Outdated industrial properties offer value-add opportunities.
With more than 140 million square feet of industrial space in the construction pipeline this year, according to Grubb & Ellis, industrial users have no shortage of new properties to consider. While national credit tenants are paying top dollar for state-of-the-art, high-tech facilities surrounding coastal logistics hubs, a growing number of commercial real estate professionals are finding investment potential in functionally obsolete industrial product sprinkled throughout small and midsize U.S. markets.
Though not equipped with today’s preferred 32-foot ceilings or early suppression fast response sprinklers, “older industrial product can meet the needs of certain users,” says Rich Vanchina, CCIM, industrial group director for Southpace Properties in Birmingham, Ala. Properties with solid structures in accessible locations can be updated and marketed to a variety of users, particularly “if the roof is in good condition, the office space is clean, and the property is priced right,” he adds.
Rising land prices, and in some markets lack of available land, are helping to create a steady market for redevelopment of older industrial assets. Last year approximately 30 million sf of industrial space totaling $2 billion was sold for redevelopment or demolition nationwide, according to Marcus & Millichap. Commercial real estate professionals are realizing the potential of these aging facilities by upgrading and marketing them to tenants who understand the economic value of repositioned space.
Deere & Co. donated 40 acres of land in Waterloo, Iowa, to nonprofit Cedar Valley TechWorks, which is rehabbing the site into a bioscience research and development park.
Ultimately “the key to marketing these [updated industrial] properties is having a product to present,” says John Rodgers, CCIM, industrial and land specialist with Grubb & Ellis/Quantum Commercial Group in Colorado Springs, Colo. Converters must be willing to expend resources upfront for upgrades and some build-out, particularly when transitioning to a multitenant facility. About 15 percent office finish is common. “This helps prospective users understand what the finished space will look like,” he says.
Some investors and brokers in the Colorado Springs area have marketed rehab projects without first investing in the properties, but with little success. Even conceptual drawings may not be enough to persuade prospective tenants: “Imagine being a 20,000-sf user walking into a 200,000-sf single-tenant facility. It would be very challenging to envision a smaller suite,” Rodgers says.
Educating and marketing to the local brokerage community is “probably the best way to create awareness” for industrial rehabs, says John W. Phelps, CCIM, SIOR, senior vice president of Grubb & Ellis’ industrial group in Atlanta. He also recommends working local channels, including chambers of commerce and economic and business development groups. Traditional marketing approaches, such as placing banners and signage at the site, also can attract potential tenants.
Local marketing makes sense: Several commercial real estate pros say the best tenant prospects for rehabbed industrial space are in their own backyards. For instance, Brian J. Young, CCIM, with Grubb & Ellis/Furman Co.’s industrial group in Greenville, S.C., often markets upgraded space to local manufacturing and distribution companies using direct mail and cold calls. These companies may require overflow space or have seasonal storage needs and are attracted by below-market rental rates. Startup companies and service businesses that don’t require modern features also may be interested in second-generation space in exchange for lower lease rates.
In the Atlanta market, “Our target tenants are almost always local service companies and privately owned companies that will consider an older [upgraded] building due to its location,” Phelps says. “These companies may want to move up to a larger space or relocate to the area once an acceptable building is made available.”
Concentrating marketing efforts on booming local industries is a strategy that David Wilson, CCIM, executive vice president of Lockard Cos. in Cedar Falls, Iowa, is using for an industrial rehabilitation project in Waterloo, Iowa. Farm-equipment giant Deere & Co. donated a 40-acre industrial brownfield to Cedar Valley TechWorks, a local nonprofit entity that is spearheading a bioscience research and development park on the infill site near downtown. Secured anchor tenant National Ag-Based Lubricants, a research center sponsored by the University of Northern Iowa that develops vegetable oil–based industrial lubricants, “will act like a magnet to attract other bio-related tenants,” he says. NABL’s lease agreement includes incentives for bringing in like-minded tenants, and the abundance of local ethanol-related companies — including many startups — will be prime marketing targets, Wilson says. Lease rates in the $5 psf triple-net range, which is below the market’s average $8 psf range for new R&D space, are another draw. “We can ramp the rates up to market over time,” Wilson says.
Lease rates for rehabbed industrial space generally run well below market, a factor CCIMs are using to differentiate their product from the competition. Depending upon the extent of the project, investors can purchase, update, and lease up properties at below-market rates and still make a profit. “Obviously, the deal has to make sense,” Young says, citing the importance of using realistic pro forma when negotiating lease rates.
In Atlanta, lease rates for rehabbed industrial properties vary greatly according to the specific product, its location, and its use, Phelps says. “An upgraded building in a functional area might be leased and sold at a rate that is 15 percent below suburban space,” he notes. But despite below-market rental rates, rehabbed properties may be worth “twice the value of before renovation.”
In areas where infill land is scarce, such as Denver, lease rates are more competitive as some users are willing to forgo high-end space for solid locations. “Quality functional space can command [rents] in the ballpark of new product in outlying areas,” says R.C. Myles, CCIM, SIOR, senior vice president and an industrial specialist at Fuller and Co. in Denver. Last year he handled the marketing and leasing for Denver Commerce Center, a rehabbed facility that includes bulk distribution, showroom, and office/warehouse components. Located downtown with direct access to Interstate 70, the central location was a major factor in securing above-market rental rates, he says.
What Investors Want
What should prospective investors look for when considering industrial value-add opportunities? “The big pieces of the property should really be in place,” says Trey Hollingsworth, managing partner of Clinton, Tenn.-based Hollingsworth Capital Partners, which has invested in approximately 14 million sf of industrial space. “If a solid building envelope is there, but it’s just missing a critical piece to lease up, it’s probably what we’re looking for,” he says.
For instance, prime rehab targets may be 100,000-sf or larger antiquated bulk spaces that are structurally sound, have 22-foot clearance, and can be broken down into small units because “these spaces can easily be marketed to service tenants that don’t need high clearance and ESFR sprinklers,” Hollingsworth says. He cites a dealer-supply company in Columbus, Ohio, as an example of a solid tenant for rehabbed space. “It was a flooring company for contractors with two or three locations. They didn’t have a showroom but still wanted good, clean space.”
Last year, an 800,000-sf former Winn-Dixie distribution center in Greenville, S.C., drew investor interest as a value-add-and-hold opportunity, says Young, who represented the buyer. The center was rebranded and upgraded with a new façade and interior improvements. Major tenant Cliffstar Corp., a national private-label juice company, was an ideal tenant for the facility since the former user also was a food-service company. “The property was fairly up to code from Winn-Dixie, but it still had to be retrofitted to meet Occupational and Safety Health Administration standards, state standards, and security requirements,” Young says.
When selecting assets to buy, Hollings-worth cautions against undervaluing the conversion process. “Budgeting for miscellaneous contingencies is important. You rarely get a blueprint when you buy from corporate sellers, so you never know what you might get,” he says. Another pitfall to avoid is underestimating neighboring tenants’ effect on a project’s marketability. “We bought properties in some downtrodden submarkets and didn’t fully account for neighboring tenants that essentially devalued the space,” he says.
Upgrading and Updating
In the current market, “older industrial buildings are bought by value-add buyers with the understanding that the buildings must be updated,” Phelps says. Common structural changes include increasing ceiling heights, creating multiple entrances, cutting driveways through the middle of properties to increase dock access, and breaking up large spaces.
In many markets there is virtually no demand for older large facilities, particularly those with floor plates of 50,000 sf to 200,000 sf or greater. “Many of the rehab projects [in Denver] involve large, functionally challenged buildings that have been reconfigured to accommodate smaller users,” Myles says. “Oftentimes the buildings have transitioned from manufacturing uses to showroom and service-type uses.”
In nearby Colorado Springs, low demand for single-tenant facilities is prompting industrial brokers to subdivide large buildings into 10,000-sf to 20,000-sf multitenant suites or condominiums. “These facilities are not obsolete for small users because they generally do not require attributes such as high ceiling clearance,” Rodgers says.
Interior improvements often include updating lighting from fluorescent to metal halide incandescent, replacing wooden dock doors with metal- or glass-paneled doors, installing new heating, ventilating, and air-conditioning systems, adding modern sprinklers, painting, and refinishing office spaces and bathrooms. Exterior improvements range from replacing facades to enhancing landscaping to painting. Though industrial users traditionally don’t require pretty sites, Phelps says that looks really do matter when repositioning older product: “The building’s appearance must be significantly improved.”
Some sites, such as the Cedar Valley TechWorks project in Iowa, require more extensive renovations to make the properties feasible for today’s users. While 41 of the buildings on the site have been razed, two six-story facilities are being rehabbed into R&D/flex space for bioscience users. Originally built in 1938, the buildings must undergo lead and asbestos abatement and be retrofitted with passenger elevators, new electrical transformers, and HVAC systems, Wilson says.
While updating old industrial facilities poses a number of challenges, there is a growing amount of interest in these projects both from value-add investors and tenants. When marketing renovated space to potential users, Hollingsworth emphasizes that there is “no handicap” for B space, as long as it meets a tenant’s need. “It’s not used car sales. There is no lemon. Why pay for top-notch amenities or higher cubic feet if you don’t really need it?”