Investing in Warehouse and Industrial Property

Abstract

In Chap. 10, we complete our analysis of the primary investment property sector considerations with a discussion of industrial and warehouse property. These properties are generally classified as industrial property given that their function relates to manufacturing, production, or storage of industrial products. A relatively new subsection of industrial property is known as self-storage, or alternatively as mini-storage. As will be discussed later in this chapter, self-storage property has widened the scope of demand for storage space to include the general public.

All you need is a place for your stuff.

George Carlin

Appendices

Warehouse Case Study #1

Industrial Properties, LLC is looking to purchase a warehouse that was leased to Ford Motors 2 years ago. The investors are looking for a loan on the subject property of $3,000,000.00. The purchase price of the subject property is $3,800,000.00, with the remaining equity to come from personal investments and 1031 Exchange dollars.

The subject property is a distribution warehouse located in Rural Hall, NC and sits on 4.5 acres of land. The warehouse has 125,000 square feet of rentable space, of which 20% is office space. The ceiling heights in the warehouse are 20 ft. Based on your market research prior to receiving this request, it was determined that this level of ceiling height is acceptable for most tenants seeking this type of tenant space. The warehouse is 15 years old but is in good condition. Ford Motors has 15 years remaining on their lease and is leasing the entire space in the subject property. The lease terms are triple net at $4.00 per square foot, with a scheduled rent increase, after each 5 year interval, of 5%. Per the lease, the landlord is responsible for the upkeep of the exterior building, but the tenant is responsible for the heating, air conditioning and other internal repairs and maintenance. You have estimated the annual replacement reserves should be 1% of effective gross income.

You have hired Messick Properties to manage the property for you, and you have agreed to 5% compensation annually based on 85% of the gross potential income of the property. At the time the lease was signed, Ford Motors was considered a credit tenant, but in subsequent years their rating with Moody’s and Standard & Poor’s has fallen close to junk bond status. The location of the subject property is excellent, as it is located near a major highway. Local appraisers note, however, that should Ford vacate the premises prior to the expiration of their lease, that 125,000 sq. ft. is a lot of empty space for this market. Additionally, other space is being built in response to Ford moving into the area. You also wonder how the recent announcement by Dell that they are closing their Winston-Salem based facility will affect market vacancy rates in the area. Based on your conversation with local appraisers, the rent being paid by Ford is within the market averages for this type of space, and the overall market vacancy rates for this type of space have run from 10% to 15% in the recent past.

• 1. Determine the net operating income for this property using the direct capitalization spreadsheet.

• 2. Determine the first year debt service coverage ratio for a loan of $3,000,000.00, at an interest rate of 8%, for 20 years.

• 3. Using a cap rate of 9%, what is the estimated value for this property? Would the value be materially different if you used the DCF valuation technique?

• 4. What happens to the DCF value as your discount rate increases from 9% to 10%?

• 5. Determine the breakeven occupancy rate and interest rate for this property.

• 6. What questions would you ask concerning the financial strength of the tenant?

• 7. What questions would you have for the borrowers concerning this single tenant facility?

Warehouse Case #2

Chapman & Loftis Company are seeking to diversify their real estate investment portfolio with a small industrial property. Since diversity is the goal, the investors desire to obtain a multi-tenant industrial property rather than a single tenant facility. While perusing the current commercial property listings, the investors discovered a property which appears to fit their needs located on Division Avenue in Garfield, Bergen County, New Jersey. Bergen County is located in northeastern New Jersey and has been known as a bedroom county to New York City given its proximity to the metropolis. Bergen County has historically been among the wealthiest and most economically vibrant counties in New Jersey. A key to the economic vibrancy of Bergen County was the construction of the George Washington Bridge which connects the county to New York City by traversing the Hudson River. Transportation in the county is considered excellent, as the county is crossed by a well organized network of highways connecting the New York region with the northeast and the rest of the country. Interstate Route 95 (the New Jersey Turnpike extension), and Route 80 are the most important, followed by Routes 1–9, Route 46, the Garden State Parkway, State Routes 4 and 17, and numerous county roads.

Six rail lines extend through Bergen County, with three carrying freight, and the other three carrying freight as well as passengers. Newark International Airport in Essex County, which is within 30 min travel from Bergen County, is one of the most comprehensive airfreight systems on the east coast of the United States. The city of Garfield is a small, semi-urban area located in southwestern Bergen County, and is in close proximity to the area’s main road systems. The city covers an area of 2.13 square miles and has an estimated population of 30,000 people. Approximately 75% of Garfield’s land parcels are utilized for residential and multi-family purposes, while approximately 10% is utilized for industrial activity.

The subject property is situated on a 0.75 acre parcel located on Division Avenue, and was constructed in 1950. Access is considered excellent, as Interstate Route 80, US Route 46, and State Route 17 are within minutes of the subject property. The immediate area of the subject is improved with several light industrial uses, lumber yards, small retail and commercial uses, and residential uses. Vacancies in the area are scarce owing to a declining number of similar small and medium light industrial buildings in the area. The subject is located near the Dundee Dam, which is a 450 foot dam extending across the Passaic River from Garfield to Clifton, New Jersey.

The subject property consists of a 30,000 square foot building currently 100% occupied by four tenants. The building is of a concrete block foundation, a masonry and wood frame, and an exterior comprised of brick, concrete block, and vinyl siding. Doors consist of metal frame glass for office space, and metal clad overhead bay doors. The office area located on the second floor is warmed and cooled by a roof mounted gas-fired HVAC system, while the shop area is warmed by space heaters. The overall quality of the facility is considered average for the neighborhood and the property age.

As part of your due diligence, you have obtained a copy of the current rent roll as is shown below:

Tenants	Sq. ft.	Rent psf	Lease term
La Voie Lighting Co.	7,500	$5.50	5 Years
Tsang Furniture Restoration	8,500	$4.75	3 Years
Saade Garden Supplies	9,000	$6.50	1.5 Years
Gallo Lock and Key	5,000	$4.80	3 Years

Based on your review of the leases, the tenants are responsible for their own utilities, repairs, and maintenance. The landlord is responsible for structural repairs to the building, insurance, and the property management fee. The tenant’s reimburse the landlord for annual property taxes on a pro-rata basis. Your research indicates that typical management fees associated with similar properties are approximately 5% of effective gross income, while replacement reserves run from $0.25 to $0.50 per square foot on an annual basis. The subject property is currently listed at $1.2 million. Typical bank lending requirements for comparable properties indicate a 75% loan to value ratio, an interest rate of 6%, a 20 year amortization, and a desired debt coverage ratio of 1.30×. Market rental rates are between $5.50 and $6.00 per square foot annually, and the market vacancy rate has fluctuated between 5% and 10% in recent years.

The seller’s agent has supplied the following expense information from the last 3 years for the subject property:

	Year 1	Year 2	Year 3
Taxes	$21,500	$22,000	$23,000
Insurance	$5,250	$5,750	$6,300
Other	$2,000	$1,000	$1,500

• 1. Assuming a cap rate of 8%, what is the estimated property value based on the direct capitalization approach?

• 2. What is the net operating income and debt coverage ratio for the first year?

• 3. Determine the break-even occupancy and interest rate for this property for the first year.

• 4. Prepare a DCF assuming your direct capitalization assumptions for the first year. Assume a 10 year holding period, a 10% discount rate, a terminal cap rate of 9%, and an increase in income and expenses of 3% each year.

• 5. What is the estimated value using the DCF approach?

• 6. What questions do you have about the quantity, quality, and durability of this investment opportunity?

• 7. What questions might you have about the condition and use of the property?

Self-Storage Case Study

Camden Yards Storage, LLC has requested 80% of purchase price for an existing self-storage facility located in Fayetteville, NC. The purchase price for this 725 unit multiple building self-storage complex is $3,900,000. The original phase of this project was constructed in 2003, and the final 175 units were constructed in 2005 and they contain climate-controlled capability. These are the only such units on-site and there are very limited climate controlled units in the Fayetteville market. The property consists of 6.70 acres, and all buildings were constructed on concrete slabs. All of the buildings have exterior walls that are a combination of pre-engineered metal and brick. They have masonry firewalls and metal louvered roll-up doors for access by the customers. A 6-foot chain link fence surrounds the property, and there are driveways in between each building which allow enough room for the largest of personal vehicles to enter into the storage area. There is 24-hour access by way of a keypad entry system, and there are security cameras on-site and inside of the buildings containing climate-controlled units. There is an office on-site which serves as housing for the onsite property manager. Relative to the competition, this is one of the nicer mini-storage facilities in all of Fayetteville. The investor has stated that they intend to pay $60,000 in annual property management fees for the subject property.

Fayetteville is located in Cumberland County, NC, and is the home to Fort Bragg and Pope Air Force Base. Both have a major impact on the economy and are considered to be the primary employers in the area. The military bases have received personnel from other facilities that have been closed in recent years, and these bases are expected to remain open. The primary customers for this property are military personnel as well as small business owners in the area who need storage space for their products. The area to the west, north, and east of the subject is primarily residential, and the area to the south is primarily light industrial. The southeastern area, the Hope Mills sub-market, is one of the fastest growing sub-markets in the region.

The investors have supplied the following current rent roll for the subject property:

Unit type	# of units	Sq. ft./Unit	Rent/Month
5×5	6	25	27.00
5×5	23	50	30.00
5×10	168	50	44.15
10×10	172	100	74.03
5×20	2	100	65.00
10×15	57	150	90.42
10×20	130	200	96.37
10×25	75	250	128.86
15×20	1	300	125.00
15×20	1	300	180.00
15×25	2	375	145.00
5×15	24	75	54.10
New 5×5 cc	6	25	40.00
New 5×10	4	50	65.00
New 10×10 cc	33	100	95.00
New 10×15 cc	10	150	120.00
New 10×20 cc	11	100	145.00

The current occupancy of the complex is 90%, as the newest units leased quickly after construction was complete. Most units are leased out on a monthly basis, although some of the climate-controlled (cc) units have 6-month lease terms. This is standard for this type of property in this market.

The investors also supplied the following historical operating expenses. Market averages dictate that replacement reserves should be equal to $25 per unit on an annual basis.

Taxes	25,000
Insurance	15,000
Repairs and maintenance	30,000
Utilities	25,000
Other	30,000

• 1. Determine the net operating income for this property using the direct capitalization spreadsheet.

• 2. Determine the first year debt service coverage ratio for a loan of $3,120,000.00, at an interest rate of 8%, for 20 years.

• 3. Using a cap rate of 10%, what is the estimated value for this property?

• 4. Determine the breakeven occupancy rate and interest rate for this property.

• 5. What questions would you ask and to whom concerning the future supply and demand of self-storage space in the area?

• 6. Who might you ask to get an idea of what the market rental rates and expense rates per unit are for comparable space in the market?