With a reasonably constructed ten-year lease, a fulfillment operation can expect to attain an equity-underwritten rate of three dollars a square foot triple net
A sustained stock market decline will be followed by shortages of long-term capital to feed the pension fund and lease equity capital markets, ultimately pushing up leasing rates
A recent article in The Wall Street Journal describes how the nation’s super-rich, rattled by stock-market jitters, are jettisoning their houses. To lure buyers, they not only lop a couple of million dollars off the asking price but throw in freebies like grand pianos, vintage cars, golf club memberships, and, in Manhattan, the prized 212 area code. Unfortunately, distribution plants don’t come with such upscale amenities. But in this economic climate, they, too, are up for grabs. A peculiar mix of economic and market conditions is driving lease rates for light-use distribution and industrial properties to their lowest levels in decades. If your company has weathered the dot-com demise and managed to craft a robust expansion plan, go for the bricks and mortar — now. When developing new real estate assets, many order fulfillment operations look for ways to finance their buildings as well as their material handling equipment. The simplicity of the phrase “lease versus build” belies the complexity and creativity of the options available to the end user. Today a peculiar mix of economic and market conditions is driving lease rates, in dollars per square foot, for general, warehousing, and light-use distribution and industrial properties to their lowest rates in decades.
We Americans have reaped the benefit of an economic boom that began in 1992 and has roared off and on throughout the 1990s, with a sudden and distinct two-year downturn. The slide arguably began with the underpinnings of Federal Reserve Board chairman Alan Greenspan’s “irrational exuberance” quip coupled with a set of proactive interest rate increases, and culminated with a stark decline in technology-related equity values since March 1999. Despite record cash influxes into mutual funds during the months of February and March 2000, the markets have remained persistently bearish over the last year. Mutual funds and pension funds seeking to avoid this sustained downturn are flush with money. What can funds do with a fat stash of cash and no safe place to put it? Images of Lucy and Ethel attending the chocolate factory conveyor belt come to mind. Consequently, to some degree, medium- and long-term equity has been flooding the real property investment market. Both the availability of and opportunities to use long-term return equity have surged in the last two years. Facility leases in the ten-to-fifteen-year range hinge on investors from pension funds and longer-term equities, so the “price” of these real estate instruments has dropped accordingly.
Today’s lease market is characterized by three circumstances that yield some great opportunities for real estate-based infrastructure development:
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a surplus of ten-year equity seeking an escape from declining higher-risk markets;
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falling interest rates lessening pressure on long-term equity yields; and
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availability of some “development-ready” real estate left over from aggressive preparation for economic growth.
Net your catch
This confluence of vital factors affecting the flow of long-term money is likely to be only temporary, so, if all other factors are in your favor, shop for your commercial building while the market is hot. Today, with a reasonably constructed lease of ten years or two back-to-back five-year options, a fulfillment operation can expect to attain an equity-underwritten lease rate of $3.00 per square foot triple net (NNN), or even less in many cases. Suffice it to say that these are incredible rates — rates on which you should leverage planned growth.
Eventually, however, the risk equity markets have to hit a reasonable bottom. Peter Lynch puts it aptly in his book, Beating the Street: “Whenever I am confronted with doubts and despair about the current Big Picture, I try to concentrate on the Even Bigger Picture.… What sort of faith am I talking about? Faith that America will survive, that people will continue to get up in the morning and put their pants on one leg at a time. Faith that America is a nation of hardworking and inventive people.… The Even Bigger Picture tells us that over the last 70 years, stocks have provided their owners with gains of 11 percent a year, on average” (Fireside, New York, NY, 1993, p. 45).
Eleven percentage points. Long-term markets only wish they could be so lucky. Typical long-term equity yields vary between 6% and 9%. Obviously, the pressure to draw equity value out of the long-term and pension markets can grow to be tremendous, given the right business conditions.
Let’s make a deal
We can expect that a sustained stock market decline will be followed by shortages of long-term capital to feed the pension fund and lease equity capital markets. Ultimately, long-term money will become more expensive and lease rates higher. How long that will take is anybody’s guess. We are at a unique point in time where a declining short-term equities market, coupled with lower interest rates and a delayed effect on the supply of long-term pension and capital market equity, has produced some of the best lease rates (adjusted for inflation) for premium property in years. Along with this abundance of capital has come a new generation of financing tools with which to obtain equipped brick and mortar.
Acquiring real property — land, buildings, and possibly all operating equipment in a typical DTC fulfillment business — is a complex process that can be carried out in several ways. What follows is an examination of these options beginning with the user side and progressing toward the side representing the ultimate owner of the user’s facility — in other words, from the tenant to the landlord and all points in between.
A number of entities can assist or direct clients in their real estate acquisition. These agencies are depicted in the diagram on page 20.
Tenant
The tenant, of course, is your company, if you represent a business concern seeking to develop real-estate-based operating capability as a direct liability on your company’s operating expenses. You as the tenant have tremendous flexibility that the rest of the players in the market may not be motivated to point out. I will describe the opportunities for you as a tenant later in this article. Let us say that for now, you are the customer. As the customer you may face a market full of aggressive persons representing most of the groups listed in the diagram. Each representative will have a specific course of action to recommend at any moment in the process. Take that in stride. Keep your head and focus on how the layering of the light industrial and warehousing real estate market operates.
Location search agency
This type of consulting agency solely represents the tenant and surveys the entire domestic market condition and opportunities for real estate development. Two primary information sources are used in this search: first, descriptions of incentives and demographic profiles published by commerce centers and municipalities on the Internet and in several commercial databases, and second, direct communication with the state’s economic development commission representative. You can often get the specific incentives you need with the help of a state commerce official. This level of incentive bonus is usually tendered in the form of tax abatements, training assistance, or bond-supported development initiatives. The potential for incentives increases with the anticipated positive impact that a prospective tenant adds to the state and local community. The advantages of using a location search agency include its focus on site selection and incentive negotiation expertise and contacts, as well as the agency’s having no financial interest in any particular property. Whether you can benefit from a location search agency or go it on your own depends on the circumstances of your business.
Contact: DCB and Company, Inc., William B. Bladen, partner, (770) 992-2277.
Tenant representative broker
Typically hired by the tenant for a fixed fee, a tenant representative broker represents the tenant in all transactions through initial property screenings and location search initiatives. In this capacity the broker acts as the location search firm, the field negotiator with the state, and the negotiation and selection assistant on closing the lease deal on the selected property.
Again, you may choose to conduct these efforts on your own, but a tenant representative broker offers the advantages of sole representation of the client and lack of financial interest in the properties under consideration.
Contact: J.M. Mullis & Associates, Mike Mullis, president/founder, (901) 753-0373.
Government commerce representative/office
Each U.S. state maintains an office that manages business development and incentive negotiation efforts. A list of these offices can be found on page 21.
Broker
A broker is the interface between you as the searching client and the owner, developer, or broker who has listed a candidate property. Brokers can be hired on either a fixed-fee or percentage-of-project basis. Although engaging a traditional broker is effective, remember that ultimately the broker is paid by the seller. The advantage of using this type of broker support lies in the fact that the property can be selected quickly, with thorough and complete research, and with a high degree of adherence to a tight timetable. These brokers may show you properties for which they are the listing broker, or which they even own. Good financial leverage can be applied in this type of situation and a fast-paced schedule can be maintained with relatively low risk.
Contact: The Staubach Company, Kristian D. Bjorson, director, Logistics Practice Group, (216) 937-4376.
Listing broker
Essentially the same as the classic broker listed above, in this case the listing broker represents the candidate property or may even own it. Again, because of the depth of immediate knowledge about the property and fewer players involved in the sale, you gain financial leverage, on-time performance, and low risk. The full array of facility opportunities other than just those listed by the broker will be brought to your attention.
Contact: CB Richard Ellis, John Porter, managing partner, Global Logistics Group, (770) 951-7851.
Developer/underwriter
Up to this point, and typically, with some exceptions, the negotiating parties are not owners or financiers of the facility or property in question. Once we broach the realm of the developer, the relationship to the financing of the candidate property changes dramatically. In most cases, the developer is the firm that initiates the rezoning, financing, and preparation of select properties for sale to the general lease market, generally at the developer’s own risk. There are two types of developers: those that underwrite their own property financing and those that rely on a third party such as GE Capital or a major pension fund representative to invest in their property development capital needs. I typically recommend using the former type of developer for two reasons. First, financing is usually quicker and less entangled with layers of risk from agreements falling through before a facility is completed. Second, the larger firms that can provide their own investment capital can typically also leverage a better rate for construction financing, reasonable construction costs, and more long-term money invested in the final facility ownership arrangement. The final step in the development process is then to sell the lease to a long-term capital investor.
Contact: Industrial Developments International, Michael Parks, vice president, national business development, (404) 479-4014.
Construction contractor
Obviously, this is the firm that undertakes construction of the building. Many times this contractor may seek its own construction financing or may partner with a developer who will provide financing for the whole initiative within a single property or development. Most client companies do not approach a contractor to initiate facility development. In bypassing one or two of the entities above, a company can wander into a risky property situation without knowledge of the problems involved or the appropriate costs for facility development. In addition, the client who works directly with a construction contractor may be at a disadvantage when negotiating with municipal incentive representatives and federal and state agencies that review and approve the project. In a sense, when you employ a contractor directly, you become the developer and inherit all the risk thereof. Most order fulfillment operations cannot afford to risk their primary business, filling orders, because of a venture in a secondary business that they should let the pros handle. Again, there are exceptions to this, and many of the top construction contractors are becoming developers themselves to save their customers the distress of a poorly developed property.
Contact: H&M Company, Roger Cook, senior vice president, (901) 664-6300.
Two additional players operate behind the scenes in the whole development and construction process.
Construction financier
A construction financier may be one of many agencies that foot the capital risk during the period of actual building construction and before a long-term investor picks up the property. Often, however, the construction financier is also a developer, long-term investor, or ultimately a party to the lease of the property.
Lease purchaser/investor
Finally, we come to the least visible and most important part of the whole facility lease chain of partnerships, that of the long-term investor. This investor may be a municipality (in the case of a bond-based initiative), a capital investment firm, a pension fund, or a long-term equity investment branch of a broad-based investment firm.
The price is right
The table on page 22 displays the fee or percentage of costs involved in the engagement of each entity in a fully brokered and developed property lease scenario. Most operations can bypass several or even the majority of these costs, but with a proportionate increase in risk.
Just what constitutes a correct course of action for each operations executive depends on the situation involved. Most of the services offered by each of the entities described above overlap to some degree. A broker can act as a location search firm, a tenant representative, a listing broker, and a developer, all in the same project.
Similarly, a construction contractor could act as a developer and financier. A good place to start is to engage a fixed-fee firm to assess the market before you proceed with agencies that charge fees as a percentage of the project, especially if you do not yet know the scale of the facility in question. With this approach, a client company can assess the risk management need and approach the incentive- and percentage-based market with the right information, while incurring only a fixed fee to kick off the fact-finding effort. In any event, unless your corporate resources are extensive, rely on the professionals to address the needs of facility development, and keep your organization free to focus on your main business.
Roger B. Cunningham is a partner at Atlanta-based distribution and logistics consulting firm DCB and Company, where he provides operations and logistics support for over 50 retail, catalog, consumer products, and e-commerce clients. Cunningham can be reached by phone at (770) 992-2277, by fax at (770) 992-0554, and by e-mail at [email protected] .
Sources: Historic Homes of America, James Tackach (New York: Crown, 1990); National Trust for Historic Preservation; Old House Chronicle Magazine (March/April 2001); The Wall Street Journal Guide to Understanding Money and Investing (1999)
Affairs of State
| State | Agency | Contact | Phone |
|---|---|---|---|
| Alabama | Department of Industrial Relations | Alice McKinney | 334-242-8609 |
| Alaska | Department of Labor and Workforce Development | Michael Cushing | 907-465-2500 |
| Arizona | Department of Commerce | 602-280-1300 | |
| Arkansas | Department of Economic Development | Derrill Pierce | 501-682-1121 |
| California | Employment Development Department | by county | 916-262-2162 |
| Colorado | Office of Economic Development | Bob Lee | 303-892-3840 |
| Connecticut | Department of Economic and Community Development | Timothy Coppage | 860-270-8000 |
| Delaware | Economic Development Office | John D. Wik | 302-739-4271 |
| Florida | Enterprise Florida | Sena Black | 407-316-4552 |
| Georgia | Department of Industry, Trade, & Tourism | by region | 404-651-8578 |
| Hawaii | Department of Labor and Industrial Relations | 808-586-8865 | |
| Idaho | Department of Commerce | Karl Tueller | 208-334-2470 |
| Illinois | Department of Commerce and Community Affairs | 217-782-7500 | |
| Indiana | Department of Commerce | Karen Northrop | 800-463-8081 |
| Iowa | Department of Economic Development | 800-532-1216 | |
| Kansas | Center for Econ. Dev. and Bus. Research (CEDBR) | Janet Harrah | 316-978-3225 |
| Kentucky | Cabinet for Economic Development | Andrew Dennis | 502-564-7140 |
| Louisiana | Department of Economic Development | Paul Adams | 225-342-5360 |
| Maine | Department of Economic and Community Development | John Butera | 207-287-3153 |
| Maryland | Department of Business and Economic Development | Sandra Long | 800-541-8549 |
| Massachusetts | Department of Business Development | regional | 617-973-8600 |
| Michigan | Economic Development Corporation | 517-373-9808 | |
| Minnesota | Department of Commerce | 651-296-6025 | |
| Mississippi | Mississippi Development Authority | regional | 601-359-3593 |
| Missouri | Department of Economic Development | 573-751-4962 | |
| Montana | Department of Commerce | Quinn Ness | 406-444-4378 |
| Nebraska | Department of Economic Development | Darl Naumann | 800-426-6505 |
| Nevada | Commission on Economic Development | 800-336-1600 | |
| New Hampshire | Department of Resources and Economic Development | 603-271-2591 | |
| New Jersey | Commerce and Economic Growth Commission | 609-777-0885 | |
| New Mexico | Economic Development Department | Joseph Gutierrez | 505-827-0300 |
| New York | Empire State Development | regional | 800-782-8369 |
| North Carolina | Department of Commerce | Michael Smith | 919-733-4977 |
| North Dakota | Department of Economic Development and Finance | Sandy Opp | 701-328-5338 |
| Ohio | Department of Development | 800-848-1300 | |
| Oklahoma | Department of Commerce | 800-588-5959 | |
| Oregon | Economic and Community Development Department | Enterprise Zones | 503-986-0123 |
| Pennsylvania | Dept. of Community and Economic Development | Team PA | 717-705-0857 |
| Rhode Island | Economic Development Corporation | Victor Barros | 401-222-2601 |
| South Carolina | Department of Commerce | Wayne Sterling | 803-737-0400 |
| South Dakota | Governor’s Office of Economic Development | Chris Braendlin | 605-773-5032 |
| Tennessee | Department of Economic and Community Development | G. C. Hixson | 615-741-3282 |
| Texas | Department of Economic Development | 512-936-0254 | |
| Utah | Department of Community and Economic Development | Larry Goldsmith | 801-538-8822 |
| Vermont | Agency of Commerce and Community Development | Chris D’Elia | 802-828-3211 |
| Virginia | Economic Development Partnership | 804-371-8202 | |
| Washington | Department of Community, Trade, and Economic Dev. | Peter McMillin | 360-725-5072 |
| West Virginia | Development Office | Todd Hooker | 800-982-3386 |
| Wisconsin | Department of Commerce | Todd Kearney | 608-266-6675 |
| Wyoming | Business Council | Linda Norman | 307-777-2844 |
This Old House
In 1894, the “unsinkable” Molly Brown paid $30,000 for a sprawling Victorian mansion in Denver built of cut Colorado lava-stone.
In 1898, Frederick Vanderbilt built his 54-room Beaux Arts mansion (intended as a seasonal home for himself and as a farm for his pure-bred livestock) on a 700-acre parcel in Hyde Park, NY, for $660,000.
In the 1920s, you could buy a Sears house, including nails, paint, shingles, windows, and hardware (Sears even threw in two trees for the front yard) from a catalog for $1,479.
Real Steals
In 1626, Peter Minuit swapped $24 in beads and baubles for the island of Manhattan. Its property value in 1998 was assessed at $23.4 billion.
In 1803 the United States paid France $15 million for the Louisiana Territory — 828,000 square miles of land west of the Mississippi river.
In 1804 Andrew Jackson bought 425 acres east of Nashville for $3,400.
In 1867, Secretary of State William Seward purchased Alaska from Russia for $7.2 million — approximately one cent an acre.
In 1883 Theodore Roosevelt bought 155 acres in Oyster Bay, NY, for $10,000 in cash and a $20,000 mortgage.
In 1890 Jefferson Davis’s antebellum Biloxi mansion was sold for $10,000 to the Mississippi Division of the United Sons of Confederate Veterans.
Say What?
Mutual funds: Mutual funds are pools of money that are managed by an investment firm and invested in various types of companies.
Pension funds: These funds are established for the payment of retirement benefits.
Triple net: A triple net or “NNN” designation on lease costs means that the lease rate expressed is net of any expenses on (N) taxes, (N) insurance, and (N) utilities/maintenance/CAM charges. This industry term allows for an apples-to-apples comparison of lease rates. When a facility lease is drawn up on a gross basis, these costs are included in the overall lease payment. Typically, triple net agreements are executed in leases of three years or longer. Gross lease agreements are less common and may involve a short-term lease or property-owner-managed facility.
Sources: RBC, The Washington Post