Monthly Archives: April 2015

What I learned in Scottsdale

A brief summary of the Industrial Deal Makers Panel follows below:


National Overview:

Most major metro areas significantly favor landlords. In some key markets demand greatly exceeds supply by 3 to 1. Vacancy has fallen to historical levels and space is difficult to find. In these markets, tenants need to acknowledge they are without leverage and need to accede to landlord’s demands if they want the space. This condition is especially prevalent in Los Angeles, Bay Area, New Jersey and Miami. Rent in these markets have increased 20 to 25%. Even in Houston fears of an oil led recession are overblown and many big buyers are taking advantage of instability to make large, significant purchases.

Development activity has mostly been in the big box segment leaving virtually no construction in smaller size buildings. One reason is the cost of small spaces with separate power, bathrooms, demising walls, and offices are very expensive to build. In addition, scarce financing affects smaller developers whereas the larger developers who have access to capital don’t find building small spaces a good use of their resources. Rents will need to increase significantly to make small spaces “pencil”.

NAIOP predicts the intense space scarcity to moderate because we are currently seeing the results of pent up demand that has lagged from the Great Recession. Demand will soon mimic trends in GDP growth which is predicted to be below historical trends. Until then, it will still be a landlord’s market. All the developers on the panel predicted they will have several years of favorable development conditions with preleasing and balanced markets for the foreseeable future.


Demand is coming from several areas. Large consumer companies are taking large amounts of space as they reconfigure distribution and efficiency patterns. The same 20 or so major companies are moving to the new generation of large 1MM SF buildings near major markets. All are making the same calculations based on population densities and road time to make fast deliveries. In addition, right to work states are boasting about major new manufacturing facilities especially in the auto and oil-based manufacturing segments like plastics. There is also a trend to protect intellectual property by manufacturing in the U.S. Finally, there is good evidence of companies expanding organically with an improving economy.


In the hottest markets, cap rates have fallen to 4.5% for institutional quality property. Some of the developers see even more yield compression to come. For new development, the strategy is to build for a higher cap rate, say 6% and sell into the lower yield market. Others are searching hard for properties where they can achieve much higher IRR’s by adding value. These developers have large companies, lots of cash, and a welter of market connections to search the deals out. It’s a matter of having the widest network of connections and a large platform to capitalize on sudden opportunities.

In a fairly radical turn of events, the majority of large developers are very comfortable taking risk on spec development if they feel comfortable with local market dynamics. In contrast, Build-to-Suit will always be a secure vehicle to showcase development expertise but in a hot market like this, it does not offer much in the way of an appreciable yield difference and will be less profitable than building spec.


All panelists agreed that we are in the early stages of an ecommerce evolution. The prototype building differs depending on whether it is a pure ecommerce building or if the building also serves wholesale operations. Location of ecommerce buildings is important depending if the objective is one-hour, same-day, or two-day delivery. Many ecommerce companies rely on parcel carriers like FedEx, UPS, or USPS so location to large parcel hubs and dense populations are primary criteria. For pure play ecommerce companies, extra land and office space are important ingredients. This is in sharp contrast to warehouse development a cycle ago where the emphasis was getting as much buildable space on the site as possible. Now the goal in site planning is to leave generous land areas to accommodate intensive trucking and expansion of employee parking demands.

One of the most interesting aspects of ecommerce is that the internal operation and design of mechanical shipping systems are tightly guarded secrets. Both the hardware and the software are carefully protected. The most important metrics are the time it takes the package to reach the loading dock and then the additional time to get the package into the customer’s hands.

Infill Development

This is the hardest nut to crack because infill location is so essential to many companies. Infill locations are the closest areas to the majority of consumers and the most qualified employees. However there is almost no land available in these areas and the cost to teardown is excessive because the developers need to compete with Users who continue to find older buildings suitable for their use. In other words the price to tear down the existing building doesn’t make market sense. A couple of the developers felt some large companies would be willing to pay above market rents to occupy a modern building in the best location. Infill properties can also have other regulatory hurdles such as environmental, zoning, and expensive developer exactions.

What Can Disrupt the Cycle?

After several long years of recession, we are witnessing a robust development cycle with extremely good fundamentals of low vacancy, strong tenant demand, low interest rates, and lots of capital. All the developers see this as a continuing trend. Even a rise of interest rates, while being closely monitored, is not a concern for the time being. Naturally a terrorist attack, geopolitical event, or natural disaster could have a profound effect, but barring something extraordinary, all expect good years ahead.


I also attended an education session by KC Conway of SunTrust Bank. He had some very different themes based on new and rising distribution patterns based on rail, intermodal, and the movement of manufacturing activity to the southeast and Mexico. A large part of the new pattern included less reliance on the Ports of Los Angeles/Long Beach and a shift to other ports including the Great Lakes.  His program was entitled, Redefining America’s Core Industrial Markets: The Good, the Bad and the Ugly. If his analysis is accurate it will add a very new and exciting chapter to industrial development in the U.S. If you have trouble finding his research, please let me know and I can make a proper introduction.




As I was driving around Dallas last month looking at Big Industrial there was news that Amazon was about to offer-one hour delivery to selected zip codes. Dallas Morning News has a good story with the reasoning behind it.  The important part for real estate location is how Amazon and others like them pick their zip codes for the roll out of the new service. Density is the primary factor. If you are 40 minutes away from the densest areas with multi-story housing, you can’t make too big a mistake. Other location criteria is still experimental, as-is many of the theories behind ecommerce location. If one-day service is successful, there will be many corollary locations in other cities. Real estate people like myself are watching the ecommerce evolution carefully.

One good book that explains location strategy for ecommerce is a newly published work by David R. Bell, Location is (Still) Everything: The Surprising Influence of the Real World on How We Search, Shop, and Sell in the Virtual One. Besides density there are additional characteristics about people that can help companies target customers partially seen behind the lens of behavioral economics. For instance, by taste preference. If the goal is delivery and service, social preferences will influence location. For instance, Stumptown coffee might want to be closer to the hipster parts of town. Or diaper delivery to where the infants are. Or Cabelas’s near their customer base of hunters. These same clusters work from city-to-city. Ecommerce companies are experimenting with a host of algorithms and analytics that measures their best locations. But none as simple as the value of being close to the densest populations with spending power. As companies specialize, they look for other specific categories. Many of the same location theories that apply in the off-line world, also apply on-line. As stated in the book, “You can’t succeed in the virtual world unless you understand where and how your potential customers are situated in the real one”

Location strategy differs among one-hour, same day, and next day. For instance, if you want same or one day, you want to be located at close-in industrial. However, if one-day or two-day is suitable, you’ll want to be close to the major package delivery hubs for a handoff to either Fedex, UPS, or USPS. Generally that means at least three to four warehouses in every quarter of the country and more depending on volume and penetration. So far large consumer product companies have been been taking most of the large chunks of space. But as the ecommerce wave is predicted to take off, smaller businesses will be also looking at expansion under the ecommerce model.

fedex map

The Challenge of Space

For big box locations, there is still plenty of land to choose but some markets are lit up and pricing is substantially higher. Closer in areas are the most intense. There is a mixed consensus that demand will continue to hold up. Some forecasters are saying the activity we are seeing today is due to pent-up demand and that things will flatten from here because subpar GDP. In contrast, those in the field report no product and intense conditions. For example, in Los Angeles rents are up 25% and there is still only minimal new construction to meet the substantial demand. One example on the smaller side is there are no buildings under 25,000 SF that have both dock-hi and ground level. This is an essential configuration for distributors who take in goods and send them on small Sprinter vans for fast deliveries in congested areas.

Ecommerce could be a continual engine that creates steady pressure for new and more modern warehouses. If you follow the experts, ecommerce buildings need extra land for parking employee cars and containers; lots of loading doors; and high cube. For that type of site plan there are no existing buildings that fit this profile. The highest and best industrial use today is selling to a User at $160 per foot plus. It means the commensurate lease at a low 5% Cap would make the rent $.66N or $.85 Gross PSF/Mo and that doesn’t include the additional land that is required to serve the use. $1.00 to $1.10 all in could likely support the development cost of a good ecommerce building in the right location – if you can find the land.  If, because of the shortage of available land, you were forced to go the teardown route, pricing goes up.

This is the challenge. The ideal ecommerce building is unfinaceable because of the above market rent. Some companies can use their balance sheet to finance ecommerce buildings. However, most ecommerce companies are newer without a long track record. If willing to use their cash, they can make a partial capital investment to effectively lower the land cost but this is not a first choice. While there is “best location” theory, the market strongly limits the occupier’s choices.

The science and math behind ecommerce is at an early stage. There have been several examples of both large and mid-size companies that have already gotten out in front but the reasons for their success are still being debated. Many others will be following with their own real estate footprint for rapid distribution methods directly to the consumer. Best retail locations will no longer be on the best shopping streets but also at the best industrial sites.


Dealin’ In Gardena

gardena industrial postcard png

The history of Gardena matches the development of Southern California with a couple of notable exceptions. From Spanish land grant, to small ranchos, a strong period of industrial growth, to today’s reliance on international trade. The unusual Japanese and Asian influence gives Gardena its unique characteristic, mostly to the positive because of the industrious nature of the Japanese culture. Interestingly, there were two waves of Japanese immigration. One in the early 1900’s as farm labor and again in the 1980’s with the arrival of the global-scale Japanese corporations. The Gardena development plan of mostly smaller industrial property is also significant.

Location is Gardena’s best economic asset. It’s equidistant from Downtown Los Angeles, LAX and the Ports. It also is relatively accessible to executive housing in West Los Angeles, Palos Verdes, and the Beach communities. It is in the center of an excellent freeway network with the 110, 405, 105, and 91 all bisecting the City. For companies that rely on a transportation network whether air, sea, or road, Gardena is the sweet spot, despite short-sightedness in the City’s zoning regulations. Finally, the climate is particularly mild because of the ocean breezes that drift across the basin, while being far enough away to avoid the fog.

On a business level, the history of Gardena is fruitful – not only because of its agricultural heritage, but because of its industry. During all the great wars, World War II, Korean War, and Vietnam, the small Gardena machine shops kept humming along supplying parts to the major aircraft contractors. The machine shops ran for a couple generations finally slowing down in the mid 1980’s when many of the primary contractors left California for other states. Since that time, Gardena has diversified its industrial base, unfortunately not participating fully because of its old industrial stock and smaller parcels which makes assemblage difficult. Still, location and access has made Gardena prosperous for many smaller companies. In many respects, Gardena represents the Jeffersonian ideal of yeoman farmers eventually yielding to self-made industrialists, on a smaller scale.

Making deals in Gardena is a little different than other locales. It has mostly small buildings, under 20,000 square feet. Many of these properties have been held for generations and suffer from considerable obsolescence. Still the improvements have value and demolition in most cases is not a solution. More importantly the real estate techniques in Gardena are different than other places because of its unique history, long-time ownership and development plan.

Especially today, in the post-recession world, most the industrial sales activity has gravitated to larger Industrial because that’s where the money is. So far, real estate investment finance has not trickled down to the smaller deals. Yes, SBA financing is relatively plentiful and for Sellers who simply want to cash out, a buyer with an SBA loan is completely viable. However many Sellers do not want to pay the capital gains taxes because of their low basis and older sellers would prefer an income stream rather than a taxable lump sum. This is where some of underused techniques are applicable to Gardena’s unusual ownership base.

In times of tight finance, Sellers may want to consider carrying back paper, wrapping underlying finance, or negotiating loan assumptions with their current lenders. The advantages are many. Sellers can defer taxes until a time when they have lower tax rates. Get a higher yield on carrying paper. Convert income into the portfolio category that can be offset from other losses. And plan to have a long payout, if desired, secured by real estate they know. Many times, when Seller’s carry paper they also obtain a higher sale price and interest rate than the market would otherwise dictate. Of course, the essential element is to have at least 20% equity in the property or other guarantees to protect against default.

At one time, so-called creative finance was very common. These are techniques often used in the sale of smaller residential apartments. Because most industrial brokers today focus on major leasing assignments and sales for larger institutions and corporations, many are no longer versed in these once very common techniques. Owners of long-held property who want to preserve cash flow, increase yield and defer taxes can find carry back financing and other related techniques extremely useful.

Finally, techniques that I describe above do have statutory pitfalls based on many years of case law. Matters of recourse, non-recourse, due-on-sale and anti-deficiency laws, as a few examples, require legal review. AITD loans with interest overrides requires an accountant’s assistance. In other words, while the economic benefits can be substantial, Seller’s need to make use of experts in these types of instruments. These are sophisticated real estate techniques that if done properly can provide more positive outcomes that all cash sales – depending of course, on the seller’s goals.

Too often property is placed for sale and owners do not consider other more beneficial methods that would have considerable benefits. One reason is there is not enough knowledge in the brokerage community. Another reason is for bigger deals there are more practical ways to sell and finance real estate. However, in Gardena, as in other similar communities, the specific nature of the industrial property lends itself to creative techniques that are not as widely used as they could be.