You’ve been in business for several years and it is profitable. You have a decision to make: Do you want to invest in the business and buy a facility, or will you continue to lease?
With the help of your accountant, you should carefully examine the anticipated capital requirements of your business. Evaluate your ability to obtain capital or loans. Don’t box yourself into being cash poor and unable to meet business obligations or take advantage of opportunities.
“The prevailing reason that businesses fail is insufficient capital. Draining capital to pay for a real estate project could be a cause,” says Howard N. Greenberg, managing member at Semanoff Ormsby Greenberg & Torchia, LLC.
“My colleague, Jeffrey Rosenfarb, a principal in Hart Corporation, a national industrial real estate firm, advises that small manufacturing firms overwhelmingly desire to own versus rent, whereas larger corporations generally prefer leasing.”
Smart Business spoke with Greenberg about some pros and cons of leasing or purchasing industrial real estate.
What issues should be examined when considering purchasing a facility?
First, what’s the nature of your business? Manufacturing that utilizes heavy, difficult-to-move equipment is where purchasing may be desirable, to avoid being at a landlord’s mercy when your lease expires. Or is it light manufacturing or distribution, that moves easily?
Second, can you obtain a facility that will remain adequate for your needs? Plan for potential future expansion. Have your counsel review the local zoning code to determine what can be built, either now or in the future.
Do you contemplate children in the business? Real estate can provide a source of income and inheritance. Counsel will need to prepare an agreement that deals with numerous issues including governance, death, disability, termination of employment and sale of the business.
Where do you want to invest your limited capital? Be sure that you will not need capital to expand your business versus acquiring a building. Lending rates are at historic lows, encouraging acquisition. Consult counsel concerning special types of financing such as tax free industrial development or state-provided financing, as well as tax abatements.
What issues should you consider if you determine to lease?
Check locally to ensure there are adequate reserves of industrial rentals available. With any lease, secure options to: extend the term; terminate early; purchase the building; for a right of first refusal; and for the ability to assign the lease or sublet in connection with your business sale.
If I decide to purchase, what entity should purchase the property, and how should the lease be structured?
Keep the building owner entity distinct from the entity that occupies it. The building owner entity should be a limited partnership, limited liability company or S corporation to enable you to utilize tax advantages like depreciation and amortization, and to permit gifting. Also, you may want to divvy up interests differently in the operating company versus ownership in the real estate company. You could decide to bring a partner into your business, but not into the building ownership.
You will need a lease between the two entities, especially if you’re going to sell the business and not the real estate. As a landlord, limit the tenant’s options and set a reasonable term.
Does new construction make sense versus purchasing and rehabbing an existing building?
With new construction or significant rehab, you must have a reliable contractor and architect. Assume that it’s going to cost at least 15 percent more and take 15 or 20 percent longer than initially estimated. Weigh the aggravation of new construction versus having your building the way you want. However, over the past 15 to 20 years, sale or leasing of existing facilities has far exceeded new construction, per Rosenfarb.
Buying and holding an industrial property usually works out well for the owner. For heavy manufacturing, building ownership, or a long-term lease with renewal options, is the way to go.
Howard N. Greenberg is a managing member at Semanoff Ormsby Greenberg & Torchia, LLC. Reach him at (215) 887-0200 and email@example.com.
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To the surprise of many, manufacturing is growing in strength in Northeast Ohio, and manufacturing properties are rapidly being bought up.
Terry Coyne, SOIR, CCIM, an executive vice president with Grubb & Ellis, says interest rates are low and demand is real, but the vacancy rates for manufacturing properties haven’t come down to the point where there have been dramatic price increases.
Bearing in mind that, in real estate, industrial property is a leading indicator of economic trends, says Coyne.
“The big-picture story is that manufacturing is leading industrial out of the recession in a hurry,” says Coyne. “It’s a good time to be a landlord and a bad time to become a tenant, which we haven’t said in three or four years.”
Smart Business spoke with Coyne about the office and industrial real estate markets in Northeast Ohio, and the conditions that have put it where it is today.
What’s happening with real estate in Northeast Ohio?
Industrial’s vacancy rate is almost always historically lower than the office vacancy rate. In Ohio, we’ve got many industrial companies, so prospective buyers have more of a base to choose from. There are fewer office properties because we’re not a headquarters-type location for regional offices. Currently, Akron’s industrial vacancy rate is 10.6 percent and office vacancy is 11.9 percent, while Canton’s industrial vacancy rate is 9.5 percent and office is 11.6 percent.
We went into the recession with high vacancy rates and are coming out with vacancy rates that are decreasing at a speed I’ve never seen. We’re down 100 basis points in nine months, which is good for any market in the U.S.
If you have a building that has any manufacturing capabilities, such as a crane, or a lot of power, or that is near railroad tracks, it’s a great time to be an owner. It’s surprising how quickly we’re coming out of the industrial recession.
The market for office properties has mostly stabilized and has turned the corner. There aren’t as many vacancies coming online because the unemployment level has gone down quarter over quarter in our metro area for three quarters in a row, and that’s reflected in absorption in the office market.
We are seeing better rental increases in industrial, better sale prices relatively speaking in industrial and, if things continue, office-type jobs should see a rebound in the next 12 to 18 months.
What’s driving this trend?
Real demand is increasing because manufacturers that have survived the recession are adding capacity or are reshoring and bringing jobs back to the U.S. The increase in transportation and labor costs in China and Asia means that the financial delta between operating there and in the U.S. is not that great. As a result, manufacturers are mitigating their risks, especially in regard to quality and timely delivery, by having goods produced here.
Also, the manufacturing market is very strong because of organic growth and, especially in Akron and Canton, because of oil and gas. The oil and gas market is adding jobs and absorbing industrial buildings, and Canton has become a headquarters for office space for those in the oil and gas market, positively impacting the region.
How is demolition impacting the real estate market?
Scrap prices were high a few years ago up until last summer. When scrap prices are up, demolition increases, but prices have since come down for ferrous metals. As a result, demolition won’t increase again until the price rises above $400 per ton. There are a lot of people combing through our market looking for the next building they can demolish, but a lot of it has been picked over.
Demolition affects the market because it wipes out buildings that are functionally obsolete. Those types of properties tend to attract low-end tenants that don’t generate a lot of income tax for cities or much in real property taxes. So from a big picture, macro perspective, demolition is a nice way to clean things up.
What about repurposing?
The competition to repurposing is demolition. It’s interesting because a lot of those opportunities are gone. And now that users have real demand, they are becoming competitors to redevelopers.
I think you’ll see a little less repurposing because we are a market that likes to own buildings — put a loan on them, build up equity and sell them. In the past three or four years, it’s been hard to get a loan, so it’s been a great time to be a redeveloper buying up properties and leasing them to those who can’t get loans. Now, however, loans are easier to get, demand is real and that will slow down the redevelopment side of the world.
Is now a good time to buy?
Low natural gas prices mean that if you’re a manufacturer, you want to locate here because one of your materials is cheap. Add that to the trend of reshoring and organic growth, and now you have three demand drivers that are real, whereas in the past you only had one.
Is it a macro shift? I hope it is, because then you’re looking at something that’s generational in scope, and if that’s the case, you’d better buy something as fast as possible.
Also working to our advantage is that when people manufacture items in the U.S., they make them in the Midwest. People are coming back, and all those laborers with the necessary skill sets and the infrastructure are here, so if you’re going to bring it back, you’re going to bring it back to where it was made the first time.
Terry Coyne, SOIR, CCIM, is an executive vice-president with Grubb & Ellis. Reach him at (216) 453-3001 or firstname.lastname@example.org.
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