How To Choose the Right Industrial Property for Your Business
Guidance on the Key Criteria To Consider, Including Timing, Economics and Operational Factors
When many novice industrial tenants begin searching for a property to lease, they assume the most difficult part of the process will be finding potential spaces. In reality, though, the discovery and accumulation of options can often be the simplest part of the endeavor. In actuality, its deciding which of those alternatives will optimally support the future growth of the company that usually requires the most effort and consideration. It’s during this phase that the business stakeholders (likely in coordination with their tenant representatives) have to take a highly strategic approach in order to foster an outcome that meets both the short- and long-term objectives of the business.
One key factor in this process is a matter of perspective. While it’s natural to evaluate properties against each other, this usually isn’t the most effective methodology. Instead, each property should be considered relative to a set of ideal criteria that is specific to your business and its requirements. Utilizing this approach will not only will shift your own thought process, but will also reorient your communications with potential landlords.
Every business’ priorities will be different, but some of the key elements that need to be assessed for almost any industrial tenant when selecting a property to lease include the following:
- Net effective rate.
- Tenant improvements.
- Financial impact on your business.
- Operational considerations.
When is the property deliverable? Is it leased, vacant or in need of renovation? The difference between a property that is occupied for another 30 days or needs renovations, compared to a vacant property that is fully refurbished, can translate into a six-month (or greater) delay in your company taking occupancy. Properties that are vacant and fully renovated, on the other hand, can be moved into almost immediately after negotiation, contract execution and delivery of all monies due and a certificate of insurance. If you’re considering a property that won’t be ready before your existing lease expires, it’s also important to be mindful of the holdover costs associated with your existing premises, as these can often total up to twice your regular rental rate.
Net Effective Rate
Comparing the proposed economic terms of different potential properties is more involved than merely considering the cost per square foot. For example, each lease can have a different commencement date, size, monthly rental rate, escalations and tenant improvement allowance. In order to make an informed and level comparison of your options, brokers consider a metric that is referred to as the net effective rate. This is the rate that the landlord is charging inclusive of free rent, the rental rate for the entire term of the lease and tenant improvement allowances. The net effective rate offers you a quick method for comparing properties that are, in most other respects, largely analogous. If you were in the market for Class B office space, this data might even be sufficient to base your decision upon. However, for industrial users, each property usually has unique qualitative and operational characteristics that need to be carefully considered before making a final decision. Nonetheless, the net effective rate will provide you with a clear understanding of what your monthly and annual expense will be for each property.
Tenant improvements are usually understood as the cost of renovating space, but that’s only one dimension of this critical component of a new property and lease. Firstly, it’s important that you clearly delineate between tenant improvements that are required for your business and those that are desirable, but not necessary. The next factor that needs to be evaluated is how much money the landlord is contributing to your tenant improvements (i.e., the tenant improvement allowance), as well as what percentage of that contribution is going to be amortized into the lease payment. The other key element to consider is who is responsible for performing the work. This is a significant issue, as managing a tenant improvement process will take hundreds of hours away from your team and core business or will require you to hire a capable project manager to lead the process with your team’s oversight and input.
Financial Impact on Your Business
Once you have developed an understanding of the various costs associated with each alternative, you’ll want to appraise how each option comports with your business’s profit and loss statements and balance sheet. This is critical, as real estate typically represents the second largest expense for industrial users after labor. Key questions to consider include: what percentage of your company’s total revenue does the property overhead account for? (While rising real estate costs have affected this rule somewhat, and there’s some variance between different industries, a general guideline is that rental expenses should represent approximately 5% to 8% of your company’s annual revenue.) What is the cash outlay required for new furniture, IT, equipment and machines, as well as the relocation from and the decommissioning of your prior building, if applicable? You will also want to consider the length of the lease and how that financial obligation aligns with your other financing and debt agreements and your long-term vision for your business.
In addition to the various economic criteria discussed above, it’s equally important for industrial users to compare potential properties from an operational perspective. All manufacturers, distributors and life science companies have metrics relevant to their business that they monitor and improve upon in order to measure how well their business is performing. These metrics can include inventory levels, turnaround times, delivery times, volume of products produced, assembly times, quality control, work safety, productivity, etc. All of these factors are shaped by the nature of the industrial building in which your company does business. For example, the shape of a building, its dimensions, the column spacing, fire suppression system, loading areas, type of loading, truck court and yard space can all affect your business in meaningful and often measurable ways.
Accordingly, it’s critical to identify the operational metrics that are most impactful to your business and figure out how they relate to the physical environment. For example, if you are seeking maximum pallet positions, you might look at higher clearance industrial buildings. You can then compare how many pallets positions you can store per dollar of rent paid and utilize that metric to drive negotiations. Alternatively, if you are looking for a manufacturing facility, you might prioritize the number of semi/fully automated manufacturing lines you can install within a property based upon the length and width of the building, electrical infrastructure and employee parking. You can then understand how many units you can produce per dollar of rent paid and utilize that metric to influence negotiations.