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NAIOP Panel Looks at Build-to-Suit Industrial Opportunities

By Darren Donnelly                                     June 24, 2005 

Low interest rates, rising construction costs, restricted land supply and uncertainty in the municipal approval process. These factors are affecting every sector of the real estate industry. At NAIOP’s June Breakfast an experienced panel looked at their impact on the industrial build-to-suit market.

The Panel

Lawrence Green of OPUS Building Corporation was the moderator for a panel consisting of Sean Ungemach, Associate Vice-President of Royal LePage Commercial, Raymond Heung, CEO of Madison Pacific Properties and Ron Emerson, President of the Emerson Real Estate Group.

Trends with Build-to-Suit Clients

Sean Ungemach, an industrial specialist and one of Royal LePage’s top brokers for the past several years, says that today’s industrial end user no longer assumes it will be a tenant and is frequently asking brokers to obtain both lease and purchase proposals. The reason, clearly, is low interest rates. The result of the highly competitive build-to-suit market is leverage for tenants to aggressively negotiate terms. Raymond Heung commented that the low interest rates provide a huge incentive for tenants to become owners instead. At the same time, there are too many developers chasing too few deals. Heung and Ron Emerson agreed that competition is so fierce in bidding scenarios that the winning developer is now often finding himself wishing he had finished second.

Green pointed out that most build-to-suit deals done in East Richmond lately have been lease deals. The reason, according to Emerson, is that the build-to-suit clients in that area have been large companies whose philosophy simply is to lease. In addition, low interest rates and competition have been forcing developers to accept lower returns and more risk. For example, landlords may now accept weaker tenant covenants and construct buildings with higher degrees of specialization. The more specialized a building is for a particular tenant, the more expensive it may be to build and the less marketable it may be if it comes back on the market at the end of a lease.

Successful Developers in this Market

Ungemach noted that in the build-to-suit market developers who own land in numerous markets have a better chance of securing more of the build-to-suit business. In addition, having a historically low land cost and in-house construction will help a developer compete effectively.

Heung commented that there are opportunities for speculative builders willing to take some risk. As the economy continues to improve and there is more demand, many tenants approaching the end of a lease are finding that they do not have time to wait for a build-to-suit property to be built. Not only have construction costs increased but construction time lines have become increasingly uncertain meaning that there are many end users who have to buy or rent what has already been built.

Emerson pointed out that, again, it is the larger developers who have an advantage in terms of availability and timing of construction. He has observed that some suppliers simply will not deal with smaller developers.

Effect of Rising Construction Costs

From the developer’s point of view the most obvious effect of rising construction costs, according to both Heung and Emerson, is that developers are winning bids only to subsequently have costs rise and "you’re dead in the water".

According to Ungemach, even though developers are indeed accepting lower returns, lease rates for new buildings are substantially higher than those for existing buildings. He predicts existing building rates will rise (hopefully as a result of an improving economy and informed landlords) but is concerned that at some point lease rates will become too high and tenants will choose to locate to other lower cost alternatives, potentially out of province.

Emerson’s experience is that in the face of rising costs build-to-suit tenants of new buildings are often scaling down original plans and taking out features in order to keep the ultimate lease rate in line.

Municipal Challenges

The panel was unanimous in its observation that there can be vast differences between municipalities in development approval processes. In Burnaby, there are no outright permitted land uses. Every use is conditional, so industrial users find themselves going through the rigors of both a rezoning process and a development approval process. Richmond, on the other hand, now has an I-1 zoning which allows numerous outright uses, making it very attractive to users. Emerson noted that for the Campbell Heights development in Surrey, where his company has been involved in all facets from rezoning through servicing and sales, they battled successfully for an outright use zoning because big international tenants simply have no interest in going through any development permit process.

Beyond zoning issues, there are huge differences between municipalities in how the various municipal departments interact with each other. In some municipalities this is a significant risk.

Campbell Heights – A Success Story

Green asked Emerson why Campbell Heights has been so successful when so many people thought it was "out of the way". Emerson replied that, when broken down into the various factors that are fundamentally important to developers and users, Campbell Heights is very attractive. The sand and gravel soil composition, for example, means that no pre-load is required, as opposed to many other areas in the Lower Mainland. The location can be approached from every direction, making it very convenient in terms of transportation. The zoning, as mentioned, allows the development approval process to be bypassed leaving only a design review process which apparently works swiftly and provides a high degree of certainty.

Opportunities – Where are the New Campbell Heights?

Ungemach advised that, for starters, there is still a fair bit of tenant absorption left to go at Campbell Heights for lots which were purchased by developers. Emerson mentioned that there are still several phases to come in Campbell Heights itself. Elsewhere, Ungemach noted that Colliers is marketing 80 acres in Chilliwack and there are numerous large transactions that have been announced in Chilliwack. Royal LePage is now marketing 40 acres in Mission as well.

Emerson noted that despite increasing container traffic build-to-suit opportunities are non-existent in relation to Delta Port and Fraser Port. The issue is that transportation infrastructure has not been planned to support increased activity. For example, there are no apparent plans to increase or change the traffic flow in the areas of the Dease Island Tunnel, which significantly restricts transportation to and from Delta Port.

Heung’s view is that build-to-suit is difficult to do and has been for the last two to three years. But, having said that, opportunities arise for those able to act quickly in response to changes in the market place. For example, his company has been doing joint ventures with build-to-suit tenants who wish to be owners but do not have the development and construction expertise to do it themselves.

- Darren Donnelly  
 

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