Let’s buy a warehouse

Business Record Publisher Chris Conetzkey and I walked out of a roundtable discussion on industrial properties with the same thought: Maybe we should buy a warehouse.

That’s a big idea for a couple of journalists, but after hearing a panel of experts talk about the need for more space and the fact that right now, because of low vacancies, landlords have the upper hand in the market, we figured we were onto a sure thing.

Our experts — Mike Bonnett of R&R Real Estate Advisors, Andy Hodges of Signature Commercial Real Estate, Matt Lundberg of NAI Optimum and Chris Pendroy of Iowa Realty Commercial — were upbeat about the hybrid flex spaces, warehouses, manufacturing and distribution centers that make up the industrial market. 

And let’s face it, you have to be upbeat to pique the investment curiosity of a couple of business reporters. Normally, we just write about the people taking the risks.

Interesting trends are afoot.

Developers of new space continue to push up ceiling heights. We heard the expression “32 clear” a lot. That means 32-foot-tall ceilings, a relatively new trend in Greater Des Moines but a staple in big cities located at the junctions of interstate highways and rail systems.

ESFR is in demand. That’s a fancy fire sprinkler system that is favored by insurance companies. The insurers pass their fancy for ESFR along to warehouse and distribution tenants in the form of lower insurance premiums.

And don’t even think about taking a pass on LED lighting. Hodges, whose company is renovating the cavernous former R.R. Donnelley warehouse on Des Moines’ Park Avenue, said the super efficient lights are a big part of the upgrade.

A trend that is spreading across other sectors of the commercial real estate market is annual bumps in lease rates. During a separate roundtable on the office sector, panelists said that what are called escalators have become commonplace. Whether your expertise is industrial or office, the annual increases help drive up property values and draw the attention of national investors.

“I think it’s just a sign of a strong market, especially when a tenant comes up for renewal,” Lundberg said. “Let’s say (tenants) get a five- or seven-year deal. When they first struck that initial lease, they were probably expecting and probably getting a flat rate for that entire term. ... I think that in today’s market if you don’t educate your clients they might have somewhat of a rude awakening knowing that they’re not going to get all the concessions they got the first go-round.”

Bonnett said R&R incorporated the escalators into their leases a few years ago.

“The annual rent bumps were more consistent with what is happening in other markets that we compete with here in the Midwest. That really helped us get that started,” he said.

Pendroy said: “I started my career in Minneapolis working seven years in industrial, and there the rent bumps are the norm. In major markets they have been for many, many years. I think with Des Moines having grown into that next level with institutional-grade product, it’s expected to see rent bumps if you’ve got national investors coming in to take a look at this market. And it adds value to the property overall.” 

Landlords are finding a new breed of tenant for some warehouse space: users, such as Hy-Vee Inc., who walk through a wide-open area with tall ceilings and envision hybrid office space. 

“We’ve had a lot of activity with nontraditional users,” Bonnett said. “They’ve been around for a while but I think there’s more folks getting into that arena than before. I think traditionally, we had a lot of new sports users here. Recreational facilities, family centers that were out looking for places where their kids could play basketball, could play baseball in the winter months.”

Hodges said nontraditional users are blending in.

“I think the credit profile of these users has gotten better. And I think the other tenants you have in your parks have become more accepting of those tenants in the facilities,” he said.

But what about the super user, Amazon.com Inc. Where is it? When will it arrive in Greater Des Moines?

“Well, I think the driver behind that’s going to be their platform of same-day delivery,” Pendroy said. “If you’re going to push that into secondary and tertiary markets (such as Greater Des Moines), you’re going to have to have a presence in those markets.”

Now, about that investment opportunity.

“I think it’s a real lucrative property buy,” Hodges said.

Issues Discussed
For new warehouse projects, height matters.
A big need for smaller spaces.
The drive to cut the distance to rooftops.

 


 

Panelists:

Mike Bonnett, vice president and commercial real estate adviser, R&R Real Estate Advisors
Andy Hodges, vice president, Signature Commercial Real Estate
Matt Lundberg, director and vice president, NAI Optimum
Chris Pedroy, senior associate & industrial specialist, Iowa Realty Commercial

Moderators:

Chris Conetzkey, Business Record publisher
Kent Darr, senior staff writer

Watch the Video:
Want to watch the roundtable in its entirety? Go to businessrecord.com/AREM


What do you see as a dominant theme in the industrial market this year and going into next year?

Chris Pendroy: Patience. Because there’s still very low supply of industrial space in the metro area, pretty much across all product lines, whether it is flex office, warehouse, distribution, manufacturing, we’ve still got a very low vacancy rate here in this market, somewhere around 3 percent. It ticked up from last year due to some space hitting the market, but I think overall, the market is still very tight.

Mike Bonnett: I believe that the trend we’re going to see this year is there is going to be more development. We need more new inventory. I think we’re going to see more development and construction of more modern facilities. As you’re seeing right now, our clients are looking for better locations, more convenient, quicker access to the interstates. I believe they’re looking for the higher clear heights. In this market, we’re pretty much building 32-foot-clear buildings today. They’re looking for facilities that have more doors and ESFR (fire suppression systems that are favored by insurance companies and can result in lower premiums).

Matt Lundberg: I think from a tenant’s perspective, you have to be proactive in the market. I think that this has been the theme for the past year or so. Typically when a tenant would engage their broker to start either renewal or looking for new space, that would usually start, call it, six to nine months before their lease expiration. I think in today’s market that needs to start at least, probably, a year out because I think a lot of tenants are having a rude awakening when they do go out to the market and there aren’t very many options for them to choose from. With the lack of inventory and with a strong market and rates being fairly low, we’re seeing land development and sales tick up with current tenants wanting to own their own real estate.

If you put your landlord’s hat on, I think the theme for 2017 is life’s pretty good. It’s kind of a landlord’s market right now. You’re seeing annual bumps in rates. You’re seeing longer term in deals. I think the short month-to-month leases that you see a lot of logistic companies searching for are tougher to find. Another thing is rent concessions and tenant improvements, free rent, I think that has kind of gone to the wayside. We’re not seeing as much free rent, and if there are tenant improvements, we see the landlords kind of pushing that off of the table.

Andy Hodges: What we saw from the landlord’s perspective for the last few years was a lot of tenants kind of waiting until the last minute, just kind of kicking the can down the road. With the limited supply that we have, it backed a lot of them into a corner and a few lost out on space opportunities. This stressed us a little bit from a developer/landlord standpoint to perform in these short timelines that we were provided at times. I’m seeing these flex and these warehouse tenants starting to be more proactive. They’re coming out a year, year and a half before the expiration of that current lease.

I think from our perspective, the market continues to be strong, the landlord-type market. I think the one thing we hope to see this year is that trend, as the office market continues to heat up, of those A, B users coming back down to that flex space. I don’t think we’ve seen a lot of that transition the last few years, but recently we’ve seen some inquiries — office users looking at our class A flex space. So we kind of see that becoming a trend here in 2017, maybe into 2018.

What’s driving office users to the flex space?

Hodges: I just think it’s price point. I mean, look at some of the new construction, this class A stuff. ... I think you’re seeing some rent appreciation in class B a little bit. I think it’s just a pricing thing. I mean it’s $9, $10 net rents up to $17, $18 net rents. I think some of them are starting to reconsider, as they come up on these lease expirations, some of them are looking at some of this class A flex product and looking at the potentially lower price point.

What is driving the annual rent increases?

Lundberg: I think it’s just a sign of a strong market, especially when a tenant comes up for renewal. Let’s say they get a five- or seven-year deal. When they first struck that initial lease, they were probably expecting and probably getting a flat rate for that entire term. Maybe they got a large chunk of free rent with that, maybe they got a generous TI (tenant improvement) allowance as well. I think that in today’s market if you don’t educate your clients, they might have somewhat of a rude awakening knowing that they’re not going to get all the concessions they got the first go-round.

Bonnett: We started doing the annual escalations a little over two years ago. Prior to that we were doing ... if it was a five-year lease maybe we’d have a rent bump at year three, so it’d be the same for year one and two and a bump year three, or year two and three and five, or two, four, five. The annual rent bumps were more consistent with what is happening in other markets that we compete with here in the Midwest. That really helped us get that started but it was more so in the office and in the retail, and industrial has not so much of a history of having annual rent bumps. 

Pendroy: I started my career in Minneapolis working seven years in industrial, and there the rent bumps are the norm. In major markets they have been for many, many years. I think with Des Moines having grown into that next level with institutional-grade product, it’s expected to see rent bumps if you’ve got national investors coming in to take a look at this market. And it adds value to the property overall, so I think it’s really enhanced the Des Moines market.

Are we slow to build here?

Lundberg: I think with the Des Moines market, we’re a secondary market. The Kansas City market has done something that I think is very interesting for a market that’s two and a half, three hours away. They’ve got a park called Kansas City Logistics Park. What that is is a 1,700-acre master planned development that’s both rail-served and it’s served by four different interstate systems. What’s fascinating about it is it has a capacity of up to 17 million square feet of industrial space. If you just think about that, that’s pretty wild. Amazon.com Inc. did a 900,000-square-foot facility down there. Des Moines always feels five to 10 years behind Kansas City, but now things are starting to get closer to the Des Moines market. I think it’ll be interesting to see the next five to 10 years what happens in Des Moines. We do kind of trail Omaha and Kansas City, some of these larger markets, but I think it’s just a matter of time until things get here as well.

Kansas City has a larger population, larger labor force; manufacturing is larger there. With e-commerce continuing to explode, I think you’re going to start to see larger bulk facilities around the Midwest. But those bulk facilities are going to need smaller fulfillment centers. Consumers now, and in the next couple years, are going to demand if they click the buy button this morning they want the good this afternoon. So I think you’re going to see a lot more need for smaller facilities in smaller markets.

Bonnett: I think when you compare the Des Moines market to, say, Kansas City, traditionally we’ve been considered a secondary, or really a more tertiary market in the logistics world. We can be serviced, same day, from Kansas City. We can be serviced, same day, from Minneapolis, so it’s kind of where we fall within that traditional network of distribution centers across the country.

I think that for Des Moines, you’re going to continue to see the newer facilities here in the size ranges of maybe 200,000 square feet to 300,000 square feet. 

Where’s Amazon?

Pendroy: Well, I think the driver behind that’s going to be their platform of same-day delivery. If you’re going to push that into secondary and tertiary markets, you’re going to have to have a presence in those markets.

Hodges: Matt or Chris, let me ask you guys, are these users, these distributors, the e-commerce, are they changing their selection criteria? I’ve been reading a lot about wanting to get closer to rooftops, almost like a retailer. Have you seen that?

Bonnett: They’re looking for that last mile. I mean, right now that’s kind of the buzzword, that last mile is getting closer to the rooftops. So with that, they are coming into markets like Des Moines.

Pendroy: When I started in Minneapolis 15 years ago, they were just starting the 32-clear product. I moved back here in 2006, and we just weren’t a 32-clear market at that time. (When) the first 32-clear building went up in Greater Des Moines, it was successful. Having that product now gives us a good look at companies that are doing a regional search, and I think that’s a great thing for Des Moines.

Conetzkey: Not to put too much into the retail component, but with Amazon doing this and Walmart doing this, are we going to see some other retailers that maybe aren’t quite that large trying to look for a space and do something similar?

Lundberg: I think it’s just the world we live in. Just picture how you purchase goods now. I think technology and just the way we live right now is going so fast that I think for us to be in this business and kind of focus on industrial is extremely exciting. ... We’re going to see a lot of new companies looking for markets like this.

Pendroy: I read recently that FedEx is going to start doing private packaging and shipping for companies that don’t have the platform like an Amazon. So ABC or whatever company is now going to go to FedEx and they’re going to be, basically, a contract shipper for them to get their products out. I think FedEx is another one to watch here in the way they are going to expand their model nationally to take advantage of those retailers that are doing a lot of online business.

Hodges: I was reading a stat that by 2020 e-commerce will be a $500 billion-plus industry. I mean, today you’re at $300 billion. I think something like that benefits the Des Moines market.

Conetzkey: You guys are really seeing positive pressure from two angles, then, if office space users are looking at industrial. Maybe there’s an option here along with retailers looking at that.

Hodges: Well, you look at all these big boxes, and a lot of them are downsizing. Their sales are up, they’re reducing their brick and mortar footprints; their product is going somewhere.

Andy, you folks are working on 500,000 square feet, something like that, at the former R.R. Donnelley facility. Who is looking at the existing space? We’ve been talking a lot about new build, but there is a fair amount of existing space that is available.

Hodges: Yeah, distribution companies, (third-party logistics companies). We’ve had some spillover from the Microsoft projects around town, different contractors coming in needing large chunks of space for a two- to three-year period with, again, you know, Facebook and Microsoft — the ripple effect of those projects.

Are there any trends that bother you? Are land prices too high? Do you see anything that you view as kind of a yellow flag?

Hodges: I don’t know about land prices. We talk a lot about the ag industry. I don’t think people realize how many ag-related companies occupy space, especially in the northwest suburbs. We have not seen it yet, but I think every year that goes by and grain prices and all the other commodity prices continue to stay down, you have to wonder if you’re going to start seeing some softening there. That’s the one thing we try to keep our eye on.

Pendroy: With the distribution users, their interest is just about quick access to the interstates. (That could include) Altoona or Norwalk, where they have some industrial parks established and the land prices are still a little lower basis than, say, Ankeny or Grimes. I think those are going to be looked at a little more in the coming years than some of the other parts of the metro.

Are industrial properties a pretty attractive investment? Are they difficult to finance?

Pendroy: Lenders like industrial right now, from what I’m seeing out there. Some lenders have to get comfortable, depending on what kind of industrial product it is. If it’s flex, you might have more of the five-year average lease, and some lenders can’t get comfortable with five-year versus out where you’re seeing some of the larger bulk warehouse deals, you hear 10-year deals for a larger tenant, so they are a bit more comfortable with that.

Bonnett: I would agree with that. I think the industrial properties are attractive for the investors and for those reasons. For the longer-term leases as well as low investment dollars in tenant improvements compared to office build-outs. There are not a lot of cash calls in a 10-year industrial lease.

Hodges: Yeah, I think it’s a real lucrative property buy, whether it’s the lender or potential investors or buyers, it’s a favorable property buy.

Are there some barriers that you would like to see removed? If we have this abundance of land, it seems like such an opportunity long term for the city to position itself to do well.

Pendroy: Yeah, intermodal in Kansas City was, I think, the driver for all the quick growth of large warehouse down there. I’m sure there were state and local governments involved with that as well. I think also the railroad was probably a big driver of that. It’s going to take a multifaceted group of railroad, city, state and private money, developers. It takes a lot of infrastructure, and I think it wouldn’t hurt our city to at least continue to explore it.

Is there any part of the transportation system that could stand some improvement that would foster more growth?

Lundberg: I think it will be interesting to see with the Highway 5/65 bypass. I know there’s talk about getting that switched over to an interstate and what that will do both for transportation as well as development.

How much of a deterrent is it when it is not actually classified as an interstate? I know it has been one of the arguments for classifying it that way.

Bonnett: They are looking for four-lane access in and out of where their facilities are located. You look at an impact of how transportation, not specifically the infrastructure, but if you look at the tractor-trailer situation right now, there’s a shortage of drivers. The stat that I pulled up when I was doing my research for this was that by 2022 we are going to be short something like 239,000 drivers. So what that’s doing is it’s forcing the logistics guys to locate facilities that can maximize the driver hours. It’s shortening the unload time. It’s making it quicker for them to get reloaded. So having the infrastructure set up so that we can create more facilities with the ease of access to get a tractor-trailer in and get them out in a short amount of turnaround time I think is critical.

I saw a story the other day that UPS will send their trucks out and with drones finishing off deliveries in rural areas.

Lundberg: It’s really interesting how we’re going to develop and adapt in the next five to 10 years just with how the world is changing.

What are you anticipating on the economy?

Pendroy: I still think there’s pent-up demand out there. We haven’t really touched on manufacturing in the industrial sector. Here in the metro, over the past year you’ve seen EP2 (Electrical Power Products Inc.) build 180,000 square feet south of town by the airport to expand its operation. You have the Baker Group that put their new 140,000-square-foot campus near Ankeny. That growth, I think, has been partly spurred by the Facebooks and Microsofts, just the building that’s going on because of those and all the things you’re seeing downtown. A lot of these companies have been holding cash on the books for some time, and I think you’re going to see them start to loosen some of that cash and do some expansion.

Conetzkey: It’s funny you bring that up. We’ve been hearing for a long time that everybody is holding their cash. Dave Nelson from West Bank told us recently that he really isn’t sure why that cash isn’t being deployed. So it’s interesting to hear you saying that people might start to deploy some of that.

Bonnett: The Wall Street Journal reported after the election that the outlook for GDP growth is strong and we were poised for growth in the next five years in GDP. So again, I mean, based on that kind of information that you hear in the market along with what we see on a daily basis in this market, we feel confident that we’re going to have strong activity in the Des Moines market, I’d say, at least for the next three to five years. We’re still building product because we’re anticipating these people coming, not just from the existing market but new manufacturers, new distributors, new light industrial logistic users.

Pendroy: I think what R&R’s doing, you know, with 250,000 square feet of speculative construction, if that doesn’t show confidence, I don’t know what does.
Lundberg: And that’s something that we haven’t seen in years. We’ve got R&R’s Prairie Business Park part two; Hubbell’s building number four, which is 110,000 square feet, will be available in June. You’ve got the Graham Group doing 300,000 feet on Delaware Avenue. I mean you’ve got a lot of people building spec right now, and I think that’s one thing to watch this year is to see how that gets absorbed. I think all signs point to “yes,” but time will tell.

Are there signs of more growth on the manufacturing side?

Pendroy: You know, if we had been talking five years ago, eight years ago, and you went and looked in rural Iowa, the number of plants that were available or shut down, they sprinkled the countryside here in Iowa. I’d say most of that space has been absorbed by companies, a lot of them ag-related. I think you’re going to see that sector continue to grow. The question right now, as Andy mentioned, is where’s our ag sector going to go, and how is that going to affect Iowa? We were somewhat sheltered and spoiled during the downturn because of the strength of the ag sector, whereas this time around that may or may not change.

Hodges: And you compound that with potentially a stronger dollar and NAFTA and all these things you hear in the news right now. What impact does that have on that sector? Yet to be determined, I guess.

Bonnett: A couple of the industries that we’re seeing some activity in is bio-ag sciences. I mean, we’ve got the Cultivation Corridor going on here and it seems like there’s an emerging market with the bio-ag science startups and companies that are treating corn, treating beans, coming up with big processes for pollination. I think that’s a driver and a market to watch.

And the other is wind energy. There’s going to continue to be more opportunities with folks in the wind industry. We have one that came in last year. And, again, you talk about product type. I mean, we put up Prairie Business Park One at 32 clear, and that allowed this wind energy company to come in and set up a training center because they needed the clear height. So inside the building they have set up a wind turbine. Now, it doesn’t have the blades on it. But they set that up so they could do all their tech training and stuff in there.

 


 

KEY POINTS

Users need to plan ahead
Warehouse space of all descriptions and sizes is in tight supply, even with plans for more large buildings on the books. With low vacancies, users should start looking for new space up to 18 months before current leases expire. At least one seasonal user is willing to let their space sit idle for part of the year, knowing that it will be available when the time comes to refire operations.

Small spaces in big demand
Large warehouse projects that top 200,000 to 300,000 square feet grab a lot of attention, but not to get lost in the shuffle are small spaces for smaller users. Warehouses that are less than 200,000 square feet account for about 80 percent of the inventory in Greater Des Moines. One broker is having difficulty finding lease space for a client who needs a mere 1,800 square feet.

Invest in industrial
Lenders and investors like the industrial market for several reasons. One reason is something called rent escalators or bumps. Those annual 1 to 2 percent increases in lease rates have been common in larger markets for several years, and they are increasingly common in Greater Des Moines over a range of commercial real estate segments, including industrial. 

Office and retail, meet industrial
Warehouse and flex space — that broad category in the industrial market that includes room for warehouse, light manufacturing and office — is becoming increasingly popular with nontraditional users. Sports and fitness operations are taking up shop in high-cube warehouse buildings. Hy-Vee Inc. took a look at a large R&R Realty warehouse in Grimes and saw a hybrid office. 

Location cuts deliveries down to the last mile
Warehousing takes a lot of shapes under changing definitions. Just like retailers, shippers want to be closer to rooftops, and that means cutting the distance of deliveries down to the last mile. That strategy is good for Greater Des Moines, and could bring large fulfillment operations, such as Amazon.com Inc. and others, closer to our neighborhoods.