Document View

This article is intended to assist the appraiser that does not have in-depth experience with the industrial incubator category of industrial warehouse property. What drives value and design parameters for multi-tenant industrial incubator properties is substantially different from what is found in other warehouse categories. The small industrial user has different needs and priorities that influence design and appraisal analysis. An understanding of the characteristics of industrial incubator properties should assist the appraiser in selecting comparables and making appropriate adjustments. [PUBLICATION ABSTRACT]

There are key characteristics that distinguish industrial incubator properties from other warehouse properties. What drives value and design parameters for multi-tenant industrial incubator properties is substantially different from what is found in other warehouse categories. The small industrial user simply has different needs and priorities that influence design and appraisal analysis. An understanding of industrial incubator characteristics should assist the appraiser in selecting comparables and making appropriate adjustments.

Industrial Incubators Defined and Described

Definition within Southern California Marketplace

The construction of contemporary industrial incubator buildings began in the 1980s. Within the Southern California market, these types of faculties now are approximately 10% of the total industrial inventory.

The following is a working definition of industrial incubator. It describes the common characteristics that the authors have found on visits to large number of these facilities in the Southern California market

An industrial incubator is a multi-tenant facility that is specifically designed to provide basic warehouse space to small industrial users. This property type is typically characterized by concrete tilt-up construction, clear heights under 15 feet, loading by overhead doors only, inclusion of 5% to 20% office space, and tight truck circulation areas designed for side loading only. Each tenant has a separate entry and signage area to maintain their separate business identity. Parking areas are shared by all tenants and customers of the tenants.

The typical size of these buildings, ranges from 20,000 to 100,000 square feet, with from five to fifty tenants. Examples of industrial incubators and their key characteristics are shown in Figures 1-4.

Literature Search for Suitable Definitions

Before presenting a customized definition of this category of property, the authors conducted a search for existing definitions of industrial incubator. The results indicate that the term typically is being used either without formal definition or with a definition that is less complete than the working definition presented in this article. Some examples include the following.

* The National Association of Industrial and Office Properties (NAIOP) does not include a definition of a multi-tenant industrial incubator in its NAlOP Market Terms and Definitions. However a chart of the different industrial property categories lists "incubator" as one category or use of space under general purpose flex buildings.1

* The City and County of San Francisco Planning Department has a glossary of planning terms. There, incubator space is defined as "retail or industrial space that is affordable to new, lowrent paying businesses."2

* The Appraisal Institute's book Appraising Industrial Properties includes a photograph of a typical multi-tenant industrial incubator as one of the categories of industrial property.5 No definition or discussion about this category is included in the text.

* In several major metropolitan areas, Grubb & Ellis provides vacancy rates and rental rate data on four categories of industrial property: research and development, general industrial (manufacturing), incubator (IMT), and warehouse/distribution.4 The survey does not define the term incubator. However, the rents and vacancy rates are typically substantially different from the other industrial categories.

* In the Urban Land Institute's Business Park and Industrial Development Handbookuie term incubator parkis discussed.5 However, the emphasis is on research or technology parks, where local communities provide low-cost space in addition to shared services (reception, duplication, etc.). The shared-service component and the research or technology focus are not part of the working definition used in the present article and are not representative of what is typically found in the Southern California marketplace.

Note that industrial incubators are for-profit, unsubsidized rental properties that should not be confused with "small business incubators." Small business incubators are programs partially funded or subsidized by governmental agencies to support and assist start-up businesses. In contrast, the industrial incubator facilities being described here simply lease space to tenants without any construction or operating subsidies and without sharing of reception and support services.

What Is Different About Analyzing Industrial Incubator Facilities?

Industrial appraisers that have become accustomed to appraising other types of warehouse facilities may find themselves either making improper adjustments or selecting inappropriate comparables. This could occur if they try to apply the same logical approach used for other warehouse facilities when valuing this property type. Consider the following logic that applies to most categories of warehouse properties, but does not apply to industrial incubator facilities.

* For most types of warehouse uses, greater clear height (height to the bottom of the truss) means greater utility to the user for storage purposes. Within practical forklift access limits, more height means more storage capacity.

* For most types of warehouse uses, the availability of loading docks or dock-high facilities is a desirable feature that enhances utility and value. This feature makes the loading process more efficient

* For most types of warehouse uses, the availability of truck circulation areas sufficient to allow semitrailer access is a desirable feature that enhances utility and value. Again, this feature makes the loading process more efficient.

* For most types of warehouse uses, the presence of long-term leases enhances value.

Enlarge 200% Enlarge 400%

Enlarge 200% Enlarge 400%

Industrial Incubator Users

Physical Considerations of the Small Industrial User

The typical industrial incubator user is a business in an early phase of growth in its business category. This type of user requires roughly 1,000 to 3,000 square feet of warehouse space with 5% to 20% allocated to office space and the balance being warehouse space. Consistent with the small space requirement, an idustrial incubator tenant is typically a low-volume operation that requires less frequent loading and unloading operations and small load size.

Financial Considerations of the Small Industrial User

Industrial incubator users normally prefer rental of space to minimize the financial burden on their startup businesses. With less firmly established revenues, the flexibility of short-term leases is preferred. Being locked into a long-term lease or a mortgage is less important than flexibility to move to a different location if the business expands or contracts within its less-established revenue patterns.

Enlarge 200% Enlarge 400%

Enlarge 200% Enlarge 400%

How Do Small User Considerations Translate into Facility Design?

The authors have formed impressions of the small industrial user and how industrial incubator facilities are used over an extended period of time. These impressions are a result of (1) surveying of local brokers handling industrial incubator properties, and (2) visits to a large number of similar properties to observe key characteristics and actually document key measurements. These visits covered geographic areas that included approximately 10% of the total San Diego County industrial inventory. Based on these observations of the industrial incubator property type, the following characteristics have been found to be of importance.

Truck Circulation Expectations Are Minimal.

For most industrial incubator buildings, access is designed primarily for pickup trucks and passenger vehicles. Use of forklifts and side loading and unloading is a necessity for most industrial incubator buildings. Truck circulation expectations are minimal, and the typical area available for truck circulation is a 25- to 35-foot radius. (Figure 5) Over 90% of the industrial incubator buildings visited fit this profile. This consistent configuration is in contrast with a 40- to 45-foot required radius for semitrailer trucks and a 42-foot distance for a single-unit truck to load perpendicular to a dock-high facility or overhead door.6 These 40- to 45-foot distances also represent the minimum distance between overhead doors and opposite parking spaces to allow clearance, assuming the vehicle backs up to the overhead door. The majority of industrial incubator properties have portions of the facility that cannot be accessed even for side loading by semitrailer trucks or single-unit trucks (30 feet in length or more).7 In examining such buildings, the authors have found multiple examples of extremely tight truck circulation with no adverse impact on occupancy or rents. This would not be expected for other categories of warehouse space.

Clear Height Expectations Are Minimal.

Clear height is the distance from the warehouse floor to the bottom of the roof truss. Clear height is an indication of how high goods can be stored or stacked in a warehouse space. Clear height expectations are minimal for industrial incubators, with most incubator buildings having clear heights of 10 feet to 14 feet This contrasts with a typical clear height of 16 feet to 35 feet for other categories of warehouse properties. In fact, for other categories of warehouse properties 10 feet to 14 feet of clear height often would be considered functional obsolescence.

Long-Term Leases Are Not a Benefit.

For industrial incubators, long-term leases are not seen as a benefit. This information comes from broker and property manager interviews. Over time, property managers have come to the conclusion that either short-term or month-to-month leases are preferred for this category of businesses. Small businesses generally are considered a higher credit risk. This is not a criticism, but a reflection of data on default rates and how the credit markets perceive such businesses. When a tenant runs into difficulty, a property manager prefers to be able to act quickly to replace the tenant with a minimum of legal cost and effort. In a large industrial incubator facility, a property manager may have twenty to forty tenants or more. Many of these may have marginal credit and profitability. Tenants on long-term leases are more difficult to evict than those on month-to-month arrangements. Additionally, some states have laws that strongly favor tenants. With this in mind, many property managers are structuring their industrial incubator facilities with month-to-month leases only.

Rents in Incubator Facilities Are Substantially Different from Those in Other Industrial Warehouse Properties.

The rental structure for industrial incubator properties also does not fit well with other industrial uses. A look at survey reports from several different regions of the country indicates that rental rates and vacancy rates are substantially different for this category of property than they are for basic warehouse space.8 The differences are in part attributable to size difference, different credit risk, and generally shorter lease terms.

Demand for Incubator Space May Be Substantially Different from Demand for Other Industrial Warehouse Properties.

Many industrial incubator tenants can readily be described as mom-and-pop businesses. What drives small business growth may be somewhat different from what drives larger industrial users. Smaller businesses may be focused more strongly on local or regional markets, while larger companies may serve national or international markets. So, the economic drivers will have some differences and demand can be expected to be different

Selection of Proper Comparables

The discussion in this article has addressed differences in size, credit risk, and lease terms for industrial incubators versus other warehouse properties. The discussion also has covered how greater clear heights, truck circulation areas, and improved loading facilities do not add value for this category of property. This range of factors underscores the importance of using other incubator properties as comparables when such comparables are available. Use of other types of warehouse properties may provide a less reliable result If other warehouse properties must be used as comparables, then adjustments for the characteristics mentioned should be considered and made if applicable. Where feasible, other warehouse properties with relatively similar clear heights, truck circulation, and loading should be used. Otherwise, the conceptual basis for adjustment is questionable. Would a small user pay more for higher clear height, better loading facilities, or better truck circulation if they have little need for them and a minimal budget?

Enlarge 200% Enlarge 400%

Conclusion

The industrial appraiser should be aware of the key characteristics that distinguish the industrial incubator category from other industrial property categories. This awareness should assist the appraiser in selecting proper comparables and making appropriate adjustments.

[Footnote]

1. National Association of Industrial and Office Properties Research Foundation, NAlOP Terms ana Definitions: U.S. Office and Industrial Market (Hemdon, Virginia: National Association of Industrial and Office Properties, 2005), 12.

2. City and County of San Francisco Planning Department, "Glossary of Planning Terms," www.ci.sf.ca.us/site/planning_index.asp?id=25365.

3. Bodie J. Beard et al., Appraising Industrial Properties, ed. Michael D. McKinley and John A. Simpson (Chicago: Appraisal Institute, 2005), 37.

4. Grubb & Ellis Research, Industrial Market Trends San Diego (San Diego: Grubb & Ellis, Third Quarter 2006), 4.

5. Anne Frej et al., Business Park and Industrial Development Handbook, 2nd ed. (Washington, DC: Urban Land Institute, 2001), 6.

6. American Association of State Highway and Transportation Officials, A Policy on Geometric Design of Highways and Streets (Washington, DC: American Association of State Highway and Transportation Officials, 2001), 20, 29-35.

7. Ibid.

8. Grubb & Ellis.