By: Justin Smith

Rating: A

This was a great overview of the US Industrial Real Estate industry. I would use this book as a reference guide. The following are the key takeaways from the most relevant chapters of the book.

Key Takeaways for the Business Owner:

1. The need for industrial space in the US is increasing due to the onshoring of goods and services and the growth of the e-commerce sector.

2. Think strategically about the space your business needs. Should you sublease from someone or get your own space?

3. How can you reconfigure your current space your business operates in to be more efficient and serve your customers better?

4. If you are renting your space, reach out to your landlord and see if you can negotiate improvements to better utilize your space.

5. Build your team of experts within this industry to think strategically about the future of your business 10 years from now.

Chapter 1: The US Industrial Real Estate Market

Major Forces that are shaping the future:

E-Commerce: 

The primary effect of e-commerce on the commercial real estate world is that far less retail space is needed in exchange for larger industrial footprints. Recent research suggests that 125 million square feet of distribution space is required for each $1 billion increase in e-commerce sales.

E-Commerce can be broken down into 3 activity segments:

1. Omnichannel: retailers that have both brick-and-mortar stores and an e-commerce channel.

2. Last Mile: This last point of departure is the bridge between the distribution center and the customer. Companies are now leasing Last Mile warehouses that allow manufacturers and distributors to hold specific levels of inventory in select urban and suburban centers so they can increase delivery speed to the customer.

3. Reverse Logistics: As e-commerce grows and the total number of overall product returns increases, so will the emphasis on optimizing reverse logistics.

Prominent Landlords and Investors:

• Prologis: Public company and REIT focused exclusively on industrial real estate and, more specifically, logistics real estate.

• Opened several innovation centers, called Prologis Labs, where they experiment with innovative ways to solve some of the pain points of their customers.

• They invest in startups that work on supply chain and logistical challenges. Customers have an opportunity to participate within this ecosystem and help provide real-time feedback to each startup.

• They continually invest in the upgrading of their properties, whether it be tearing down and redeveloping older properties, increasing trailer storage where appropriate, or reworking property layouts to incorporate more loading docks.

• Blackstone: Link Properties: the focus on major markets and gateway cities, and their portfolio consists of smaller infill buildings, rather than larger distribution and fulfillment centers.

Chapter 3: Thinking Strategically

Subleasing: an integral part of the warehouse leasing business, as business growth often does not coincide with a lease expiration date.

There are 3 parties involved:

1. The sublessor: the company that is leasing the building and no longer needs it

2. The sublessee: the new company that wants to take over the building lease

3. The master lessor: the landlord that owns the building

The sublease contract memorializes this negotiation. The sublease contract, however, does not supersede the original agreement between the sublessor and the master lessor. This means two documents need to be reviewed and approved by all three parties.

Lease Termination: Termination fees represent the cost of ending your lease early and fluctuate based on supply and demand dynamics, as well as ownerships.

In most cases, the ability to terminate may be allowed after the initial three to five years, at the cost of three to six months’ rent, paid at the time of termination.

Chapter 4: Redesign Your Environment

Building programming is the active planning a company goes through to identify what they need in their future building. Space planning happens after you have gone into the market, found a building, and need to figure out how to fit your company’s needs into that specific building.

Warehouse Space:

• What is the total amount of warehouse space needed and how could it be better configured?

• Break down your warehouse space into its components:

• Shipping and receiving 

• Raw material storage

• Low-height pallet stacking areas

• High-height pallet stacking areas

• Total racked areas

• Manufacturing

• Assembly

• PackagingProduction machines

• Electricity

• Backup Generators

• Fire Suppression

• Dock Equipment

• Fencing

The 3 Components of a budget for a tenant to move are:

1. The cost to lay out and fit out a new building

2. The cost of the move from the old building to the new

3. The cost to decommission and surrender the prior building back to the landlord

Chapter 5: Team and Timeline

Build your list of whos:

• Executives: must have a working knowledge of logistics and supply chain, commercial real estate, commercial construction, zoning, economic incentives, public utilities, property taxes, common area maintenance (CAM), and more.

• Broker: Your broker is the quarterback and you are the coach

• Project Manager: Project managers do whatever is needed for the project. They create project budgets, assess the needs of the company, and manage outside vendors, such as general contractors and furniture vendors. They can work with your own IT department, coordinate orders and deliveries, manage your mover on move-in day, and direct employees in the new facility.

• Architect: Help provide creative designs to a property’s shortcomings.

• Furniture Vendor: Plan furniture program and order to fit the office space.

• Material Handling: Vendors in charge of racking, storage systems, mezzanines, forklifts, conveyor belts, automation, and more. The architect of the warehouse systems.

• Industrial Engineers: Guides for companies that are relocating their manufacturing operation.

• Supply Chain Consultants: lead supply chain optimization studies to take into account both supply and demand, along with decisions such as make or buy.

• Warehouse Automation and Robotics Consultants: Design the systems within the warehouse for material handling, robotics manufacturers, and automation integrators.

• Conveyor systems are largely categorized as transportation, accumulation, and sortation systems. 

• Transportation systems utilize gravity, belts, and rollers to manually move products down the line.

• Autonomous guided vehicles are pallet running systems.

• Site Selection Consultants: Flat-fee-based consultants who work with large organizations like a broker to assess greenfield development and the politics and economics of operating in new geographies. The 3 scenarios when a company reaches out to site selection consultants:

• Underwriting and analyzing expansion into new geographic regions due to capacity constraints.

• Adapting to changing business conditions causing companies to migrate to certain business conditions causing companies to migrate to certain areas over time as labor availability infrastructure and geopolitical risk shift.

• Evaluating redundancy, consolidation, plant closures, and necessary reinvestment during mergers and acquisitions.

When evaluating a new market, start at a high level to get an understanding of each market’s attributes. You should assess the following:

Labor Attributes:

1. Labor Quality: the concentration of workers in a particular industry, turnover rates, etc.

2. Availability: size of workforce, number of workers with the requisite skills, unemployment rates, etc.

3. Costs: wages, benefits, insurance, etc.

Economic Incentives:

1. Cash incentives: Cash or cash-equivalent incentives like free land.

2. Infrastructure incentives: Site improvements and prep.

3. Performance-based incentives: Property tax abatements for creating jobs.

4. Nonmonetary incentives: incentives that speed up your project and reduce red tape.

Basic Timeline of a Tenant Move:

• Initial Assessments - one month

• Lease review

• Physical-condition review

• Operational review

• Existing landlord review

• New building programming

• Budgeting

• Build your team - one month

• Assess internal capabilities

• Assess external capabilities

• Select project champion

• Interview vendors

• Select vendors

• All-hands meeting

• Build your timeline

• Market engagement - two to three months

• Assembling opportunities

• Property tours

• Initial inspections

• Secondary inspections and bidding

• Lease proposal negotiations

• Lease contract negotiations

• Tenant improvements - two to four months

• Space planning

• Bidding

• Work letters

• Permits

• Construction

• Inspection

• Furniture, fixtures, and equipment - two to six months

• Furniture

• IT

• Security

• Signage

• Equipment

• Machinery

• Racking

• Move day - zero to three months

• Decommissioning - one month

Chapter 6: Engage The Market

A great broker leverages relationships within the brokerage community to find opportunities that are not yet available. Typical activities of a Great Broker include:

1. Communicate with other brokers who represent landlords and have similar listings.

2. Communicate with institutional investors and developers about their rent rolls.

3. Speak with the investment community about their acquisitions pipeline.

4. Brainstorm with developers who own land sites about their plans to build new industrial buildings.

5. Market client requirements directly to private property owners through my phone, email, and postcards, utilizing proprietary databases.

6. Market client requirements on LinkedIn.

Chapter 7: Proposals and Projections

• Lease Proposal: Document used by the landlord’s attorney to prepare the lease contract.

• Parties: the trade names, or official legal entities, for both the landlord and the tenant.

• Property Address

• Premises Size: Approximate size of the building

• Lease Commencement Date

• Lease Term: the length of time you want to be able to utilize the property.

• Lease Rate: the lease rate quoted per square foot per month.

• Lease Rate Adjustments / Escalations / Annual Increases: how much rent will increase each year. Should adjust each year to keep up with inflation. The industry standard is 3%.

• Lease Type: the lease type denotes the inclusion or exclusion of property operating expenses.

• Gross: the tenant pays rent, while the landlord is responsible for the property tax, insurance, and CAM expenses.

• Modified Gross: the tenant pays the rent and maintenance expenses while the landlord is responsible for the property tax and insurance expenses.

• Triple Net: the tenant pays the rent, property tax, insurance, and maintenance expenses.

Early Occupancy: The time you can use to move into the property, set up furniture, and install IT cabling, equipment, and racking before you start paying rent. This means the landlord retains partial possession, which is usually for the purpose of completing tenant improvements.

Rent Abatement: Free rent is a concession the landlord provides only if it is needed to attract the tenant to sign the lease. Landlords routinely add a month of lease term to the total lease length for every free month given.

Operating Expense Abatement: It is assumed by the real estate community that you will pay the operating expenses during any free-rent period unless explicitly stated otherwise.

Security Deposit: How much security deposit is reasonable in the industrial market? The main factors to consider are:

1. The length of time the company has been in business

2. The company’s income statement, balance sheet, and/or tax returns

3. The size of the landlord’s tenant improvement contribution

4. The length of the lease

Agree to terms before you negotiate the contract!

Chapter 8: Tailor-Made Leases

AIR CRE Contract: The American Industrial Real Estate Association (AIR CRE) contracts are the most balanced commercial lease contracts on the market. Everyone in the industry knows the AIR CRE lease document inside and out. You should feel comfortable signing the AIR CRE lease document as either a landlord or a tenant, knowing it could be easily modified to encompass the spirit of the negotiation between the two sides.

Hazardous Materials: You want to make sure you are only responsible for the hazardous materials you bring onto the property and that you handle and dispose of them in a professional manner that does not damage the property.

Replacement Obligations: The most common use of the replacement clause is with the replacement of HVAC units. The standard language and expectation for HVAC replacement is when the cost of repair is greater than 50% of the cost of replacement. Who fronts the cost for the replacement? The standard AIR lease language is that the landlord contracts and pays for the HVAC replacement and then bills the tenant for a portion of the cost, typically the amount of time the tenant used it divided by the useful life of the equipment.

Chapter 9: Tenant Improvements and Construction

Many private landlords expect little to no tenant improvements, and when they do, they take the form of “move a couple of walls”.

Institutional landlords, on the other hand, carefully consider operating budgets for tenant improvement allowances. The landlords will usually talk about tenant improvement allowances in terms of dollars per square foot.

Tenant Improvement Allowance:

Who is in charge of the tenant improvement construction?

• Landlord in charge: Advantage is time savings, the landlord’s expertise, and pricing power for the landlord. The tenant reimburses the landlord plus management fees.

• Tenant in charge: Advantage is the tenant can negotiate a credit for free rent to help offset the construction costs.

The SBA can give loans to fund tenant improvements.

Tenant Improvement Amortization: If the landlord is funding tenant improvements to build out your space, they will expect it to be paid back over time with interest (0-8%). The payback period is the length of the lease - usually five years on buildings that are 10,000 SF or larger. On longer leases, you might have a payback period that is shorter than the lease.

Chapter 12: Ongoing Support

Lease abstract: a two-page brief of the lease document in Excel, with all the critical dates, dollars, rights, and obligations that you can upload into a database in the cloud. The purpose of a lease abstract is to have a form of the lease that is easy to access and manage, so you do not have to go through a sixty-page contract to solve a problem.

Chapter 13: Achieving Scale

To scale it pays to have one broker become a single point of contact for your company and then go about managing all of your local brokerage relationships. It is not that having a local broker is not important; it is quite the contrary. The issue is, managing local brokers is not usually of strategic value to executives as they scale their businesses. 

Companies that have between ten and one hundred locations usually gravitate toward a single broker. The premise is that you can increase the speed at which you have high-level engagement to make informed decisions.

Chapter 14: Taking Investments To The Next Level

Multi-Tenant Business Park: This type of industrial investment is a great starting point for the early-stage investor. These properties are called incubator parks, business parks, business centers, industrial parks, or multi-tenant industrial parks. Think of these as apartment complexes of the industrial real estate asset class. Projects can vary from one 10,000 SF building up to a large project encompassing multiple buildings totaling 300,000 SF. Typically, these buildings provide multiple small spaces for startups and local service businesses, ranging from 1,000 to 5,000 SF per unit.

Multi-tenant projects provide for income-stream diversification. Compare this with the earlier example of a single-tenant building where you either have cashflow or you do not. With investment in a multi-tenant project, you have five to fifty tenants producing income, but no single tenant makes up more than 5-10% of the project. Of course, the tradeoff for this steady stream of income is an increase in management duties. Managing twenty leases means there is more of a need for a property manager, CAM, HVAC maintenance, and enhanced tenant relations.

Conclusion

As the US Industrial Complex grows, you need to invest in your education and your team of experts in this sector to navigate the changing future. Whether the changing future means you will be investing in this sector or simply just utilizing the buildings for some of your operations, the Industrial Real Estate sector affects us all.