In our weekly industrial meetings, this question often comes up; In a vacancy rate environment of less than 2%, and an industrial market of less than 40m square feet supporting almost 1m permanent residents and 8.5m tourists, why isn’t more industrial development?
No one could argue that Oahu has experienced challenges to industrial development over the past 8 years. First, the recession hit in 2008 whereby demand was low and banks were generally not lending on vacant land. Between 2010 and 2013, there was very little vacant land available. Now there is a perception that construction and raw land prices don’t support development, or that with long permit and construction times, a builder may “miss the market”.
We believe a deeper dive into the numbers show why there is a great opportunity for owner users and investors to develop industrial property on Oahu, specifically in Kapolei.
Sometimes we hear feedback that raw land in Kapolei is too expensive and has risen too quickly. To investigate, we pulled every comparable in Kapolei Business Park and Campbell Industrial Park since 2006. The ten-year average for vacant land between 2006 and 2015 was $29.77 psf. Current land prices hover around $33 psf. From this data, one could draw an inference that raw land in this area is a stable investment and that trying to time the market to save a few dollars is a risky endeavor. One could also infer that strong demand, coupled with land prices in town being over $100psf, land in Waipahu and Pearl City being north of $50psf, and land in Waipio Gentry being around $70psf, Kapolei has plenty of room for upward price movement.
Other feedback we hear is that total costs to develop and operate are far more expensive than simply leasing. Again, the numbers show this to be untrue. For perspective, Colliers year-end 2015 industrial market report noted a trailing base rent average of $1.17 psf. This is a blend of all industrial properties island wide in all physical conditions. While our base rent average has risen over 15% in the past 2 years, it has risen overall just over 5% since 2007. Many would argue that given our lack of inventory and the lack of overall base rent increases over the past 8 years, we are due for an uptick in our industrial base rent averages. This is already demonstrating itself for non-functionally obsolete product island-wide which has asking rents of between $1.20 and $1.50 psf.
We recently bid out two different development scenarios relating to a 2.5 acre parcel we have listed for sale at 91-103 Hanua Street in Kapolei. One scenario was a 56,040 square foot concrete tilt up warehouse with 30 foot ceilings, 4 sunken docks, over 3,000 square feet of new office, and 46 parking stalls. The other was for a 30,000 square foot metal building with 25 foot ceilings, 1 sunken dock, 1,000 square feet of office space, 40 parking stalls and ample yard space. The bid numbers came out to $7.6m, and $3.48m respectively. ($135 and $116 psf) We then added in the cost of the land at $33psf ($3.6m). Total development cost for option A was 11.2m, and 7.08m for option B. This included projected soft costs and Kapolei traffic impact fees.
If an all cash investor required a 6% year one rate of return on these developments, he/she would lease these buildings to a tenant for $1.00 psf for option A, and $1.18 psf for option B. (Including the excess raw land.) This investor could enjoy a year one 6% return and lease a brand new building for cheaper than our market average. To further support this, we just renewed two tenants in Kapolei who occupy a total of 77,000 square feet as high as $1.20 psf base rents. These buildings were built in the 70’s or early 80’s.
For an owner user, it is even more palatable. Not only would they control their own destiny, fix their operation costs, participate in the potential for appreciation, operate out of a new and functional building, and enjoy the huge benefits of mortgage interest deductions and depreciation, but they would enjoy an even reduced monthly payment. A user putting 20% down on option A ($2.24m) demanding a 6% return to himself on his money, and financing the rest at a 5% interest rate, would have a monthly payment equal to $1.02 per square foot compared to $1.00 psf if they were renting from the investor discussed above. This does not take in to account their own return or the tax savings of depreciation.
There appears to be plenty of leeway to safely account for many different equity and financing scenarios.
We are seeing compelling reasons for investors and owner users to build industrial space, and we are hopeful that this article spurs that discussion.