the coasts, where demand for goods imported into the ports has been hurt by the reluctance of cash-strapped consumers to spend their dollars.

Nationwide, 979 buildings totaling 86.5 million square feet were in the construction pipeline in the third quarter, according to CoStar data -- about half the number of structures and space being built at this time last year.

Among the myriad of economic issues causing the slowdown are rising unemployment, higher energy costs and lower retail sales, which have a ripple effect on warehousing needs, said Craig Meyer, managing director and national brokerage leader of industrial services with Jones Lang LaSalle.

"We’re looking at the storm clouds in the horizon and just don’t know right now if it’ll be another Katrina or a summer shower. Fortunately, there have been signs of an economic slowdown for several months, so tenants and developers have had time to adjust their strategies, unlike past economic cycles that took many by surprise," Meyer said. "Companies have avoided unnecessary moves and focused on cost control, flexibility and short-term solutions. In the short term, this creates negotiating leverage for tenants still in growth mode, while over the longer term, a cautious stance helps the market maintain stability and avoid overbuilding."

Meyer noted that the development pipeline is at its lowest ebb in 15 years -- down by as much as 70% from last year, and the financial crisis and credit crunch will insure continued pain heading into 2009.

ProLogis and its main competitor AMB have decreased leverage and tried to stimulate liquidity by scrapping spec development starts in favor of retreating to more stable and predictable income streams from direct-owned properties and investment management. ProLogis now expects to start a sharply curtailed $2.7 billion and $2.9 billion in projects his year, mostly build to suits and projects in fast-growing emerging markets, Schwartz said.

"It’s clear that in this market our 13-year track record of progressively creating greater value through development activity is being heavily discounted -- or more accurately -- not being recognized at all by investors," Schwartz said. Though still core to ProLogis’s business, development has been "a less predictable source of earnings -- both on the upside, as we reap the benefits of declining cap rates during recent years, and now on the flip side of that equation, with the margin compression -- exceeding anyone's expectations and requiring a reset in our required development yields."

Although fundamentals seem to be holding up fairly well, Meyer’s prognosis is circumspect. "If we can continue to muddle along as we have been, we should be pretty well positioned by 2010. While building will continue, the challenging financing environment and the uncertain economic outlook will certainly curtail new starts across the board," he said.

The brightest light in the industrial real estate market has been exports, which have experienced double-digit increases over 2007 and will probably continue well into 2009 in response to the declining dollar. For the first time in 10 years, however, imports have dropped by 5% and are expected to fall further in the coming year, particularly in the major West Coast ports.

One bit of good news is that industrial vacancies aren’t spiking up at the rates seen during the previous downturn. The national industrial vacancy rate moved from 8.6% in the second quarter to 8.8% in the third quarter. That's still a 60-basis-point rise from the same quarter a year ago. But compare it with the more than 200-bp rise between first-quarters 2001 and ’02, when increases of 50 to 60 bp each quarter were the norm.

JLL’s Meyer expects the national industrial vacancy rates to accelerate, reaching double digits by year-end, with vacancies for distribution space rising as high as 14%. If that comes to pass, it would be the highest vacancy factor of the decade, eclipsing early 2001's 9.7%.

The national rate fell as low as 8.1% during the fourth quarter of 2007 as the most recent real estate boom was receding, the lowest since third-quarter 2001’s 7.7%, according to CoStar data.

In the third quarter 2008, Los Angeles and its two major ports continued to be the tightest U.S. industrial market with a vacancy rate of 3.6%, followed by San Francisco (4.3%), Long Island, NY, (4.5%) Orange County, CA (4.7%), Seattle/Puget Sound (5.2%), Houston (6.2%) Kansas City (6.4%) Cincinnati (6.5%), South Florida (7.4%) and Oakland/Eastbay, CA (7.5%).

The five markets with the highest vacancy rate were Memphis (14.1%), Phoenix (13.6%), Columbus, OH (12.5%), Raleigh-Durham, NC (12.4%), and Boston (11.9%). Phoenix and Southern California's Inland Empire (Riverside and San Bernardino counties) recorded the highest jump in industrial vacancies over the last four quarters at 4.9% and 4.3%, respectively. Memphis, Boston and Pittsburgh saw the greatest year-over-year declines in vacancy at 1.3%, 1.1% and 1%.

Though some markets may see modest rent growth, Jones Lang LaSalle expects rental rates to drop between 5% and 7% by year end, adding to the already significant pressure on owners to snag and retain tenants.

"Landlords must act quickly and decisively in this competitive market to stay in the game," Meyer said. "More than ever, tenants will be focused on shorter terms, flexibility, increased concessions and speed to market at the lowest possible occupancy costs."

Metro areas with the largest hike in average rents in the third quarter were Seattle-Puget Sound at 16%, South San Francisco Bay/San Jose (12.3%), San Francisco (12.2%), Austin (8.9%) and Long Island (7.3%). Markets with the steepest rent drops were St. Louis (-10.2%) Baltimore (-4.8%) Dayton, OH (-4.7%) Phoenix (-3.8%) and Detroit (-3.7%).

Industrial absorption fell into negative territory in the second quarter for the first time since mid-2002. However, during the third quarter’s mini-rebound, 28 of the top 40 industrial markets tracked by CoStar showed positive absorption, led by Memphis (2.83 million sf), Chicago (2.22 million sf), Philadelphia (1.99 million sf), Boston (1.76 million sf) and Indianapolis, IN (1.51 million sf).

The highest third-quarter negative absorption was in Los Angeles (-2.2 million sf), followed by South Florida (-1.63 million sf), Atlanta (-1.27 million sf), Tampa/Jacksonville (-1.17 million sf), and Washington, D.C. (-888,000 sf).

With the credit crunch continuing to bite deeply, sales volume fell in the second quarter -- the latest period for which CoStar has complete sales statistics -- with 844 buildings totaling 64.9 million square feet trading hands for $4.24 billion, compared with 1,450 buildings totaling 108.6 million for a total of $7.55 billion a year earlier.

At the same time, more than half of U.S. markets recorded sales price increases from a year ago, led by Houston (67.6%), Jacksonville, FL (66%) and South San Francisco Bay/San Jose, CA (36.1%). Prices fell most sharply in Austin, Cincinnati, Boston and East San Francisco Bay/Oakland, each of which fell more than 30%.

Jacksonville, Washington, D.C. and the Inland Empire have shown the greatest increase in sales volume over the past year, while San Francisco, Austin and San Diego showed the largest decline.