Chapter 22 Outline / Page 1 Chapter 22 Industrial Property, Office Building and Shopping Center Analysis This chapter demonstrates analysis of investment proposals involving industrial property, office buildings and small shopping centers. Examples of each are presented to illustrate differences as well as similarities. Demand factors and location considerations are discussed for each property category. Brief case illustrations demonstrate differences in procedure dictated by variations in institutional arrangements or market characteristics. CHAPTER OUTLINE A. Investing in Industrial Buildings 1. Industrial buildings are perennial favorites among real estate investors. Reliable, credit- worthy tenants, long-term leases, and opportunities to shift many, if not all, operating expenses to tenants account for the popularity of these structures among investors. 2. For their part, business operators frequently find themselves short of operating capital and prefer to channel available resources into business expansion rather than into real estate ownership. 3. Investors and business tenants thus find in leased industrial buildings a symbiotic relationship. B. Demand for Industrial Space 1. Demand for industrial space is largely a function of the demand for products produced by the industrial sector. a. Forces that increase demand for manufactured goods also increase demand for industrial space. b. Any situation that causes a decrease in demand for manufactured goods will cause decreased demand for industrial space. 2. Of course, changes in demand for space are not as volatile as changes in demand for industrial goods. Manufacturers generally adjust their space needs based on longBterm projections of product demand. 3. Periodic shifts in demand for industrial space of various types and in different locations reflect alterations in composition of the industrial sector. a. Growth in service and technology-based industries has in recent years sparked increased demand for light assembly and research facilities. b. Decrease in demand for the products of heavy industry has greatly reduced the demand for structures employed in these manufacturing processes. Chapter 22 Outline / Page 2 C. Location Factors 1. Location near Fuel or Power Supply. a. The nation’s first steel-making centers were located near coal mines because of the large quantities of that fuel required in early steel-making processes. b. High electrical power requirements favor the location of aluminum and electrometallurgical processors near sources of relatively inexpensive hydroelectric power. 2. Location near Markets. Home building, commercial baking, and beverage bottling are examples of industries where transportation costs increase as the product approaches the end of the production process. Accordingly, these products are generally fabricated near the location of their final use. 3. Location of Footloose Industries. Many industrial location decisions defy all the preceding classifications. a. Because transportation is not a major item in their production costs, some manufacturers base location decisions on other criteria. b. They frequently choose locations remote from both raw materials and markets, thus incurring double transfer costs, in order to gain reductions in other processing costs. D. Types of Industrial Buildings. There is no official classification system for industrial buildings. Yet they can be usefully characterized according to the nature of the building’s construction or the type of tenant it attracts. 1. Heavy Industrial Buildings. Petroleum, steel, and rubber processing facilities, as well as truck and auto manufacturing facilities, are all examples of heavy industrial buildings. Structures housing such industries are usually custom designed to accommodate specific needs. 2. Loft Buildings. Loft buildings were one of the nation’s earliest types of industrial buildings. They are multi-story structures, usually with wood or concrete frames and masonry exterior walls. Loft buildings were designed to accommodate manufacturing processes as they existed in the early 1900s. 3. Modern One-Story Structures. The most common industrial structure built today is the modern one-story facility, typically located in a suburban industrial park. These buildings are usually designed for occupancy by a single tenant. 4. Incubator Buildings. Incubator buildings are smaller multi-tenant structures. New firms rent space in such buildings, and as business expands, they move to larger quarters. Chapter 22 Outline / Page 3 E. Investing in Office Buildings 1. Dramatic growth in the service sector of the economy has in recent years greatly increased the demand for office space. a. Modern high-rise structures are rapidly replacing older, smaller buildings in central business districts. b. Many office centers have sprung up in suburban locations. These are usually mid-rise buildings or one and two-story structures in office parks. 2. Demand for office space, like that for industrial space, is a derived demand. It is related to the demand for services supplied by occupants of office buildings. a. Increases in the number and size of service industries such as law firms, accounting firms, and financial institutions is translated into expanded demand for space to house these activities. b. Moreover, total demand for office space has expanded due to the trend among employers to provide more space per employee. 3. Owner-occupied office buildings are often designed to project the desired image of the owner-occupant. Investor-owned buildings, in contrast, tend to be somewhat more functional and less luxurious. 4. Office building tenants typically enter into multi-year leases. a. Office building owners learned long ago that if they are unable to raise their rentals annually, increases in operating expenses will greatly erode their profits. As a result, they pioneered the process of passing increases in expenses on to their tenants. b. Leases often contain a clause stating that the landlord will pay operating expenses up to some specified amount per square foot. Any increases above this amount are passed to the tenant. This represents a significant decrease in the risk that office building ownership would otherwise entail. 5. Tenants often take options to renew leases on occupied space. a. Such lease arrangements inevitably contain a formula for computing increased rental rates for the renewal period, based upon changes in the general price level. b. Such a provision spares the tenant the expense and bother of finding new quarters, and spares the landlord the expense of locating a new tenant. F. Investing in Shopping Centers 1. Relationships between landlord and tenants in shopping centers differ from those in free-standing stores and other structures. Chapter 22 Outline / Page 4 a. Major stores in shopping centers, called anchor tenants, attract shoppers to the center and thereby create customers for smaller specialty shops. b. Investors and developers have long provided favorable lease terms to anchor tenants, and achieved their greatest returns on rentals received from specialty tenants. c. More recently, developers have allowed major tenants to construct their own buildings on sites leased from the owners. This reduces the owner’s investment, and often increases their return because they no longer own space subject to rental rates favoring tenants. 2. Lease arrangements also differ in shopping centers. a. Shopping center owners set a base rental rate, and often increase the rental rates as the tenant’s sales volume increases. This is known as a percentage clause in a lease. Percentage clauses have the effect of making the shopping center owner a partner in the business of the tenants. For this reason, tenant sales volume and tenant mix are very important. b. Large shopping center tenants typically lease space on a net basis, that is, they pay all expenses associated with operation of their space. c. Smaller tenants often pay their own utility expenses, while the landlord pays other operating expenses. d. Shopping center tenants also often pay a common area maintenance fee. This fee reimburses the owners for maintenance of common space such as parking lots or mall space. 3. Neighborhood Shopping Centers a. Neighborhood centers serve a relatively small trade area, from which customers can commute by automobile within 5 to 10 minutes. b. As anchor tenants, neighborhood centers usually have a food store and drugstore, which may occupy a combined total area of 35,000 to 50,000 square feet. c. Total area within neighborhood shopping centers ranges between 50,000 and 100,000 square feet. 4. Community Shopping Centers a. In addition to a major food store, most community centers feature a junior department store or a major discount department store as an anchor tenant. b. The department store, typically ranging in size from 50,000 to 100,000 square feet, is usually located at the opposite end of the center from the food store, with specialty shops between. Chapter 22 Outline / Page 5 c. Having two anchor tenants increases the range of a community center’s trade area, which may extend from 10 to 15 minutes in driving time from the center. 5. Regional Shopping Malls a. Considerably larger than community centers, regional shopping malls may encompass 200,000 to 400,000 square feet of retail space. b. They usually feature one or two major department stores as anchor tenants, and provide facilities to a variety of retailers ranging from convenience goods to shopping goods such as furniture and appliances. c. Regional shopping malls have a trade area extending from 15 to 30 minutes in driving time from the facility. 6. Super regional Shopping Malls a. Super regional shopping malls are a by-product of the nation’s high speed, limited-access freeway system. Ease and speed of travel have greatly expanded the trade areas of centers with good freeway access, enabling them to support much larger concentrations of retail facilities. b. In contrast to their regional counterparts, super-regional malls may feature as many as four major department stores as anchor tenants. c. They tend to be very large, often encompassing from 500,000 to 750,000 or more square feet of retail space. 7. Lifestyle Centers a. Lifestyle centers cater to upper-middle income consumers (household incomes of more than $75,000), who do not like to shop in regional malls. b. They house retail shops in a high quality, open-air setting near neighborhoods where upper-middle income consumers live. The appeal is short driving time, easy access by automobile, and convenient parking near the consumer’s store of choice.