Robert L. Dragoo
Historically, industrial parks have been constructed as horizontal property regimes in Colombia, Mexico and Peru. In this structure of development, land is grated and compacted, infrastructure built-out, and finished industrial lots sold to investors and users. There are clear pros and cons to this development model and it is evident that stratified ownership of industrial parks is declining. As local and foreign capital participation in the sector increases more investor owned or wholly-owned parks will become increasingly prominent and dominant. Mexico has transitioned to a wholly-owned industrial park development model, and Colombia and Peru have seen advances towards it.
High IRR for Developer - Developers of industrial parks can often structure JV agreements with landowners, and generate high IRR returns by developing a stratified industrial park and selling finished lots. Presales can be used to fund infrastructure – and the exit of the developer can happen relatively quickly.
Land Carry Risk – The developer of an industrial park exits the project relatively quickly. Lots are pressold and delivered – the purchaser of the finished lot is left with the land risk. The finished lot may never be built on, the owner is responsible for taxes, maintenance, and industrial park fees.
Cannot Innovate – Industrial parks design and functionality is changing with the advent of new technologies and with changing tenant needs. A stratified park cannot make general adaptations as easily as a wholly-owned park. Examples include modifying the entrance of the park to utilize new technology – or modifying power-electrical systems to be more reliable or with higher capacity. Stratified parks may struggle to get lot owners to reach a consensus on a course of action, and also, it may be hard to find funds for such improvements among the owners.
Tenant Mix – Tenant mix is often thought of as a retail concept, however, it applies in industrial parks as well. In a stratified park, there is little control over which tenants are located near other tenants. A small lower-paying tenant utilizing a high volume of smaller trucks could be a thorn in the side of a large higher paying multinational. Also some retail users may prefer to locate next to key product providers. A wholly-owned park can control the tenant mix so the park functions by leasing to compatible tenants.
Velocity of Price Increases/ Decreases - Within stratified parks, there is often strong price competition for tenants, and this sometimes drives prices upwards or downwards quickly. There are many owners of lots that are very interested in generating income from their lots, and are willing to lower prices in order to build on their properties. Prices can increase rapidly, and decrease rapidly due to competition within the stratified parks.
Difficult to Assemble Lots - In a stratified park, it is difficult to assemble different lots in order to satisfy needs. Sometimes a user is interested in a larger build-to-suit project than can fit on one finished lot. Multiple lots must be added together, and sometimes there are different owners.
Building Cycle Not as Fast - In a stratified park, individual lot owners struggle to complete a build to suit warehouse for a tenant, due to the complexity of the transaction. In a stratified park, a tenant or broker may contact a contractor, who looks for lots – negotiates the lot, and works on a potential design for a tenant. The broker may have to work on structuring the financing of the project with a real estate fund, and or bank. There are many actors which must work together, and often they do not have the expertise to structure the business effectively. According to Annette Fernandez, CFO of LatAm Logistic Properties, the lack of expertise is what slows the process significantly. Often, the stratified lot owner is unsophisticated, and it is difficult for them to navigate the build-to-suit process. Errors can be made in the design and financing process. In a wholly-owned scenario, the tenant negotiates with the park owner a lease rate and design specifications – then the project is constructed. The wholly-owned park developer is an expert in executing build to suit projects for industrial users.
Little Money for TIs – in a stratified project, individual lot owners may finance projects with their own capital. Often, multinational or regional companies require TIs and improvements to new and existing warehouses – but sometimes, owners do not have the capital available to satisfy the tenant’s needs. Wholly-owned industrial parks plan for this – and have funds available to finance TIs and the interior fix-out of warehouse space.
Cost Savings – Operations and design of the project itself has a major effect on costs, which are passed on to tenants and affect their bottom line. When designing industrial parks – wholly owned/developers have an advantage: since they operate industrial parks as asset managers and owners, they understand costs and how to minimize them. Their self-interest is to develop and build the most cost-efficient buildings over the long-term in order to increase property value and the return of the asset. Stratified property developers are usually focused on the short-term business of selling lots, not the long-term operation of the park.
Change of the Model - Wholly-owned parks are being developed, and have the highest design and development standards in their respective markets.
· Mexico - Mexico converted to wholly owned parks in mid-1990s. The impulse of this was NAFTA, which allowed for construction of maquilas, or manufacturing parks. National and international institutional developers such as Vesta, Vertex, Prologis, El-Man, and Macquarie, among others, developed parks that have high demand for multinational users. This was possible with the long-term funding options provided by GE Capital, Prudential, and AIG. Today, there is long-term funding options for parks provided by Fibras and Afores such as Fibra Uno and have resulted in consolidation of parks nationwide.
· Colombia - Stratified parks continue to be developed, but with new real estate funds being created – there is more potential for wholly-owned parks. Terranum built Zol Funza (http://www.zolfunza.com/), which has some of the most advanced warehouses in the country, and LatAm Logistic Properties (http://www.latamlogisticproperties.com/) is building a logistics park that has AAA specifications.
· Peru – There has been wholly owned parks that have been developed (due to the consolidated nature of Peruvian real estate), however, the design of such parks has been to lower specifications. LatAm logistic Properties is developing a logistics park outside of Lima. The target market of the park is regional and international companies who require high specifications.
Robert L. Dragoo
In Latin America (Mexico, Colombia, Peru), appraisers are faced with this challenge in preparing appraisals in an opaque market where information is difficult to collect and verify. With limited information, appraisers sometimes use the area of land (square meters, M2) as a basis of comparison in appraisals. This could be a mistake as development potential can vary significantly between land comparables – a price per buildable unit, or price per buildable square meter are superior methods to use.
M2 - This measures the surface area of a property. It is a very basic metric because it does not reflect what can be built on the property. Using this method, without having comps that have similar development potential, can lead to unreliable valuation conclusions.
Price per Buildable Unit - Sophisticated buyers of land, such as developers and builders use this method to value land, however, unit sizes can be different depending on the product conceptualized. For example, it may be difficult to use this metric for a suburban site, where unit sizes are larger in order to cater to families, versus infill sites, that may have smaller units designed for working professionals. This method can be useful when comparing sites in similar submarkets that have the same use and similar product type.
Price per GBA - This method considers development potential and can be used to compare different uses. Often, parcels of land may have various financially viable uses. Developers use this metric to evaluate properties – as zoning and the market can vary from property to property. It is important to note, that in order to calculate the potential gross buildable area of a site two things must be considered:
· Zoning restrictions: FAR (floor to area ratio) limits, SCR (site or building coverage ratio) restrictions and setbacks – which impact the total allowable area to be built on a site.
· Market: This indicates what is financially feasible to be built. Just because a property can legally have a very dense property built on it, the financially viability of such a project must be considered. This can often be determined by surrounding buildings in the submarket and their respective uses and vacancy, and projects that are under construction.
Often, in Latin America, appraisals the productivity of a property is not analyzed properly – or sometimes not at all. It is difficult to find the information on what can be built on a site, and it takes time to research. Using square meters may be quick and relatively easy as a basis for comparison, however, the practice can lead to mistakes if the comparable properties are not researched properly.
Robert L. Dragoo
In Colombia, most malls and office buildings in the marketplace are owned by various owners and not wholly owned such as in the United States or Mexico. This ownership form, known as stratified title, has an impact on the market through the velocity of price increases or decreases and the length of the building cycle. Property profitability if also affected through the ability to change the tenant mix and differences in operations. Per Jorge Lizan, Managing Director of Lizan Retail Advisors (LRA), a New York based company specializing expansion of retailers on a global level including Latin America, "Colombia is one of the few countries in the world where shopping centers are owned by stratified title, a system which developed due to the lack of financing for shopping centers and office buildings."
Velocity of Price Increases/Decreases. Within buildings, in a strata title market, there is often strong price competition for tenants, and this sometimes drives prices upwards or downwards. Currently, in some office sub-markets in Bogota, there is excess supply being completed and delivered to the market. In this environment, we have seen price decreases occur more quickly. Further, often individual’s private investment motivations drive these decreases – some owners view investment in an office floor or retail space as a pension or steady source of income. Some are willing to drop the rental price of a space to cover the cost of common area maintenance charges and property taxes, or even personal expenses. A wholly owned building owner has more control and can limit price decreases, and does not compete against itself. Also, wholly-owned investors tend to have more financial wherewithal to withstand downward market trends and optimize rents in an upmarket.
Building Cycle Not as Fast. The overall building cycle is lengthened in a stratified property market because the information loop is longer and does not react as quickly. In a wholly-owned market, property owners are professional and constantly monitor the market to make investment decisions. Supply and demand can be analyzed, and are predictive of vacancy and pricing. Developers do market studies and feasibility studies before building – and investors and bankers study these reports closely when evaluating the feasibility of a project. When the project is complete, they will hold it, and they will be responsible for its profitability over the long term. In a stratified project – individual office floors or shopping center locales are sold preconstruction to individual buyers or owner-operators, who are not real estate professionals.
They do not spend as much time studying the market – nor have the inside information that is hard to obtain in the opaque real estate market of Colombia. Developers have limited interest in doing market studies – if properties are sold successfully preconstruction, they move forward and are built. Lizan agrees that "Strata title developers usually develop properties without the proper feasibility analysis, as they would not be the asset managers in the first place, creating a situation in which many unfeasible shopping centers were developed or properties with GLA that did not have market demand."
Individual investors do not have as up to date knowledge or information as a real estate professional, and it is hard for them to predict vacancy and pricing of the future project. In an over-supplied stratified market, projects are built that are not feasible, as investors continue to invest, without fully understanding the market dynamics. It takes longer for individuals to understand that there is an over-supply in the market, or that pricing is not increasing, thereby lengthening the building cycle and making it less efficient.
Effectiveness of Tenant Mix. This is the real weakness of stratified ownership in shopping centers – as owners cannot control where tenants locate. Each owner decides which tenant they will rent to, regardless of what they sell, their reputation, and brand image. In some shopping centers, there are lesser known brands, that can pay high rents, which occupy prime spaces. This does not help the overall center, and hurts sales of other tenants. Wholly owned shopping centers on the other hand, optimize their mix to drive shoppers to their centers, and organize them in a way that maximizes sales of their tenants. In the long-run, the best tenants will move to wholly owned centers – generally sales will be higher. In office buildings, the tenant mix is less important, but can have a negative effect. There are examples of owners renting to tenants who have large influxes of visitors such as embassies or doctors’ offices – which occupy parking and access, but also decrease the overall attractiveness of the office building.
Cost savings – Operations. Design of the project itself has a major effect on costs, which are passed on to tenants and affect their bottom line. When designing new shopping malls or office buildings – owner/developers have an advantage: since they operate shopping malls as asset managers and owners, they understand costs and how to minimize them. Their self-interest is to develop and build the most cost efficient buildings over the long-term, to increase property value and the return of the asset. Stratified property developers may be involved in some of the property management of their buildings – but do not have self interest in optimizing operations in the long-term nor asset value. Stratified ownership buildings are often built more economically, to give the appearance of a higher rate of return for future owners. However, this cost savings sometimes affects the operations, they install cheaper less cost-efficient lighting, non-durable flooring, and low quality insulation. In addition, sometimes, stratified property developers do not build enough parking which further limits the potential sales and success of a center.
Change of the Model. Lizan believes "The system started to change just recently, mostly by the entry of international developers, coming from Chile, Guatemala, El Salvador, Portugal, etc. Nowadays, there are still shopping centers being developed under the old stratified ownership system, but more and more are also being developed under the international best practice of leasing, and of course, the best shopping centers currently under development are with these model." As the retail and office markets trend to development of more wholly owned properties, we hope to see improvements in the design and overall quality of product delivered to the market.