The commercial real estate market is so hot that industrial properties in the Metropolitan Baltimore market are selling for record high prices. Some of these industrial buildings are vacant and are selling for as much as 10% above reproduction costs, with leased properties selling for up to 30% more than reproduction costs.

There are many reasons for this increase in industrial property value. Climbing reproduction costs are a big factor with new construction costs for bulk buildings anticipated to be $55 to $60 per square foot. Twenty-four-foot clear office/warehouse (front park-rear load properties) are selling for reproduction costs of $70 to $80 per square foot.

It's Real Tight

For the sake of comparison, bulk industrial buildings in the Marshfields Business Park in Baltimore County recently sold for $75 per square foot, with most of the tenants' leases expiring within 24 months. A 105,000-square-foot office/warehouse building at the Free State Business Park in Howard County sold for $105 per square foot, with only one 30,000-square-foot tenant. Furthermore, there are numerous sales pending on vacant and leased buildings supporting these sale numbers.

Another contributing factor to the increase in industrial property values is the lack of land available in Baltimore. Therefore, users or developers looking for properties of two to three acres up to 100-acre business parks are having extreme difficulty finding any available industrial-zoned property in the area.

As a result, land values are beginning to approach $300,000 per acre for a finished or semi-finished lot, up from $100,000 to $200,000 per acre during the last five to 15 years. The rule of thumb for industrial properties is traditionally a land value of $10 to $12 per buildable square foot. Current land prices are now commanding $15 to $20 per square foot.

The land in the Patapsco Business Center (adjacent to Parkway Business Park) sold for about $230,000 per acre in 2005 with pending 2006 sales at $300,000 per acre. That represents an increase from $16 to $17 last year to $18 to $20 per buildable foot today.

Buying Interest High

Another factor spurring industrial demand is low interest rates coupled with the considerable number of users who prefer to own their real estate. With rental rates climbing slowly, many users, including smaller condominium users, are drawn to the market to acquire buildings.

The limited available supply, coupled with strong demand, is pushing prices higher and higher. Low interest rates, combined with Wall Street's lackluster performance, are pushing many institutional and private client capital companies into the market for diversified investments.

Again, the increased demand and short supply is pushing prices up. CalEast sold a 10-year-leased, new, build-to-suit for Baltimore Air Coil for a 6.5% capitalization rate. The supply and demand factor mentioned above is also being driven by a decrease in the vacancy rate. Vacancies are falling into the single digits for all industrial product types in all submarkets, except for Harford County, which will continue to see double digit vacancies due to excessive supply.

Indicators Up

In summary, the industrial market will continue to see appreciating property values due to rising construction costs, a lack of available land, low vacancies and continued investor demand, good infrastructure and a growing port and airport, combined with good labor and overall projected employment and economic growth.

The impact of the Base Realignment and Closure will drive demand for space in Baltimore as well. The combined Fort Meade/NSA campus and Aberdeen Proving Ground in Harford County are scheduled to receive an increase in approximately 15,000 to 20,000 jobs, with a multiplying private sector effect of another 20,000 to 30,000 jobs, totaling 30,000 to 50,000 new jobs in the Baltimore market. This should continue to cause vacancies to drop and rental rates and industrial property values to rise.

But the looming question concerns how high rental rates will go. When interest rates climb/the economy slows down, what will the effect be on overall returns and property values?

Also, at what point in time will tenants move to another geographical location to lease or buy industrial buildings for a significantly lower price? Other land constrained markets, such as New Jersey and Florida, have industrial rental rates in the $6 to $7 per square foot range.

The Metropolitan Baltimore market is on schedule to be getting those same rental rates at the end of 2006 and into 2007. But can the market sustain it? And will the tenants pay the price?

Jim Lighthizer is a partner with Chesapeake Real Estate Group in Glen Burnie. He can be reached at 410-787-8799 and jlighthizer@cregllc.com.