An Insider’s Guide to Industrial Real Estate Part II

What Are the Different Kinds of Industrial Tenants?

Industrial tenants can run the gamut, but generally they fall into two types of companies: manufacturers and distributors. Some companies will have a mix of both manufacturing and distribution but will lean more heavily toward one versus the other.

What Makes an Industrial Tenant “Sticky?”

Chicago, like many big cities, has a strong manufacturing base, and therefore, our company tends to focus on manufacturing tenants. These companies tend to have big machinery that, once installed, is difficult to move. This makes them what we call “sticky” tenants; the cost to move their machinery is cost prohibitive, so these companies will often stay for ten, twenty, or even thirty-plus years.

For example, we have a tenant that manufactures magnets for medical equipment. They have 160 machines. The cost to move their operation from one facility to another is simply cost prohibitive. Instead, as companies like this grow, they’ll look to expand into adjacent facilities or others located within walking distance. The most sophisticated machines need to be disassembled into pieces and moved by specialty movers, which can cost $10,000 per machine or more.

The cost of moving a distribution facility is significantly easier. Distribution tenants can bring trucks in, load up their pallets, and move these pallets to their new building. They can move over the course of the weekend.

How to Determine the Creditworthiness of an Industrial Tenant

There are many ways to evaluate the creditworthiness of an industrial tenant. Typically, large, corporate companies like Amazon and Walmart are considered the safest, most creditworthy tenants. Government agencies also tend to be creditworthy. We have the US Postal Service as a tenant in one of our buildings, which has been the envy of some of our competitors. Government agencies might not be willing to pay a premium for their space, but it’s almost guaranteed that they’ll pay their rent (even if not always on time!).

There are other ways to look at a tenant’s credit worthiness.

At Brit Properties, we take a comprehensive look at a business. We’ll start by visiting their existing facility to see how much activity is happening there, how many people work there, and how long those employees have been there. Longevity is important to us because consistency matters to an industrial landlord.

If we’re comfortable with the existing operation and feel that there’s a deal to be made, we’ll then ask to see the company’s financial statements. We don’t ask about financials before that because financials are highly personal—this is information that most companies only share with their executives and lenders. Therefore, only when we’re close to signing a lease will we probe further. It’s a bit like dating: move too fast, and you’ll turn them off.

When we get to the point of looking at financials, we look at three major things. First, we want proof of their annual sales. Second, we want to know about the company’s profitability. And third, and perhaps most surprising, is that we want to know about the company’s customer base, including how many customers they have and the size of those customers as a share of the company’s revenue.

This third factor is especially important. We’ve had situations in which a tenant relies on a single customer for 50% or more of their revenue. Even though it was a long-term customer, an unexpected turn of events (e.g., hiring a new purchasing director) can result in that contract being canceled. When this has happened, we’ve had tenants who call and explain they can no longer pay the rent and may need to go out of business altogether.

When looking at a tenant’s credentials, we also want to spend time getting to know their business. We want to know the company’s story and understand their products. Sometimes, a tenant who might have less-than-stellar credit might otherwise be a compelling tenant once we get to know more about the business plan, operations, and long-term goals. In cases like this, we might be willing to take on more risk for a highly promising company that may not otherwise have the credit we’d expect.

We don’t always get it right. For example, we no longer do business with automotive companies or moving companies. We’ve had bad experiences with both of these types of tenants. One of the most trying situations is when we had to sue an auto body shop for nonpayment of rent. The client turned around to countersue us, arguing that we hadn’t put a security system in the building which, under the lease terms, was his responsibility. His wife even threatened us, saying the tenant was going to “kill” us—which wasn’t altogether impossible (we later learned he had done prison time for assaulting someone else). In any event, this is an example of when we didn’t do our due diligence on a tenant and paid the price. The court eventually tossed the countersuit and found in our favor, but it taught us not to work with automotive companies moving forward.

Of course, there are exceptions to this rule. We know the Chicago-area industrial market so well that if a start-up tenant approaches us, we can usually find someone else who knows the founders of that company who could vouch for them (or not). Whenever leasing to a start-up industrial company, reconnaissance is very, very important.

Leasing to Start-Up Industrial Companies

Our industrial properties are not designed for tenants like Amazon or Walmart, but they aren’t ideal for start-up industrial companies either. Our buildings tend to be mid-sized, which makes them more suitable for companies who have been in business a bit longer and have a more established track record. For that reason, we tend not to lease to start-up industrial companies.

Why Establishing Relationships with Industrial Tenants Matters

In our 30+ years in business, we have only had a bad experience with three or four industrial tenants. This is because we spend so much time getting to know prospective tenants before ever signing a lease. Then, we nurture these relationships over time.

The Importance of Industrial Real Estate Tenant Renewals

Tenant renewals are important for landlords in any industry, but this is especially true for industrial landlords because tenants tend to occupy entire buildings and those buildings can be difficult to release, leaving landlords with significant carrying costs in the meantime.

This is why we begin the lease renewal process early. We are usually in contact with a tenant between eight and twelve months prior to their lease termination. Because we know our tenants well, and because we are hands-on property managers, we can usually get a good sense for whether a tenant will be renewing or not.

It might be that a tenant does not want to renew because they need more space. In situations like these, we can start looking for new buildings that better accommodate their needs, and then we can begin targeting other industrial tenants to backfill their existing space.

It’s not uncommon for industrial tenants to hire a commercial real estate broker to help them negotiate their lease renewals. This is a good way for the company to ensure their interests are protected when negotiating with a landlord, who has their own best interests in mind. We’re always willing to work with brokers, who usually earn about a 3% commission on the lease renewal. This is worth the cost for us to keep our valuable tenants in place, which takes away the risk of vacancy.

How to Market to Industrial Tenants

While lease renewals are ideal, tenants inevitably turn over, and we need to backfill those spaces. This is where broker relationships come into play. The Chicago industrial market is a very well-established broker market. Almost every tenant is represented by a broker, as is almost every industrial landlord. It is a very tight-knit, highly engaged community. It’s not uncommon for 50+ emails to be exchanged between the broker community each day. Many of these communications are asking about what sort of space is available or what types of space tenants need. Therefore, when it’s time for us to lease an industrial building, we always turn to the broker community first.

Another marketing strategy we use is to post our properties on national databases like LoopNet or CoStar. Typically, it’s not tenants who look at these sites but instead, the brokers who represent these tenants.

Why Non-Profits Can Be Great Industrial Tenants

Many landlords will shy away from leasing to nonprofits, many of which are reliant upon fundraising and donations to stay afloat. But in our experience, nonprofits can be great industrial tenants. The key is to do due diligence on these tenants just as you would any other—which includes looking at the nonprofit’s financials.

Understanding the Chemicals Industrial Tenants Use

The manufacturing industry has many companies who use oils, solvents and other chemicals that can potentially cause environmental contamination. Prior to signing a lease with any new tenant, we ask about the products they use and how they contain those materials to prevent hazardous spills or damage to the building.

Our leases also contain nearly two full pages related to environmental considerations, including which types of chemicals they can or cannot use. If the company uses chemicals that we’re unfamiliar with, we’ll discuss with a local engineering group who provides us guidance as to whether those chemicals are of concern or not. We do our best to ensure that no dangerous chemicals are brought on-site.

That said, if a tenant wants to use a dangerous chemical without our knowledge, it’s possible to do so. There is a chance we might never find out, and as an industrial landlord, that is a risk inherent to our business that we must take. It’s no different than leasing a residential apartment and taking on the risk that the tenant engages in prohibited activity—anything is possible; it’s on us to use leases that protect our best interests in the event they do.