BUYING IN
Small Industrial Space is Selling Fast; No Letup in Sight, Observers Say
The commercial real estate market has seen better days. The economy is stagnant, foreign markets are in turmoil and few jobs are being created. Until these conditions reverse, big public companies aren’t likely to commit to a lot of new space by lease or investment.
Yet there is a commercial real estate segment that’s booming despite the tepid forecasts.
Sales of small industrial buildings,primarily those smaller than 50,000 square feet,are hot. And it’s most popular with small business owners who snatch up the property and then occupy it.
Business Journal real estate reporter Daniel Williams asked real estate executives, industry leaders and business executives what’s driving the industrial market and why the small-business owner is such a player these days.
Kevin Turner
Senior vice president, Colliers Seeley
International Inc.
There has been a significant number of owner/users purchasing new buildings smaller than 10,000 square feet.
Typically the buyer has outgrown a multi-tenant park, is cash rich and would rather own bricks and mortar than a dot-gone stock certificate. Long-term ownership is considered a conservative, safe bet for these buyers.
And given the internal rate of return on equity for the developer, low interest rates for the buyer and a rebounding economy, there is a compelling reason to continue to build. The challenge is land availability and having a marketing plan and proforma drilled down to respond quickly when opportunities arise.
Also on the rise is a trend of converting leasehold interest to fee ownership. One of our clients,Santa Ana-based Behr Process Corp.,recently finished a four-building, six-parcel complex of more than 327,000 square feet and three acres of surplus expansion land. The process took more than 18 months to complete and the final piece of the puzzle closed last month.
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John McDermott
Regional manager, Sperry Van Ness
The Orange County industrial investment market is being driven by the fact that many investors are selling their office, retail and multifamily properties at extremely high prices per foot and, in turn, are seeking to acquire industrial properties which provide comparable cash on cash returns at both a lower price per foot and at lower rents.
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Rob Guthrie
President, Guthrie Development Co.
Housing is what’s driving the small industrial market. At least for our product type,we’re selling buildings that are about the size of a house.
Within industrial in general, it’s an anomaly. There’s not a strong economy. There’s no job growth. And yet, this segment is booming.
Low interest rates are playing a part in the success. Investors are looking more and more to real estate as an investment opportunity. That’s also helping drive the market right now.
There’s actually a real frenzy going on, but we do worry that it might get overbuilt.
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Dougall Agan
Principal, Foothill Ranch Company
Orange County’s entrepreneurs are driving the industrial market right now. Businesses in the apparel, medical, pharmaceutical, as well as the defense and aerospace sectors have the greatest demand for industrial space under 30,000 square feet.
Many small businesses are taking advantage of the current low interest rates.
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Bryan Bentrott
Vice president, MDC/BAM Holdings LLC
The driver of the industrial market is the small business, principally firms with 10 to 30 employees, where the owner of the company wants to own his real estate. These are firms that have built retained earnings and, with as little as 10% down, can qualify for SBA financing and end up owning their facility with an occupancy cost equal to the cost of leasing.
Our current projects in Otay Mesa and Corona seek to capitalize on this trend.
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Steve Case
Managing director, CB Richard Ellis Services Inc.
Much of the demand is for space 50,000 square feet and smaller. The demand is coming mostly from manufacturing and distribution sectors. Right now, there is great demand to own. We believe the driver is the low interest rates.
A small-business owner can get an SBA loan and only have to put 10% down. So, you have a small down payment with interest rates at 5% to 6%. With those numbers, the small-business owner can pay less to own than he would to lease. It’s simple economics and that’s what’s driving the demand.
One of the other drivers is consumer products. Consumer spending has been a real bright spot in the recent economy. Manufacturers are seeing good activity from everyone ranging from toy manufacturers to food distributors.
When you look above 50,000 square feet, activity is much quieter. We’ve seen a couple of major deals above the 50,000-square-foot mark. There’s a project in North Orange County for a half-million-square-foot distribution center, but that’s the exception. The majority of activity is coming from the smaller companies.
Stock prices have been hit very hard. Public companies are concerned with managing stockholders’ holdings. They’re waiting for stability in the stock market before striking out on new ventures.
Smaller businesses are not acting like a turtle in its shell. They are not worried about stock prices like public companies are. They’re just looking at their own success, the demand for their product and low interest rates. That’s a recipe to buy.
We’re seeing a similar mindset in the housing sector. Many believe there’s a bubble out there, but it hasn’t hit yet. With small-business owners, there’s that same phenomenon taking place.
It’s almost like retirement planning. The small-business owner owns and occupies his business. When it’s time to retire, he can sell or lease out the space.
I don’t see this activity letting up as long as interest rates stay where they are. Interest rates will have to climb before it won’t be attractive to own instead of leasing.
And if we see a soft market where rents decline, then you might see a situation where owning is not as attractive as leasing. We have seen some softening of rents within the larger activity range.
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Jim Camp
Vice president,
Lowe Enterprises Real Estate Group
What’s driving the market are small businesses and the continued entrepreneurial spirit of starting new companies. In the industrial world, Fortune 500 companies are holding their position.
But the small business economy has not retreated. Small businesses are not subject to Wall Street; they’re subject to the supply and demand of their industrial products. And that demand has remained strong.
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Bob Mosey
Owner, Moseys’ Production Machinists Inc.
We spoke to our broker and realized we would save $500 a month to own than we would to lease. That’s $500 a month in my pocket and not somebody else’s. That’s $500 a month we can use to invest in our operations.
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Mike Hefner
Senior vice president,
Voit Commercial Brokerage
I think there’s always a demand for distribution centers in this part of the country, with the ports nearby. With importing and exporting there’s always that need. But we are seeing a demand for industrial space to buy. We’re seeing that primarily from owner/users who want to move from being tenants to owners. Many of them view real estate as an investment. Activity for buildings 50,000 square feet and above is very, very soft, but very strong below that level, especially at 40,000 square feet and below.
I believe low interest rates are driving the market overall. If interest rates rise, I think we could still have solid activity.
It depends on the economy. If it remains static, then things could get pretty grim. It could take the only strong component out of the marketplace.
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Jeff Gill
Managing principal, MCG Architecture
There has been a definite improvement in the industrial sector of the local commercial real estate industry in recent months.
Even during the recession of 2001, the Southern California economy continued to experience a feisty strength that helped buoy our local markets, in spite of general weakness that led to widespread stagnation in the commercial real estate sectors.
Interest rates remain near historic lows, which has helped fuel an interesting entrepreneurial boom in the industrial sectors. The recent uptick in the industrial sector is directly attributable to small business owners who are taking advantage of low interest rates to buy their facilities rather than lease.
Indeed, while the large industrial companies went into a defensive mode during the recession, small business became very active. And it is the small industrial buildings,50,000 square feet and smaller,that are responsible for the reemergence of the industrial sector.
Strong growth in the small industrial market has ushered in industrial “condominiums” where many large and medium-sized buildings are being divided into several very small spaces of 5,000 square feet and less for use by multiple small businesses. I expect to see a surge in industrial condo projects for the foreseeable future,at least until interest rates rise to an untenable point.
By then, I think it is safe to assume that the big industrial users will be back in full swing again.
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Jeff Read
Senior vice president, Grubb & Ellis Co.
The current OC industrial market is largely driven by the owner-user sector.
The strongest area of demand is for smaller industrial buildings of 25,000 square feet or less. The reason for this strength seems to be a combination of extremely low interest rates and a high level of confidence among small and regional companies in their businesses and in the local economy.
Due to attractive financing packages available today, it may be more cost effective in many cases to buy than to lease. And tax benefits plus the opportunity to generate equity appreciation through ownership provide compelling reasons to buy.
Without any substantial increase in interest rates, I anticipate this segment of the market to remain strong for the near term.
On the other hand, the leasing market has been very slow for the past six to 12 months, particularly for industrial space 50,000 square feet or greater. We see some positive signs of recovery within this sector, possibly attributable to pent-up demand, as “Corporate America” begins to make decisions to move forward.
This is a positive change from a recent trend of larger companies renewing leases on their existing facilities as opposed to relocating. I am optimistic that the leasing market will continue to show improvement in the next six to nine months.
