Industrial

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Industrial Rents
Industrial properties lease to tenants by a variety of methods depending on the marketplace and the design. Depending on the type industrial property, the lease may be gross, industrial gross, modified net, or triple net.

A dock high warehouse in a big box layout will generally have a high clear height and minimal office space. The base cost of the building is relatively high but there is little buildout and low operating expenses. There are fewer tenants in this type project and most are large, credit-worthy tenants performing large manufacturing operations, bulk storage, or freight handling. Rents are more homogenous among these tenants. Such users can be found mixed with other types of tenants in some projects, but for the most part this type of warehouse project is uniform in its users. Rents are industrial net with the tenants paying only a small portion of common operating expenses.

On the other end of the spectrum (with some other industrial types in between) service center industrial properties are more office- and retail-like in their design and use, effect higher rents, have a wider range of users, and lease to smaller and lower credit tenants. Whereas the rents are higher, the risk is greater. Some of these spaces can be virtually all office (i.e., high improvements) and many are more technical for such manufacturing as electronic components. Leases can range from gross to triple net with the basic premise that these tenants pay all or most operating costs.

There are several layers of industrial types between these two – generally a mix of various percentages of each. It is important to define the classification of an industrial property before starting a comparison or income analysis.

We believe that each industrial property can be divided according to the type and size of boxes. Moreover, all tenants in each category – each size and style – should be analyzed according to the same basic rent; i.e., all tenants in a certain size range within the type should be at the same rent.

We look at market indicators and reports of industrial rents according to classification, then review recent leases made in each project. It is important to ascertain the incentive allowance and buildout for each deal to determine if the rent is influenced thereby. Once we define the rent for the market segment, we say that all tenants in that range should pay the same rent. If there are no deals made for larger or smaller spaces for which we believe there should be a rate variance, we can extrapolate a rent based on previous leases and market conditions for those categories.

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Industrial Properties
The statistics contained in an industrial analysis should be a collection of factual data and opinions of market conditions with respect to the measures of value commonly applied in real property appraisal. We seek to compare actual performance (demonstrated by the rent roll and accrual operating statement) with market conditions to arrive at an opinion of market value as defined by text in the Texas Property Tax Code and by case law derived from trials applying these laws. The fee simple appraisal method is the correct method.

A fee simple income model considers:

1. Tenants in place and leases made
   1. Evaluating leases made in the last year according to market standards and by analyzing potential non-standard or non-real estate influences on rent.
   2. Measuring occupancy of the subject against published occupancy reports.
2. Configuration of the real property improvements and an assessment of the relationship of the subject property to contemporary market standards.
   1. Size and shape of buildings – rent stratas based on size.
   2. Adequacy / superadequacy of improvements.

We have applied the following theories to all of our models:

Rents
Fee Simple Rent is the amount that is paid to lease the real estate and building improvements with standard market allowances for leasehold improvements, standard market incentives, and standard market leasing commissions. Any influences exceeding that of the real estate and related market standards may be considered intangible, such as:

1. Attraction of credit tenants (the allure of the business influence of these tenants).
2. Attraction of management expertise and ownership intentions and capabilities.
3. Excess TI’s or incentives – in effect, an amortizing loan to enter the lease.

The tenant who gets the best deal – the lowest rent – achieves the closest to market rent. Large tenants get lower rent because they reduce risk. Any property can be analyzed for rent based on configuration of the improvements and relative occupancy by large and small tenants. Rents are stratified according to size.

Occupancy
As rents are rising in a market (timely and/or geographically), occupancy will decrease and
should be constructively realized.

Operating Expenses
A property that is leased at market standard occupancy operates at market.
A property that is over or under occupied for market standards will realize
expense changes with occupancy changes.

Reserves
Any and every prudent investor/buyer will consider the cost of repairs to maintain the property
as well as the ongoing cost to sustain and replace the income stream, and will accrue these funds as an operating expense.
Income replacement costs include: Tenant improvements, real estate commissions, legal fees, and such other incentives as free rent, relocation allowances, and design services.

Capitalization Rate
The effective cap rate should consider the influences of age, condition, location and relative
market status of the subject but not the influence of creditworthiness of tenants. Moreover, there must be a balance among rents, occupancy and cap rate factors. Highest market rents and occupancy cannot match with lowest cap rate (there is no upside potential). By deducting the cost of taxes in operating expenses and adding the tax rate to the cap rate (loading the cap rate), a fair and accurate analysis is made.

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