Understanding Today’s Industrial Market on Long Island

By Tom Attivissimo, CCIM and James R. MacCrate, MAI, CRE, ASA

Overview

Long Island is a unique industrial real estate market.  It is surrounded by the Long Island Sound and the Atlantic Ocean, and has limited access through New York City by trucks over bridges, limited train access, and a very limited number of ports for sea access.  Long Island was once the cradle of aviation and provided room for expansion of industrial and warehouse space as New York City was transforming into the financial capital of the world, driving up prices on industrial real estate in the five boroughs.  The demand for industrial space on Long Island continued through World War II, the 1950’s, and 1960’s.  Beginning in the 1970’s, the industrial real estate market shifted as the aerospace, aircraft and supporting industries suffered during the recession of the 1970’s.  Today is no different as the industrial market suffers from the current recession, while the Long Island economy  continues to shift to service industries, and high tech and biotech development expands.

 

History of Demand

 

The following chart summarizes the changes in manufacturing employment and total employment in the Nassau-Suffolk real estate market area.  The New York State Department of Labor data is based on non-farm employment estimates, by place of work, which provides the most up-to-date employment estimates available by industry and is based on the NAICS classification system.

 

The downward trend in manufacturing is quite obvious even though total employment has continued to grow modestly.  While economic incentives exist to attract manufacturing companies to Long Island, they have failed to stem the losses.  In addition, financing has been available with 40% financing from the Small Business Administration and 50% bank financing, but the activity has been weak from October 2008 through May 2009.  SBA activity has improved from late spring 2009 to present and that trend is expected to continue.  The Small Business Administration also has increased project limits that permit larger transactions.

 

Employment is a key factor to watch for potential trends in the industrial sector.  According to the Department of Labor, from November 2007 to October 2009, almost all sectors are trending downward, and that trend is expected to continue through 2010.  The manufacturing, trade, transportation and utility sectors are all trending downward, which all effect the demand for industrial real estate.  The only sectors that have a positive trend are education, health services and government.

 

Industrial Supply 

While the demand for industrial space has weakened, the supply is constrained with very little new construction in the bi-county area.  Users of industrial properties are trying to lower their fixed costs by looking hard at their real estate.  Many companies are outsourcing their warehouse operations to logistics companies.  Others are reducing their inventories, consolidating operations and have laid off workers.  Because of this consolidation and plant layoffs, industrial properties have been coming on the market.  In 2009, the industrial available inventory for lease or sale remained level with 2008, as indicated by the following chart based on data collected by Greiner-Maltz.

 

If one looks back over the last 6 months of industrial activity, market activity is improving.  Although there is no positive absorption (except for May 2009), the gap has closed a bit in the last two months as indicated on the following chart of monthly activity based on data collected by Greiner-Maltz.

 

Sysco acquired the old A&P warehouse in Central Islip for a total of 526,000 square feet in May, which accounts for about half of the total square footage absorbed.  A transaction of this size comes along once every 5-10 years on Long Island, and Sysco was in the market for a number of years.  More buildings have been leased than sold during this period. This has been caused by a number of factors.  Business owners want to hold on to the cash they have to maintain stability and not tie it up in brick and mortar.  Landlords in the second half of the year have become ferociously competitive with concessions and work letters to attract new tenants and retain existing ones.

   

In addition, financing is reportedly available but difficult to obtain.  The traditional banks are more inclined to lend with the SBA as opposed to a conventional transaction that requires 30% cash.  With SBA financing, the small business owner can keep more working capital in the company for growing it or emergencies, which could help the industrial sector.

 

The following chart provides data from Greiner-Maltz on the average number of months required for properties to be absorbed historically.

 

Pricing

As for pricing of industrial properties in the first half of the year, owners’ expectations were still high, especially in the under 50,000 square foot range.  The smaller the building, the higher the expectation, and that was a trend that carried over from 2008.  The over 50,000 square foot building has been difficult to sell or lease.  Prices have decreased substantially for larger buildings, especially 80,000 square feet or more.  Even as prices have dropped to a number that would have been a great deal in 2008, there are no takers.  As time marched on in 2009, a new crop of purchasers was entering the market; their mantra is “let’s steal it” and owners who can hold the line on price do not sell.  The landlords that want to sell or lease drop the price to meet market.  The following chart, based on data from Greiner-Maltz, indicates the trend in the average listing price and average sold price from 2002 through 2008.

 

Prices have fallen dramatically since their peak in 2008 and continued to in 2009.

Summary

The industrial real estate market on Long Island will remain weak until the economy recovers.  Even then, the bi-county area has several factors that will restrain the demand for industrial space.  First, the economic base of Long Island has been shifting since the 1970’s to a service-based economy.  Changes in transportation, technology, automation and manufacturing processes have eliminated the need to have manufacturing processes near the consumer.  Secondly, the high cost of doing business on Long Island has led to a geographical shift in the demand for industrial sites.  The cost of housing, real estate property taxes, corporate taxes and labor is among the highest in the nation.  Third, the transportation of goods on and off Long Island is difficult with limited means of ingress and egress, and traffic congestion increases the cost of moving finished materials off Long Island to other markets.

 

Over the long run, some positive factors will create demand for industrial space on Long Island.  Those companies that are located in Queens and Brooklyn will continue to look toward Nassau and Suffolk County because land is scarce and the cost of space is higher in those locations.  New industrial construction is constrained by the current economic conditions making existing, high-quality space desirable as indicated by the escalating sale price per square foot through 2008.  Older industrial buildings may be converted to an alternate highest and best use at a reasonable cost.  Finally, vacant land is scarce on Long Island and that has a positive impact on the value of existing industrial properties.  These factors will soften the impact of the current downturn in the market.

 

©2009 Greiner-Maltz & MacCrate Associates LLC.

Department Retail Stores & Rents

By Maxwell O. Ramsland, Jr., MAl, CRE and James R. MacCrate, MAI, CRE, ASA

Introduction

As reported by Newsweek, the United States is over stored as retail construction continued in 2007 and 2008 by unregulated financial lending practices.  New retail construction does not generate new business; it creates competition for finite sales volume.  Numerous retail bankruptcies have occurred, retail stores are closing, and vacancies are increasing.  In addition, retail sales have declined as indicated in the following chart as more space has been added to the market compounding the negative factors affecting the department stores, shopping centers and retail establishments.  

One can clearly see that retail sales peaked in 2007, while additional retail space came on to the market and retail sales were falling.  It is important to remember that adding more retail space to the market does not usually create demand or increase retail sales.  It divides existing sales and takes away sales from existing retail stores.   Therefore, this would tend to indicate that the value of retail space unencumbered by existing leases must be falling.  The value of retail space is directly related to the volume of retail sales per square foot.  Total consumer expenditures in retail stores can provide useful information to properly analyze the value of retail space.  The U.S. Census Bureau announced total retail trade sales were up 3.0% (±0.7%) from July 2009, but 6.0% (±0.7%) below last year, July 2008.

 

Definitions

The income approach is usually developed to estimate the market value of retail space, including department stores and shopping centers.  The income that is derived for retail space, such as department stores, usually comes from two sources – base rent and a percentage rent which are defined as follows by the Appraisal Institute.

 

Base Rent – The minimum rent stipulated in a lease.

Percentage Rent – Rental income received in accordance with the terms of a percentage lease; typically derived from retail store and restaurant tenants and based on a percentage of their gross sales.

A minimum rent is usually stated in the typical retail store lease, although a straight percentage lease is occasionally encountered.  An overage rent clause provides the landlord with the potential for additional income if the retail store is successful.  Overage rent is defined as follows.

 

Overage Rent – The percentage rent paid over and above the guaranteed minimum rent or base rent; calculated as a percentage of sales in excess of a specified breakeven sales volume.

 

Based on the above definitions, if retail sales volume declines as is indicated by current trends, the value of retail space must be negatively affected.  The percentage lease makes the landlord a partner in the tenant’s business and provides the lessor some protection against inflation, but works against them in the current environment and values decline.

 

Market Rent for Retail Stores

Market rent for retail stores, such as department stores, as noted above, is traditionally based on the store’s actual productivity, or actual sales and includes a portion of fixed rent per square foot, up to a given breakpoint level plus one or more percentages of sales to a maximum percentage of sales.  The typical department store rental pattern is presented below; this pattern demonstrates that as sales increase, rent per square foot increases, but that percentage rent increases at a decreasing rate.  The following chart indicates the trend in percentage rents as the retail sales volume increases.  The data was compiled from Dollar & Cents of Shopping Centers from 1990 through 2008 by Ramsland & Vigen, Inc.

 

Extraction of 2009 Estimated Retail Sales per Square Foot For Department Stores

The Urban Land Institute’s Dollars & Cents of Shopping Centers: 1990 – 2008 provides an authoritative chronology of department store and shopping center rental and sales.  The following graph identifies the 18-year chronology of median sales per square foot from 1990 to 2008 for department stores.  Retail sales at department stores have fallen 7.4% for the first eight months of 2009 in comparison to the first eight months of 2008 that has been incorporated into the graph.

This would tend to indicate the market value of department stores continues to fall since there is direct correlation between retail sales volume, market rent and market value unencumbered by any existing leases. 

Percentage Rent over Time for Department Stores

The following chart indicates the trend in the median percentage rent reported and the calculated median percentage rents over time.  The 2009 estimate is based on a regression equation assuming that retail sales remain unchanged at department stores, dropping 7.4% for this calendar year.

The range in percentage rents is quite narrow but can be quite misleading because of the manner in which department store leases are structured (base rent plus overage rent at declining percentages) results in the following relationships: as sales increase total rent per square foot may increase; and, as sales increase, rent as a percent of sales may decrease.  Therefore, the total contract rent as a percent of sales may actually increase in 2009.

 

Total Rent vs Total Retail Sales per Square Foot

Ramsland-Vigen, Inc. collected the total retail sales volume and the total contractual rent obligation on department stores over a period of years.  These included the base rent and the overage rent.  The following chart summarizes the relationship between the total rent as a percentage of retail sales per square foot per square of building area.

 

As sales go down, rents go down but at an increasing rate.  The preceding chart clearly indicates that the total rent (base rent and overage) as a percentage of the total retail sales per square foot declines as the total retail sales per square foot increases at department stores.

 

The following article, Department Store Sales Comparisons for August 2009 indicates the trends at several department stores in the U.S.  In addition, retailers fight another day as U.S. shoppers return, retail vacancies hit multi-year highs , Retail Sales Fall as Auto Drops, and flat retail sales are anticipated for the holidays.

 

We would like to acknowledge the contributions of  Shannon Luepke [SLuepke@ramslandvigen.com] for her research for this particular blog.

©2009 MacCrate Associates LLC.

A Little Bit of History – Gross Rent Multipliers in New York City over Time?

By James R. MacCrate, MAI, CRE, ASA

Often investors estimate the price that they are willing to pay for apartment projects in New York City by using a gross rent (income) multiplier or an effective gross rent (income) multiplier.  The Appraisal Institute defines a gross rent multiplier as:

 

 “The relationship or ratio between the sale price or value of a property and its gross rental income.”

 An effective gross rent (income) multiplier is defined as:

 “The relationship or ratio between the sale price or value of a property and its effective gross rental income.”

 The effective gross rental income is defined as:

 “The anticipated income from all operations of the real property after an allowance is made for vacancy and collection losses. Effective gross income includes items constituting other income, i.e., income generated from the operation of the real property that is not derived from space rental (e.g., parking rental or income from vending machines).”

 

The multipliers have surely moved over time.  In the Appraisal Journal, October 1952, Louis Winnick reported the long-run changes in the valuation of real estate by gross rents.  Data compiled between 1890 and 1892 for New York from the Real Estate Record and Guide indicated gross rent multipliers between 9.5 and 10.1 for tenements and apartment houses respectively.  These multipliers increased slightly with an average of 10.6 indicated by nine properties sold and analyzed in Building for Profit (by Reginald P. Bolton, page 41) in 1912.  By 1925, the reported gross rent multiplier dropped to 8 times the gross income.  This article indicated that gross rent multipliers fell below 5 during the 1930’s.

 

In the Appraisal Journal, October 1942, John C. Tredwell, MAI in New York indicated that the “typical speculative buyer” who acquires property with debt would pay about 6.4 times the gross rent.  Buyers who pay all cash would pay about 5.7 times the gross rent.  These were based on actual transactions.   The article inferred that the higher multipliers were due to the low level of interest rates during the war that would rise after the war was over.

 

Fast forward to 1975, gross rent multipliers fell.  In October 1975, the New York Times reported that Edward Sulzberger, president of Sulzberger-Rolfe, Inc., who managed about 150 buildings with 15,000 tenants, stated that three years earlier (1972) investors might be satisfied with a 6% or 7% return, and then (1975), he looked for 10% return.  Joseph D. Mandel, a vice president at Sulzberger-Rolfe, Inc. stated going back two years (1973), the gross rent multiplier ranged between 5 and 6 times the gross rent roll.  Quality properties were reported to be selling between 2 or 3 times the gross rent in Manhattan in 1975.

 

In May 2009, Massey-Knakal, real estate brokers, looked at 25 years of history in the movement of apartment capitalization rates and gross rent multipliers in Manhattan for walk-up and elevator apartment projects.  By 1988, gross income multipliers peaked at an average of 9.32 for walk-ups and, then, declined during the 1990’s recession to a low of 3.57 in 1992.  As the market improved, gross rent multipliers began their move peaking in 2006 or 2007 at more than 15 time gross annual rental income.  What goes up; must come down. And, so they did in 2008.

 

Gross income multipliers must fall because vacancy rates are increasing, operating expenses, especially real estate taxes, are increasing, and the cost of debt and equity are higher.  Recent sales clearly indicate the downward momentum in gross income multipliers.

When Will Real Estate Prices Stabilize in the New York Metropolitan Area?

By James R. MacCrate, MAI, CRE, ASA 

Many so called real estate experts have been predicting the bottom to the real estate market will occur in late 2009 or early 2010.  No one can predict with any degree of accuracy the future, much less the bottom of the real estate market in any metropolitan area.  It is important for real estate professionals to remember that real estate markets vary by location.  Some markets will do well while others are doing poorly.  For example, the Detroit real estate market was depressed long before the recession was declared official by the federal government and the beginning of the decline in the New York real estate market.  The real estate market in the New York metropolitan area was driven by low interest rates and by the growth of the financial, insurance, and real estate sectors of the economy which began in earnest in first quarter of 2004 as indicated in the following chart:

 

Total employment is now falling with the FIRE and construction sectors of economy taking a big hit in employment beginning with the collapse of Lehman Brothers.  Real estate salespeople, brokers, and appraisers must stop listening to the noise from Washington, D.C., politicians, and others who have mislead us in the past.  What we are witnessing, the economists and politicians have witnessed this before during the late 1920’s, the late 1950’s and early 1970’s.  In order to properly value real estate, one must cut out all the outside noise and analyze carefully what the local real estate market data is telling you. 

 

On a Macro Basis the Indicators are all Negative 

The recent indicators reported by the government suggest that the economy is improving because the rate of unemployment is declining, consumer confidence is improving, the rate of decline in manufacturing is subsiding, etc.  All of the above and other statistics still suggests that economy is not improving and real estate values will not begin to rebound until the economy turns over and employment begins to increase with an increasing payroll income and wealth.  That is not bound to happen for awhile.

 

In the New York Metropolitan area, the leading indicators for increasing real property values are all declining, including the following:

 

• Population is stabilized or falling
• Number of households has stabilized or is declining
• Total employment is declining
• Total payroll/income is declining
• Consumer confidence is negative
• Businesses are still contracting including manufacturing, retail and the financial services sectors of the economy. 

The results of the 2010 Census should be interesting nationwide.  Listen to what the leading indicators are telling you about the macro market. 

 

Now, on a Micro Basis 

Real estate is fixed and immobile. The value of real property is driven by local indicators which impact the demand for real estate in a specific location.  All the macro indicators referred to above are also negative in the New York Metropolitan area.  In order to determine if the real estate market is rebounding versus stabilizing at a much lower level of activity and prices, the following factors should be analyzed carefully in addition to the factors that generate demand: 

• Sale price trends
• Increase/decrease in the number of sales
• Increase/decrease in the number of listings for sale
• Increase/decrease in the number of days on market
• Increase/decrease in sales concessions
• Response to for sale or for lease advertisements
• Increase/decrease in the number of foreclosures
• Increase/decrease in the number of loan defaults. 

These trends are extremely important to watch, but the trends will not reverse until consumer confidence is positive and total payroll/income, employment and the number of households is increasing.  It must be remembered that real estate prices remained depressed for several years after the recessions of the 1970’s and 1980’s.  Why should this time be any different, and, in fact, it is already still worse in many markets.

For additional information on price reductions, see More U.S. home sellers cutting prices: survey and LPS Releases Study That Demonstrates Impact of Foreclosure Sales on Home Prices.

 

This was originally posted by Jonathan J. Miller under Straight from MacCrate.

 

– August 2009

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