The Different Types of Industrial Investments: Owner User

The Logistics of Leasing

The term owner user refers to a business that both owns and uses the building. It is the simplest first step towards ownership for companies. Most small businesses initially lease 1,000-10,000 SF until they reach a stable size and profitability and decide it is time to own instead of lease. Owner user buildings are usually smaller in format from 3,000-10,000 SF. Companies that are buying their first building for their business get a bank loan. Anecdotally, 75% of these buyers utilize SBA loans, and 25% use conventional financing.

An SBA loan is known as the poor man’s loan in that it is the loan that requires the least amount of down payment. As a result, most people use this for their very first purchase. The down payment for 99% of industrial property buyers utilizing an SBA loan is as little as 10% of the purchase price. I helped my local veterinarian purchase his building with 0% down payment, but that was on a property loan from a bank that specialized in veterinarian banking. Who knew there was such a cottage industry!

The structure of an SBA loan is a composite of two loans. The first loan is for 30-40% of the purchase price and is the portion lent by the SBA. The second loan is for the remaining loan balance and by a conventional bank. The SBA is happy because they are promoting small business growth and ownership, and the conventional bank is happy that they are only loaning out 50% loan to value, so they have less skin in the game.

Typical amortization for these types of loans is 25 years with the loan being due in 25 years as well. Interest rates are fixed for a period of time before being adjusted every few years at regular intervals.

If you choose to pay off your loan before the first three years, you will be subject to a prepayment penalty. Prepayment penalties provide stability for banks loan portfolios since many banks keep smaller commercial real estate loans on their books.

A conventional loan has much of the same terms but with a larger deposit that usually represents 25%-35% of the purchase price. Loan fees are generally 1-2% of the loan amount and are negotiable depending on the bank.

Loan brokers are a borrower’s best friend. A loan broker’s job is to know all lenders in the market, shop your loan to the best banks, and negotiate favorable loan terms. You can do it yourself if you are so inclined. I have found the best results working with a loan broker because there are too many banks in this space to know which one is best. It takes an incredible amount of time to fill out each bank loan application. Haggling on all of the deal points is best with a buffer as well, so that you don’t get too emotionally involved with any given bank at first. I wouldn’t say that I enjoy this part, but I do find satisfaction in figuring out all of the players and finding suitable options.

There is no warranty period where the landlord is going to fix anything that is not in good working order in a purchase. Here you will want to hire an inspector to walk the property and provide an inspection report for you that will detail every nook and cranny of the property. You must take ownership of the inspection process as you will find that inspector is not you, they never will be, and they can’t possibly be as vested in the process as you. You should verify everything with your own eyes or, better yet, have some of the different construction trades come in, with your inspection report in hand, and give you a real assessment of the cost to bring deficient items up to snuff.

Inspectors offer different inspection packages. These packages differ in the level of detail. The more thorough inspection packages will provide an estimate of the remaining useful life of all of the building components and show you where each part of the building falls within that useful life. The most detailed inspection includes budget line item costs for each building system. The budgets can help you prioritize big-ticket building systems when negotiating seller credits.

Phase 1 reports are reports that your bank will require you to have completed for the property. This report is one that a qualified consultant will prepare. They research public databases for environmental regulatory boards within the property’s city, county, and state municipalities to see if there are any active environmental concerns or if there were ever any in the past. This report will usually tell you if the property ever had underground storage tanks, the status of their removal, and soil remediation at the time of removal. The report will let you know if there were ever any unsafe chemicals used within the building that were publicly disclosed. Over time different chemicals have been deemed unsuitable for use within warehouses. Some of these chemicals are susceptible to leaking into the slab and contaminating the soil and groundwater. The reason the bank requires these reports is to have a full picture of the property and the risk associated with it. Remember that if you do not pay back your loan, the bank will take the property from you, and any environmental issue related to the property will be their problem.

Now all of this discussion of buying an industrial building for your business to occupy isn’t exactly for pure investment since the building is serving the dual purpose of being a place for your business and investment in industrial real estate.

Most CPAs promote property ownership for tax purposes and suggest that the building is in a separate LLC. The general framework is to maximize your company’s tax savings by having your company lease while maximizing your personal income tax savings by owning the property. In this instance, your company can write off its lease expenses, property tax, insurance, and maintenance expenses. The building ownership entity can depreciate the property improvements, write off the interest paid on loan, have the tenant effectively pay down the mortgage, resulting in cash flow and potential for appreciation to the ownership entity.

There is always a dichotomy and healthy tension between what rental payment the company is making to its landlord. This moment of stress is where transparency and open discussion between the business owners and the building owners is involved if there are any differing ownership percentages between the two entities. In this instance you are both landlord and tenant.

For example, let’s imagine you are the CEO of the company, but you only own 75% of the company stock, and your partners own the remaining 25%. Yet, you are the sole building owner. You can see how you might be inclined to want to have the company pay a slightly higher rental rate to maximize your building income if it is not of material consequence to the company. You have conflicting fiduciary responsibilities at this point. Whenever that is the case, the best thing you can do is disclose this conflict. Be very transparent about how you will address these fiduciary responsibilities and how they affected the final rental rate outcome.

Owner User to Investment

When I think of investment in single-tenant buildings, I usually see the owner/user model as a practice run. Once you make this initial investment, the benefits become clearer, and you have developed your management style, you will find that you now have a skill that you can turn into an investment platform. In a perfect world, the business owner would be able to keep the first building and buy the next larger building when they are ready to grow to the next size. The older, smaller building would be put on the market for lease and leased out to a new tenant.

There are many different variations of this theme. Another typical example that works well for business owners is when they keep trading up to a larger building as the business grows. Eventually many business owners decide it is time to sell the business. When they do this, they can sell the company and keep the building. Business owners consider this the perfect retirement when they can move on from the day to day management of the company and now have passive income from a tenant they know intimately.

I’ve seen this play out with business owners in buildings 5,000 SF, 20,000 SF, 100,000 SF, and larger. The only limit to the size of this outcome is the scale of the business and the ultimate footprint that the business needs to be successful. This idea also scales geographically. For example, there is a landscaping pipe supply company that purchases 5,000 – 10,000 SF industrial buildings. These buildings must have a small yard for outdoor storage, which is rare. Once they find the right building, they buy it. Over the years, they open a new branch in a new city, expand to a new county, then to a new state, and purchase each building along the way.

Another industrial private equity fund started with a business owner that was an apparel manufacturer. Over the years, he had built a substantial business manufacturing out of several different facilities in multiple markets within the United States. What he found upon the sale of his business is that he was more successful with the industrial building investments than the manufacturing business itself. In true entrepreneurial form, he went on to raise private equity funds to scale his industrial investment business which he operates to this day.

The concept is that acquiring and managing industrial real estate is a skill set. Once you have built this skill set, it is a craft that you can now put to work to be able to create value in the marketplace.