President-Brown Commercial Group, Inc.

As the brunt of the recession fades from memory, small to mid-sized businesses are approaching the industrial market with renewed confidence. The result is a focus on long-term planning, which is prompting an uptick in activity and pushing vacancy rates downward.

According to Colliers International, a surge in user demand helped boost industrial leasing activity throughout the Chicago market by more than 27 percent from the second quarter of 2011 to the third quarter. The vacancy rate fell nearly one half of one percentage point during that period, from 11.76 to 11.28 percent.

Many businesses have spent the last two years streamlining operations and paying off debt to protect and enhance their position in the marketplace. As they emerge from the economic downturn with stronger balance sheets, they are feeling more confident and are looking longer term when evaluating space.

During the height of the recession and its immediate aftermath, many small to mid-sized industrial businesses were signing one year leases, as they retrenched and reacted to economic conditions. Those that have weathered the storm are now feeling more secure and willing to plan ahead three to five years.

The long-term horizon is a good move for today’s tenants, as it allows them to leverage existing market conditions and lock in at lower lease rates.

This approach—getting your house in order through an evaluation of a business’ financial and business plans—is as sound today as it was two or three years go.  Businesses—and the landlords that lease them space—no longer are willing to take the types of risks in bankrolling space like they did in the past.

Longer term financial planning –of at least three to five years– is essential when weighing today’s real estate decisions, as it allows business owners to see the ups and downs of sales and inventory as well as income and expense streams over a longer time horizon.

High Quality Industrial Space in Short Supply

In markets that are attractive for the small to mid-size user, statistics further demonstrate the market improvement. For example, in the O’Hare submarket, the vacancy rate fell from 13.17 to 12.04 from the second to third quarter. Leasing activity rose by 1.64 millions square feet, a 39.2 percent increase and the highest increase in the past two years.

In the Elgin/I-90 submarket, the vacancy rate dropped from 13.35 percent to 12.17 percent during that period. Leasing activity was concentrated among small users and totaled 185,900 square feet, a 43.7 percent increase from the second quarter, according to Colliers International.

As this recent growth has occurred, companies are finding that high quality industrial space is difficult to find. Buildings catering to users of 50,000 square feet or less with tall ceiling heights and good access to regional transportation are in such short supply and that it is pushing some sales prices upward.

Brown Commercial, for example, represented a company wanting to purchase a well maintained building in a prime Franklin Park location. With few alternatives that met the buyer’s needs, a bidding war occurred and pushed the purchase price to approximately 10 percent more than the list price. While just a snapshot of the overall suburban industrial market, this example shows how basic market fundamentals (good location and good building amenities) continue to drive the market.

Rent Concessions are Easing

This renewed interest in expanding or upgrading space has translated into increased activity in certain markets. This starts a positive chain of events: vacancy rates are beginning to drop and, consequently, rent concessions are starting to ease.

Improvements in the Lending Environment

The lending environment also is improving, as banks become more willing to take modest risks. Further, there is an increased level of activity with the various SBA loans, as they require only a 10 percent down payment from the business and a smaller funding level from the local bank. The combination of incentives available and low interest rates means that capital available has never been more attractive. Consequently, the volume of loans being made to small businesses looking to acquire or renovate real estate remains strong.

While the market still has a ways to go to return to “normal,” there are many signs that Chicago’s industrial market has turned a significant corner. For users of 50,000 square feet and under, those signs are steady corporate growth, renewed interest in facility upgrades and building purchases, and a focus on expansion.

These small to mid-sized users are important to the long term viability of the market. As we see positive signs of momentum, it bodes well for the entire market as we head into 2012.

Dan Brown is president of Brown Commercial Group, Inc. a privately held commercial real estate company in Elk Grove Village specializing in leasing and selling industrial, office and investment property, and assisting clients with land acquisition and new construction projects.

NAI Hiffman Industrial Services Group

Chicago’s O’Hare industrial market houses a diverse mix of distribution and manufacturing companies in one of the largest concentrations of industrial property in the Midwest.  Surrounding O’Hare International Airport, the O’Hare industrial market is comprised of Elk Grove Village, Des Plaines, Rosemont, Franklin Park, Bensenville, Wood Dale and Itasca.  During the economic downturn, this market suffered greatly and still shows signs of high vacancy rates, historically low rental rates and sale prices.  What signs can we look for to forecast the future of the O’Hare industrial market?

It is hard to find consistent and clear data to predict future trends, but two good sources of local information provide an insight into this market.  First, the Chicago Department of Aviation collects monthly air cargo volume figures based on freight tonnage at O’Hare International Airport.  Second, the Federal Reserve Bank of Chicago tracks Midwest manufacturing output in Illinois, Indiana, Iowa, Michigan and Wisconsin.  Reviewing these two indicators tells a great story of where this market has been and where it is going.

In the heart of this market, air cargo volume at O’Hare can be used as a leading indicator for distribution space demand in this area.  Using a regression model on O’Hare air cargo tonnage and the O’Hare industrial vacancy rate over the past ten years, the effect of cargo tonnage is statistically significant and negative.  This means when air cargo tonnage increases or decreases, there will most likely be a lagging opposite effect on vacancy rate.  As an example, in 2009 we experienced the lowest cargo volume recorded over the past ten years and a 14% decrease from 2008.  The vacancy rate in the first quarter of 2009 was 11.22%.  It increased to its highest reading in the past 10 years to 12.59% in the first quarter of 2010 representing a 12% increase in the vacancy rate within 12 months.  We soon witnessed the opposite effect with a dramatic 24% increase in cargo tonnage during 2010 which paralleled a 7% drop in the vacancy rate from the first quarter of 2010 to the first quarter of 2011.  Currently cargo tonnage through the third quarter of 2011 has decreased slightly by approximately 4% versus the same period in 2010 with a corresponding 10.8% vacancy rate.

The importance of air cargo distribution in the O’Hare market is exemplified by a few recent deals.  The largest transactions in the market this year were logistics companies leasing modern distribution space.  CEVA Logistics leased 232,000 square feet and Hegele Logistics leased 207,000 square feet in the 439,000 square foot ProLogis owned building at 855 N. Wood Dale Rd in Wood Dale.  Companies like these that rely on expediting time sensitive products through O’Hare Airport drive much of the space demand in this market.

The volatility of 2009 and 2010 is behind us.  We now see a stabilization of air cargo volume at O’Hare over the past twelve months.  With no new speculative property development in this market, we should see demand continue to slowly reduce current vacancy rates.

Another pulse to watch in this market is the Chicago Federal Reserve Midwest Manufacturing Index.  While broad in its scope of coverage across the Midwest, it uses “hours worked” data to measure monthly changes in regional manufacturing activity.  The height of this index achieved a reading of 101.3 in January of 2008.  The lowest point recorded a 68.3 in June of 2009, representing a 33% decrease from the peak.  The September 2011 index was 85.2 which is a 25% recovery from the bottom in 2009.  This reading is also the highest level in three years since posting an 86.5 in October 2008.  The current index is only down 7% from the 10 year average of 91.3 although it has remained relatively flat over the past six months.

The Chicago Federal Reserve Midwest Manufacturing Index is not a leading indicator for industrial demand in O’Hare.  However, it is a general gauge for local production which directly impacts the supply chain and movement of goods through this area.  While our economy shifts towards distribution, manufacturing is still dominant in the O’Hare market.  One of the largest manufacturing deals in O’Hare this year was the relocation of Toyo Ink America to 108,000 SF at 1225 N. Michael Drive in Wood Dale which doubled their capacity.

Relative to the air cargo volumes at O’Hare, the Chicago Federal Reserve Midwest Manufacturing Index corresponds to the variability seen over the past couple of years.  Keep a watchful eye on these important statistics as they will likely determine future demand in the O’Hare industrial market.  While both data sources show improvement from the bottoming out of these indexes in 2009, neither set indicates substantial growth in the near future.  The stabilization in these latest figures should allow for a slow but smooth take-off to recovery in the O’Hare market.

Follow these statistics at www.ChicagoIndustrialist.com

Adam Marshall, CCIM, is an industrial real estate broker at NAI Hiffman and specializes in the O’Hare and surrounding markets.

Managing Director – Avison Young

The Chicago industrial market is desperately in search of equilibrium and consistency. Without it, many in the industry question when a significant and sustainable recovery will occur.

The market continues to struggle with volatility in absorption, moving from negative to positive from quarter to quarter; flat rental rates; aggressive concessions; and a slightly improving appetite for investment property. These factors, when viewed in light of the overall economic and business climate, point to a slow and sometimes choppy road for the foreseeable future, perhaps until 2014.

A sustainable recovery in our eyes equates to market characteristics that were prevalent between 2004 and 2005:

• quarterly absorption of 4 to 5 million square feet
• quarterly leasing activity totaling 7 to 9 million square feet
• quarterly sale activity totaling 5 to 6 million square feet
• little if any tenant improvement money
• speculative construction in high profile markets

In these times, it is more important than ever to look beyond the market to the individual participants –

the tenant with a lease expiration or the company needing to take money out of its real estate assets. The fact remains there are businesses out there with legitimate requirements that need to develop a real estate strategy and apply it to their business plans.

Real estate professionals who want to position themselves and their clients for success as we move out of this downturn should focus on the following strategies. In part, they need to answer the question: Where do you want to be when the recovery is in full swing?

Changing the Broker Mindset

The key to prosperity in today’s market, and moving forward, is to rethink the traditional, transaction-based “broker mentality.” Today’s tenants, owners and investors want much more than someone to handle their lease transactions. They’re looking for a strategic partner who can help them restructure their debt, lower occupancy costs, improve efficiencies and find the latest sources for green energy. It’s not just about the real estate. It’s about operations, return on investment, P and L and providing your client a competitive advantage.

Real estate professionals should approach this new way of business from a proactive and creative stance. Seek out and suggest cost saving options for the clients. Initiate discussions with state and municipal leaders about tax abatement or green energy tax credits.

Get Creative with Build to Suit Opportunities

There also are opportunities for build to suit transactions in select infill neighborhoods around the Chicago area. As many companies struggle with increasing transportation costs, some are finding an infill site can be more desirable than paying for trucks to idle in traffic all the way from Bolingbrook to Chicago.

Maximizing the Buy Low, Sell High Approach

The old axiom of “buy low, sell high” can be applied in creative ways in today’s market. While one might think that selling a building now is a losing proposition, there are opportunities for savvy investors to capitalize on the buying side.

Owners who have a well positioned building with strong, long term leases in place can command a fair price, even in a down market. By cashing out, they can funnel that money into new properties and take advantage of discounted pricing. These types of deals work best when selling a well located building with strong fundamentals.

Understanding Today’s Business Climate

Many business owners are taking a step back and reevaluating their financial goals before committing to a plant expansion, lease renewal or new headquarters facility. With slow economic growth and a lack of real consumer spending, owners are reluctant to commit to long term investments. An owner might be hesitant to commit to a $30 million to $40 million real estate project, for example, when there is uncertainty over the return on investment. By understanding an owner’s mindset and operational challenges, a real estate professional can help find creative solutions that fit that client’s needs.

There are many challenges in today’s market.  Real estate professionals need to play a different role and bring a wider range of services to the table, moving beyond the “just get the deal done mentality.” By becoming the trusted advisor on restructuring debt and adding green energy strategies, you can bring real value to your clients as they navigate a very different business climate.

Michael McKiernan is a principal and the managing director of Avison Young, Canada’s largest independently-owned commercial real estate services company. He is responsible for the overall operation and direction of the Chicago office, overseeing the efforts of office, industrial, retail and investment teams.

Vice President – NAI Hiffman

People were already gathering in the meeting room for the logistics session and it was going to be crowded.  This particular panel had seven members.  A little large in number for a panel, however, the panelists were an all-star cast:  three CEOs from major 3PLs, two heads of logistics for major retailers and two high profile transportation analysts.  When the presentation started, each panelist spoke about their company before moving to the analysts’ projections.

The analysts began with issues facing the logistics industry and where they foresee companies focusing in the coming year.  I was in the front row, pen in hand.  Unfortunately, at the end of their segment, my paper was still blank.  Forecasting issues and visibility were their main theme – not much of a real estate play there.  The moderator then moved to questions from the audience.

At that moment, power went out in the hotel.  The exit lights provided minimal lighting, but the moderator apologized and calmly continued the session asking for questions.   Seated in the front row near the moderator, I was probably one of the few people he could actually see.  I raised my hand and he pointed to me. I asked, “What about energy (fuel) fluctuations and how this affects your business?” The panelists’ responses were uniform.  “What was once a topic of quarterly to semi-annual conversation was now a regular monthly if not weekly agenda item.”

The lights remained off, I raised my hand and the moderator called on me again.   “What is the outlook for capacity in the trucking sector?” Again, their response was uniform.  “We are closely monitoring the anticipated impacts of CSA 2010 and any further modification to the Hours of Service.  It is anticipated that the trucking sector will tighten up and retain purchasing power – truck pricing will be going up.”

The lights flickered, and soon the room was lit. My hand went back up. The moderator once again gave me the nod so I asked one final question.  “Where does rail fit into your plans and do you foresee increased utilization of rail?” The response from the panelists was again consistent.  “We are looking for ways to integrate more with the rail networks and increase our business with them.”

The panel took a few more questions before breaking.

On average, transportation costs are typically eight to ten times the cost of real estate and in most scenarios, transportation is the true “driver” behind real estate decisions.  With this being the case, as a real estate broker, I attend or am directly involved with about ten logistics conferences per year and  find a consistent theme: whether a particular conference or tradeshow focuses on ocean trade, rail trends, intermodal shipping, logistics, exporting, 3 PL’s, commodities or port infrastructure, real estate is rarely a topic of main focus or even on the agenda.

The most interesting thing is that the issues raised at these conferences and the obstacles the transportation-centric companies are attempting to overcome are without question shaping the foundation for the future of industrial real estate.

So what is that future?  What is the path that addresses the issues of higher fuel costs, decaying infrastructure and fewer truck drivers?  The answer is rail.  Migration to rail is absolute.  The industrial developments that include a rail component will be in demand, able to charge a premium and maintain occupancy.

The railroads have been preparing for the increase.  The BNSF Railroad anticipates capital expenditures in 2011 alone to be $3.8 billion.  Their capex budget in 2010 was $2.7 billion.  The BNSF, Union Pacific, CSX, NS, CN and Kansas City Southern have all been expanding and/or developing their logistics hubs during the economic downturn.

There are other indicators.  The Journal of Commerce has reported that a trucking shortfall of 180,000 is predicted for 2012.  A recent survey by the Wolfe Trahan research group stated that shippers shifted freight from all-truck modes to intermodal at the fastest pace in years during the second quarter of this year.  Rail is the only viable alternative to trucking.  For most of the products being shipped, barge transport is not feasible due to perishable content or time sensitive delivery. Airfreight, as an alternative, is too costly for most and drives up the cost of the goods beyond competitive points.  Other than trucking, intermodal presents the only real option from a transportation perspective.

For those who dare, check out Chuck Taylor of Awake! – an organization he founded to raise awareness so supply chain professionals will understand the stakes and take an active role in shaping energy policy.  To be clear, Chuck does not state that we are going to run out of oil, however, 98 percent of supply chains run on oil and at the moment, there is no readily available cost effective substitute.  As Chuck states, “Get ready for the Inevitable, the End of the Oil Age is Coming.”

In commenting on energy (oil), the point is not to discuss if in fact we’ve reached “peak oil” (the point when maximum global petroleum extraction is reached, after which the rate of production enters decline).  Economic growth is still slow, but when things begin to pick up, oil prices will, without a doubt, begin to rise.  People in China, India, Brazil, Russia and Middle Eastern countries want a more westernized lifestyle, which means their demand for oil will rise as well.

With the unpredictable fluctuations in oil prices, it is safe to assume that costs will continue to rise.  This will drive and force change in the supply chain network.  The majority of the distribution networks were designed with the assumption of cheaper oil as well as a more traditional level of trucking capacity.  With the comparative level of corporate spend on transportation, companies will be forced to evolve their network strategy to survive.  Influencing and accelerating this is the fact that network change is not a fast process.

Network change will happen by shifting to the next “path of least resistance.” Rail is the logical migration. This is not five years out: this is now.

Duke Realty

When ground was broken in late 2007 for a speculative warehouse and distribution center in suburban Chicago, plans called for the roughly 650,000-square foot facility to be packed with green building features. Those included hundreds of skylights to reduce the need for electric lighting, motion detectors and photo sensors to automatically shut off unused lights, water-saving plumbing fixtures, and other energy-conserving features. In fact, the developers were so successful in including sustainable features that the building earned Leadership in Energy and Environmental Design (LEED) Gold certification from the U.S. Green Building Council.

Yet, despite all its sustainable features, a tenant for this green building has not been found.

Admittedly, this facility had the unfortunate timing to come online during one of the most challenging commercial real estate periods we have seen in recent times. However, this building remains vacant even as other similar-sized industrial buildings in Chicago have been leased. That begs the question: Is LEED certification a good investment, especially for an industrial facility?

The case for LEED

During the past several years, most developers and many end-users have been aggressive proponents of green buildings. More and more, however, developers and users – even some prominent architects like Frank Gehry – are questioning the value of LEED certification.

This has sparked a healthy debate regarding the need for LEED, but that has also created uncertainty for many developers, owners and tenants. So let’s take an objective look at the costs and benefits associated with LEED certification for industrial buildings.

First, here are some of the good reasons to consider LEED for new or existing industrial properties:

• Social benefits. Incorporating LEED features results in higher-efficiency buildings that are more likely to conserve resources and reduce pollution, and better protect occupant health.

• Financial benefits. For the owners of LEED-certified buildings, increased energy efficiency reduces operating costs, and those savings fall straight to the bottom line in the form of increased net operating income (NOI). LEED certification can also boost real estate asset values for owner-investors. For users, LEED features can enhance worker productivity, lowering overhead costs and increasing employers’ NOIs.

• Tighter management. LEED certification requires careful measurement and documentation of building performance. Closely tracking electric and water consumption, indoor air quality, and other factors creates focus and might help to motivate property managers to continue to maximize efficiency. The data generated also contributes to more informed decision making regarding building systems.

• Credibility. LEED certification represents third-party verification of a building’s sustainability. While the owners of other buildings might claim they are green, independent LEED certification provides proof.

• Improved marketability. In theory, the prestigious LEED designation gives buildings a marketing advantage relative to non-LEED buildings – with at least some prospective tenants – possibly allowing owners to command higher rental rates.

Another perspective

As sustainability and green building have gone mainstream in recent years, seeking LEED certification has become almost routine for some developers and end users. However, there can often be valid reasons to forego the LEED process:

• Higher construction costs. There is no escaping the fact that LEED certification usually increases up-front construction costs. Every project is different, and the extra costs will vary depending on which level of LEED certification is being sought. But various studies have estimated that the LEED “premium” can be up to 5 percent for the minimum LEED standard to up to 30 percent for the highest-level Platinum certification.

• Added cost of the LEED process. In addition to higher construction costs, the added costs of extra research, design, commissioning and modeling required for LEED compliance, the costs of documenting the LEED process, and LEED registration and certification fees must be considered. Those additional costs can run tens of thousands of dollars – even hundreds of thousands of dollars, depending on the project. Some have argued that pumping those dollars into additional sustainable features makes more sense then spending that money on LEED documentation. More and more, we are hearing about buildings that could have qualified for LEED, but their developers made a conscious decision not to invest the additional time and expense required. Some have called that strategy “going green without the plaque.

• Minor improvements in sustainability. Although the lower levels of LEED certification are undeniably a positive step toward sustainability, the actual improvements in energy efficiency can be relatively modest, often less than 20 percent. Granted, those savings can add up during the life cycle of the building. But they might not be dramatic enough for a developer or owner to be willing – or able – to absorb the additional up-front costs.

Lease rates vs. LEED

When developing new industrial buildings – especially speculative buildings – developers must make a judgment call as to whether the benefits of LEED certification outweigh the costs. And they must make it based on current conditions.

For the developer of the warehouse and distribution center mentioned above, LEED certification was part of its marketing strategy. The developer attempted to differentiate the facility on the basis of its LEED-certified sustainable features. Even though the lease rates were higher than those of less green buildings, it was reasonable during early to mid-2007, when the project was in pre-development, to assume that some tenants would be willing to pay more. It made sense to think that certain environmentally conscious executives would pay above-market rents for a sustainable facility that was a better fit with their corporate mission, strategy and brand image.

Today, however, many industrial users are having second thoughts about the costs associated with LEED certification. During this still-fragile economic recovery, minimizing overhead expenses has become the top priority for many businesses. When it comes to leasing space, many industrial tenants are simply seeking the lowest possible lease rate while still satisfying their requirements. For them, at least in the short term, the prestige and long-term savings associated with doing business in a LEED-certified building has taken a back seat to controlling costs.

Even before the economic slump, it is probably fair to say that most industrial users were less interested in LEED certification than office users. Since clients often visit office buildings, office users understandably feel compelled to present a responsible, professional image, and doing business in a LEED-certified building can help to reinforce and burnish that image.

Industrial users are also concerned with brand image, and undoubtedly would welcome the reduced operating costs of more energy-efficient LEED buildings. Some have made a significant corporate commitment to sustainability. But most industrial tenants’ customers rarely visit warehouses and distribution centers, and those customers often pay little attention to those buildings – if they are aware of them at all. Thus the branding value of LEED certification is a secondary consideration for many “behind-the-scenes” industrial users.

Opportunities for LEED

Speculative industrial development in the Chicago area will remain limited until rental rates and availabilities return to pre-recession levels. Speculative green projects are even less likely. Though the capital markets have improved, obtaining construction financing for most projects remains challenging – let alone for anything that adds to the project’s cost and makes underwriting even more difficult. Even if a developer can get financing for the additional costs of sustainable features that might require charging rents that are too high to be competitive.

“No one pays for LEED on a spec building,” a local broker told me recently. But when sustainability is a fundamental component of a user’s corporate mission, there could still be opportunities to incorporate green features in built-to-suit facilities. A recent example is the regional distribution center that was built for BMW of North America LLC in suburban Chicago. With BMW’s blessing, that 306,240-square foot facility at 100 S. Internationale Parkway in Minooka received LEED Silver certification in early 2010.

Another local example was an existing non-LEED spec building in the northern suburbs that was upgraded to LEED for Commercial Interiors requirements at the request of the tenant, The certification received for the 234,715-square foot facility in Niles is considered the green benchmark for tenant improvements, and is often pursued in existing structures.

Sensible sustainability

Seeking LEED certification is a worthy goal that can often deliver considerable direct and indirect value. A sustainable facility demonstrates a commitment to social responsibility, and can yield long-term cost savings for both building owners and occupants.

But the realities of the market place during the past two to three years have undercut the power of LEED. The supply of industrial space in the Chicago area still outweighs demand and, for many prospective tenants, minimizing costs has taken precedence over LEED certification.

That situation is likely to moderate as the economy strengthens and the commercial real estate market moves closer to equilibrium. At the same time, sustainable design and implementation will probably become more streamlined and less costly. For now, however, developers, owners and users should take an objective look at whether LEED certification is a viable strategy.

Susan Bergdoll is Vice President of Industrial Leasing for Duke Realty’s Chicago office. For more information, please visit the company’s website at www.dukerealty.com.

Senior Vice President of Operations-First Industrial Realty Trust

According to economists, the most recent recession ended in mid-2009 and we are now a full two years into the recovery.  A quick look at industrial vacancy rates in Chicago makes it clear, however, that the recovery has been and will continue to be a slow, upward climb.  With the overall industrial vacancy rate in the double digits, and some submarkets lingering in the mid-teens, the market is competitive, to say the least.

This type of market exacerbates the need for ownership to increase its focus on attracting and retaining tenants. An owner’s approach to property operations and leasing is a critical component in this effort.  While one cannot change the location or certain physical aspects of a property, effective owners aspire to make a given asset the highest quality and best maintained stop on a leasing prospect’s market tour.  The prospect’s impression should be that ownership is involved and focused on its portfolio and its customers.  This can be accomplished through many means, but communication, capital management and attentive property management are paramount.

Communication is the tried and true method of customer satisfaction. Often in real estate, however, property managers do not view tenants and prospects as customers, and do not provide them with the response times and prioritization they deserve. This is primarily due to the fact that industrial property managers and leasing representatives spend so much time on the road traveling from property to property. This makes it more likely that they will defer returning phone calls for hours or even days. To overcome this, ownership must commit to making tenant and prospect calls a priority, even if they do not have a ready solution to a tenant’s problem. This also means providing an alternative contact in their voice mail, when the main tenant contact is unavailable.  Ownership can reinforce this commitment with employees and tenants by testing it through customer satisfaction surveys.  An example: Over years of tenant surveys, First Industrial Realty Trust has found a direct correlation between the percentage of calls returned promptly and the overall satisfaction rating reported by tenants.  Those surveys and results show that satisfied tenants are also more likely to renew and provide referrals.  To accomplish the objective of being responsive to tenants, First Industrial employs a “2-Hour Rule” in which every tenant call is required to be returned within two business hours. This policy has become the cornerstone of First Industrial’s industry-leading service program.

Another avenue of ownership communication is during the leasing process.  It is common in industrial real estate for ownership to be a passive entity during this time period. To the tenant or prospect, ownership is the third party broker and attorney. Direct contact with ownership takes place only over the phone during lease document negotiations, if at all.  Ensuring that an employee of the owner attends as many showings as possible can be an effective demonstration of commitment and interest.  From the standpoint of property knowledge, no one can better demonstrate how a building can fit a prospect’s needs than someone with skin in the game and knowledge of the property.  Third party agents are important partners in the leasing process, but cannot be expected to have a full understanding of ownership’s objectives and priorities.  In addition, personal attention from ownership creates personal relationships, allowing the opportunity to sell the property, as well as the ownership group itself. This can become a differentiation point during a prospect’s tour and sets the stage for the “principal to principal” negotiations that close deals.

Strategic capital management is another effective way to place your vacant space on the prospect’s short list. This comes in two forms: work to make a vacant space move-in ready and base building (exterior) capital.

For make ready work, speed to market is the key. Ownership should be strategizing at least 60 days before an existing tenant moves out of a space. Discussion should revolve around “what does this space want to be” or “how can we maximize marketability”?  Owners often make the decision not to make dramatic changes to a space at the outset, hoping to find the needle in the haystack who needs the space as-is.  Then, after months or years of downtime, ownership makes the hard decision to spend the money they should have spent to begin with.  It is better to make the tough decisions today. For example, unless it is in pristine condition, new carpet and paint should be standard for each vacancy. The office space should be reconfigured for optimal efficiency, warehouse lighting should be upgraded to T5s or T8s and dock doors and levelers should be repaired or replaced. If the space has 20% office in a 5% office market, it is better to tear it out the build-out then to be chronically eliminated from tour lists. Once upgraded, the spaces must be maintained in a clean condition, especially bathrooms which make an important impression.  Anticipating tenants’ needs will result in shorter downtime, which quickly offsets the capital invested. Finally, make the space memorable. First Industrial places small refrigerators in its larger availabilities filled with drinks, which makes a memorable impact and clearly sends a message that ownership is tenant-focused.

Similarly, base building improvements and maintenance such as parking lots, roofs and building envelope are another opportunity to either attract or repel potential tenants. In a competitive market, many owners tend to conserve cash and control costs. That is understandable, but can be short-sighted if the replacement/repair is truly needed. Even an investment of several dollars per square foot will be quickly recovered by expedited lease-up, considering gross rents in the Chicago market average over $5.00 per square foot. In addition, keep in mind that capital investment not done today is not eliminated, only deferred. Therefore, it is better to do it now and get the immediate benefit, then to delay and regret. Investing capital helps win prospects and, over the long-term, translates into a higher quality portfolio, increased occupancy and higher property values.

Despite the beginnings of stabilization, we are still in the most competitive market we have seen since the late 1980s and every edge is important to successful leasing. Ownership must move away from a commodity mentality and make their properties stand out from the competition if they want to outperform in this difficult market.  Taking care of your customers and buildings goes a long way towards that goal.

Richard Prokup is Senior Vice President of Operations for First Industrial Realty Trust’s Central region, where he oversees asset management, operations and lease negotiations.  Mr. Prokup has more than 20 years of commercial real estate experience. He earned his masters of business administration and bachelor of fine arts at the University of Memphis

Executive Vice President – Arthur J. Rogers & Co.

One of the hot button topics in today’s political environment is jobs. The economic downturn of the past few years came with staggering job losses; and while we have moved toward recovery, the unemployment numbers remain at staggering highs. According to the United States Depart of Labor’s Bureau of Labor Statistics, the national unemployment rate as of July 2011 is 9.2 percent (up from 9.1 percent in May), and in Illinois it’s hovering around 8.9 percent. In other words jobs, and job creation, will be the number one issue of the 2012 presidential election debates.

Regardless of where you fall on the political spectrum, common rhetoric in the jobs debate focuses on the loss of manufacturing positions to other countries, China in particular. It’s a charged course of dialogue that easily elicits fear in many Americans; after all, the thought of losing a significant portion of the country’s livelihood to a growing foreign powerhouse can be quite intimidating. And this isn’t a new phenomenon. Throughout the past decade the United States has focused on reducing our reliance on the manufacturing industry while looking to boost the service industry to create more jobs – particularly in the financial sector. However, as was made clear by the devastating turn of events in the past few years, our economy cannot rest solely on the strength (or lack thereof) of our financial industry.

Case in point, as was noted in an article published June 27^th in the Wall Street Journal entitled, “Is Germany Turning into the Strong, Silent Type” both the United States and the United Kingdom admonished Germany for “clinging to an outdated manufacturing base that couldn’t possibly compete with lower-cost industries in China and Eastern Europe.” The view from outside Germany was that the country should focus on deregulation while seeking more growth in the financial services industry. Sound like a familiar course of action? However, while we Americans are shaking our heads in hindsight, Germany had some foresight.

Today the German economy is the strongest in the West and is well-positioned for many years of increasing exports. So how did they do it? According to the same article in the WSJ, former German economy minister, Michael Glos touts, “We got through the crisis better than almost any other country. It isn’t a miracle, it’s because we stuck to manufacturing whereas other countries deindustrialized.” Germans held to several philosophies in order to make this work, including an aversion to debt and a belief that quality goods do create prosperity. Or as the article said, “…solid public finances, a balance between business flexibility and a strong social safety net, and a belief that well-made goods, not financial wizardry, are the foundation of [Germany’s] prosperity.”

What is the lesson for Chicago, as well as the rest of the nation, in all of this? Quality goods do matter. Rather than being overly concerned about the loss of low-paying manufacturing jobs to China; we should instead focus on what we do well here in America – and what we do well is produce educated, talented and creative engineers, designers and entrepreneurs who in turn create quality products. High-quality goods do pay off, just ask Germany whose “Made in Germany” label has become associated with a quality many find worth paying for – including China. In fact, the same scenario is paying off for many U.S. manufactures today. It’s not just a hypothetical situation – it is actually happening.

According to the U.S. Census Bureau, U.S. exports to China in 2000 totaled around $16 billion while U.S. imports from China totaled about $100 billion – or 6-1/4 times more imports than exports. This is about what you’d expect given our national rhetoric, but the interesting thing to note here is how those numbers look 10 years later. In 2010, U.S. exports to China approached $92 billion and imports came in around $365 billion. The difference in imports this time is only 3.9 times more than that of exports.

While these statistics are due in part to the weak U.S. Dollar, it’s also directly related to the fact that the U.S. produces a quality product – particularly when it comes to machinery – and those products are desirable in the production of other goods. Also contributing to the statistics are an improved U.S. productivity and a drive to move manufacturing closer to where the products are being sold. This, in and of itself, is a huge benefit for the U.S. which boasts the largest consumer market in the world. Additionally, the U.S. is in a position to improve the manufacturing process. We have a vast number of out-of-the-box thinkers and entrepreneurs, all of which put the country in a position of strength when it comes to manufacturing.

Where does this leave us, particularly with such a large industrial and manufacturing base in the Chicago area? In a solid position to export parts and machinery to other nations which then finish the production process; thereby creating a truly global manufacturing industry. It’s an exciting time to be in manufacturing and despite what you may read, consider the following from an article entitled “The Exaggerated Rumor of Manufacturing’s Death” by Mark Henricks and featured on Bnet, The CBS Interactive Business Network, “…the torch as top global manufacturer passed to China. That’s a momentous event, surely, but it’s worth noting that China, though producing slightly more than the U.S., has a population more than four times as large. U.S. manufacturers still produce twice as much as Japan, three times as much as Germany, and 10 times as much as India.”

So what’s the moral of this story? We just need to look to our neighbor to the West for answers. Patience, fiscal responsibility and a reliance on our strengths – education, talent and quality – will serve our manufacturing industry, and ultimately our entire economy well in the long-run. We don’t need to fear China, or bemoan the loss of our low-paying manufacturing jobs. In fact, U.S. manufacturing levels are at the highest levels in seven years, according to the Institute for Supply Management. What we need and what we can have, is access to well-paying, quality jobs. We don’t need jobs for jobs’ sake. We need jobs that will offer the citizens of this country a better living. Likewise, we don’t want to be a low-priced provider of goods. We want to be known for quality. We want “Made in America” to carry behind it the force of our great nation.

Senior Vice President – Duke Realty

If leasing due diligence is like passing through airport security, one could say that tenants usually endure the equivalent of full-body scans and pat-downs while landlords sail through the “fast lane.”

Historically, prospective office and industrial tenants have undergone close scrutiny from developers and landlords to assess their creditworthiness. Yet would-be tenants have usually been more concerned with lease rates, operating expenses, tenant improvement (TI) allowances and other issues, often paying scant attention to the financial position – or even the identity – of their future landlords.

Today, however, with many properties struggling financially, there is heightened risk that owners will fail to perform – and that can be disastrous for tenants. That is why prudent tenants should take a much closer look at the backgrounds and capital positions of potential landlords and their buildings.

It’s a tenant’s market, but…

Attractive lease terms can present tremendous opportunities for businesses. Prospective tenants can potentially lock in favorable terms that will significantly reduce their overhead costs for years to come.

Though large rent abatements and TI allowances can be tempting, landlords may be offering these incentives for other reasons. Perhaps the owners are struggling financially and are desperate to lease space. Deep discounts, especially as part of long-term leases, may be indicative of a landlord’s inability to obtain financing for new developments or generate sufficient operating income to refinance or service the debt on existing buildings.

When the commercial real estate business was booming in 2004-07, a general assumption prevailed that developers and landlords would meet their financial obligations. But, as the recent downturn has demonstrated, commercial real estate can carry unexpected risks. That’s why it’s important to scrutinize the financial positions ofpotential and existing landlords.

The U.S. economy is strengthening, and conditions are improving, but the commercial real estate business remains challenging. Though the month-over-month growth in the CMBS delinquency rate has slowed, March 2011 delinquencies reached their highest point ever, 9.42 percent, according to the Trepp data service.

Trouble for tenants

If landlords are under financial pressure, they might not be able to raise the capital needed to meet their obligations, which can cause significant difficulties for the tenants.

For example, let’s say a manufacturer needs to ramp up production to serve a major new client. To facilitate that, the manufacturer depends on being able to move into a newly constructed warehouse and distribution center by a certain date. But if the developer fails to obtain financing and construction is delayed or cancelled, the manufacturer’s delivery schedule, reputation and very existence could be threatened.

In the case of an existing building, tenants who were recruited or retained by attractive rents and generous TIs might find that the landlord is unable to meet its debt service for that building. Or perhaps that property is performing, but the landlord is being squeezed by other properties in its portfolio. In either case, those financial pressures can result in deferred maintenance and repairs, TI funding delays, unpaid commissions and fees – all of which can have a negative impact on the corporate image and operations of the tenants.

Before the financial crisis and the Great Recession, it seemed as if financing was within reach for nearly any commercial real estate project. Whether the capital was used for new development, renovations, TIs or operating expenses, credit was readily available.

But that spigot closed in 2008 and today’s underwriting standards remain much tougher – nor is that likely to change any time soon, as financiers remain cautious about their lending practices.

Thus, prospective tenants must recognize that these are extraordinary times in commercial real estate and the capital markets. That presents extraordinary opportunities – and risks.

How tenants can reduce risk

Here are some ways prospective tenants can reduce leasing risk:

1.) Know the developer or landlord. Who owns, or will own, the building? What is their track record with respect to similar projects? How much experience do they have with this specific product type? Would you normally consider this developer or landlord if they weren’t offering such attractive lease terms?

2.) Dig into their finances. Conduct careful due diligence into the overall financial position of the developer or landlord, as well as the status of the specific building under consideration. What kind of access to capital do they have? Is financing in place for a new development? Is the mortgage current or up for renewal for an existing building? Who is the lender? What is the lender’s financial position and current strategy with respect to commercial real estate?

3.) Do a reality check with the marketplace. What are current and projected market conditions with respect to vacancy rates, lease rates, TI allowances and other lease terms? How do the terms being offered by your potential developer or landlord compare? Are they significantly below market and, if so, will the net operating income (NOI) be enough to support a well-managed, well-maintained building?

4.) Understand the specific lease terms. What penalties are in place if a landlord fails to perform? Do tenants have the right to terminate leases?  What protections do tenants have for quiet enjoyment if a lender forecloses?

Proceed with caution

It is a tenants’ market. There are outstanding values available to businesses that can identify available space that is in alignment with their business objectives. But today’s commercial real estate market carries risk. Deals could turn unfavorable,  even disastrous,  for tenants if developers or landlords fail to perform.

Historically, landlords have held tenants to high financial standards. Tenants can more safely seize opportunities and mitigate risks by holding landlords to similar standards.

Steven W. Schnur is a Senior Vice President with Duke Realty and heads the firm’s Chicago office. For more information, please visit the company’s website at www.dukerealty.com.

ARCO/Murray National Construction Company

Industrial vacancy rates in the Metropolitan Chicago Area have continued to decline through the 1^st quarter of 2011 to nearly 11 percent, yet many developers and institutional owners maintain portfolios with a considerable amount of available square footage for lease.  Although net absorption is rising in most submarkets, the competition is still high, which leaves landlords strategizing for ways to differentiate their assets from the competition.  One way many of our clients have responded is by making speculative improvements to their buildings in an attempt to “make ready” their assets in order to attract new tenants.  We are regularly asked by listing brokers and building owners to recommend and budget basic improvements that can be made to their buildings to make them more attractive to prospects.  When exploring this question further, we have uncovered some of the most cost effective speculative improvements that can lead to the highest return on investment for landlords.

Landlords view tenant improvement budgets as a percent of annual rent.  The question becomes; what level of tenant improvements will be sufficient to attract new tenants to a space?  The goal of “make ready” improvements is often times to increase speed to market.  Most requests for proposals ask for occupancy in as short as 60-90 days from execution of the lease.  With the tenant improvement process often taking 4-6 months, it is critical to understand ways to achieve occupancy for tenants prior to completing all of the requested tenant improvements.   Most municipalities require a few key improvements for tenants to occupy a building.  These include completed and working restrooms, code compliant fire alarm systems, and emergency and exit lighting for egress from the space.   While most buildings have working lighting and fire alarm systems, speculative buildings often do not have restrooms in place.  Adding a restroom core to a speculative warehouse building can range in cost from $30,000-$70,000, but when complete, can offer tenants immediate occupancy in a building.  This allows landlords to begin collecting rent immediately, rather than waiting for these improvements to be completed after a tenant is signed up.  Take for example a 100,000-square-foot building with a $3/SF gross rent.  The additional three months’ rent can offset the upfront cost of the restroom improvements by providing immediate occupancy to the building.   Landlords that simply offering a competitive rent without the opportunity for immediate occupancy often miss out on tenant’s that would have otherwise decided to move into their space.

Other low cost warehouse improvements that have become common as a means of attracting new tenants include: painting of interior walls, replacing or upgrading warehouse lighting, and demolishing prior tenant improvements to open up a space and make it appear available for immediate occupancy.  Painting of interior warehouse walls can cost as little as $0.20-$0.40/SF and can improve the appearance of existing lighting, and help with the appearance of existing warehouse space.   Older buildings can appear new and compete with newer buildings offering higher rents.  Lighting upgrades are almost always requested by prospective tenants.  Landlords can stay ahead of this requirement by replacing lighting prior to new tenants.  Providing new fluorescent lighting in warehouses typically costs around $0.50/SF.

Landlords should also consider speculatively improving the office space in their buildings.  To be competitive, it is necessary for the office to appear modern, clean, and new if possible.  Landlords can refresh the finishes in existing offices by replacing the carpet and painting existing walls for as little as $5-$7/SF.  Other ways to improve the image of an office space might be to replace the ceilings, lighting, and/or doors and hardware.  Often times, we recommend that landlords paint the grid or replace the tile only in lieu of completely replacing the ceiling which costs $1/SF in lieu of $2.50-3.00/SF.  Similarly, landlords can replace the bulbs, ballasts, and lenses of existing light fixtures or use retrofit kits to make the lighting appear new without completely replacing the existing fixtures.  Refurbishing the existing lighting can cost only $1/SF in lieu of $2.75/SF for providing all new lighting.  One less intuitive reason that this may be a good strategy for landlords is that it can help control costs.  If an existing office appears to be clean, new, and ready for immediate occupancy, tenants often do not request as many additional improvements from the landlord.  Often, clients will choose to spend $8-$10/SF refreshing an existing office prior to a new tenant to prevent needing to offer a tenant $15-$25/SF for office improvements to attract the new lease.

In a multi-tenant building, the biggest unknown for prospective tenants is what their space will look like.  If landlords market their buildings by simply stating that tenants will be provided with a build-out allowance for office space, there can be a disconnect with tenants who are not aware of what the allowance will buy them.  One way for landlords to overcome this is by speculatively building one office space in the building to demonstrate to touring tenants what the finished product will be.  This can also provide speed to market for the asset.   We recommend that offices be built as “white box” spaces which include only perimeter walls, flooring, ceilings, and lighting designed as an open office area with only interior walls for restrooms.  It is fast and cost effective for a tenant to build private offices, conference rooms, and break rooms within the footprint of the “white box” space after they commence the lease.  These improvements can also be done with the tenant operating in the building.  For example, the cost for 2,000 square feet of “white box” speculative office space can be between $30-$40/SF in lieu of $60-$70/SF for fully improved office space.  By allowing the tenant to move in and commence the lease immediately, the initial months of rent payments can offset some the upfront costs incurred by landlords.

Those who take the initiative to complete speculative improvements prior to leasing have better success in leasing their assets.  Determining what level investment in speculative improvements should be made is dependent on the desired speed to market, tenant expectations, and control of future costs.  The strategy will be different for every landlord and each specific building, but it is clear that a little preparation by way of low costs speculative improvements can go a long way to leasing a building sooner.

Joseph Pomerenke is the Director of Business Development for ARCO/Murray National Construction Company.  Joseph received his Bachelors of Civil Engineering from the University of Notre Dame and Masters of Architectural Engineering from Illinois Institute of Technology.

Executive Managing Principal
Newmark Knight Frank Epic

Whether our clients know it or not, they need a different approach to problem solving.  That’s why the brokerage industry is changing its business model.  We have to be stronger, smarter and better aligned with our clients to have any chance of converting the limited number of opportunities out there.

Commercial real estate brokerage is a solutions-based business.   It used to be that clients identified needs or inefficiencies in their businesses and then asked brokers to find a real estate solution that either makes or saves money.  In normal times, deals came together quickly and all interests were served.

But times are different, and we won’t return to the peak of the recent market upswing for many years, if ever.  The underlying problems in business today are profound, and real estate as an industry – in its weakened condition – can’t always deliver clear and straightforward answers.  The best way to effectively compete is to think more advisory, expand our knowledge base and deepen our benches; we can’t space-jockey deals anymore; we need to know the “why” behind every client requirement and not just the where.

Change is here.

All industries over time experience periods of expansion and contraction; the brokerage industry right now is in change mode, posting a bit of both.  Large, national and global-platform brokerage houses are migrating to a predominantly corporate services delivery system, chasing business at the C-Suite and not the mean street.  Local boutique firms are washing out, merging with other like-minded firms or aligning with bigger, stronger partners.  With a few expectations, the independent “network” model is fizzling because it cannot truly deliver a consistent level of service market-to-market, and it lacks a central repository of intellectual capital and shared resources that member firms can draw from.

The transformation of brokerage nationally and here in Chicago is already underway.  The former Epic Realty Partners became Newmark Knight Frank, the former GVA principals joined CTK, Colliers underwent a schism, Canada-based Avison Young opened an office here, and St. Louis-based Cassidy Turley is circling.  In other markets around the country, local firms left the ONCOR and GVA networks, and Grubb and Ellis recently announced that it was for sale. NAI is still very strong in most markets.

The change is being driven in part by corporate space users requiring a higher level of services, and local users needing a more consultative approach to help them make critical decisions.  Common sense tells us that if more brokers are pursuing fewer opportunities, the brokers with the best process, the most resources, the best talent pool and the best pitch are most likely to prevail.  We should all want to be part of that group.

Three Ways to Improve.

Most of the changes occurring seem to center around three key activities: making more resources available to clients; raising the skill and intellectual levels of brokers; and “adding to the bench” through mergers, recruiting, and inviting young brokers back in to the business.  These survival strategies impact corporate and local market clients because they benefit as we grow stronger.

All brokers should consider reframing their client service model to become more advisory.  This begins by respectfully challenging the assumptions that produce the client requirement and looking beyond real estate to determine what dynamic is truly driving the need.  Is it overall area capacity, or could it be supply-chain based?  While it may be counter-intuitive to our livelihoods, the solution is often not space-based but rather process-driven or founded in a labor, production or transportation realm. By asking the right questions, we can better assist the client in thoroughly thinking through the challenge on our way to unearthing the best possible operational and economic solution.

If brokers don’t have consulting, supply chain, target area cost modeling, design, construction, management or investment expertise on their team or in the firm, then align with a third party who does. The market is favoring the full-service model over segmentation and specialization.  Clients seem to be migrating toward brokerage firms with broad service offerings because decisions today require evaluation and analysis over multiple sectors of the business.  Bringing to the table experts in many areas will enable brokers to win more assignments than just being a specialist in one area.

Surrounding yourself with resources is also a way to achieve the second key success activity: raising the skill and intellectual level of brokers. In this job-loss era, the middle-manager workforce has been reduced and real estate and strategic decisions are being made at a higher corporate level by big-picture executives.  More secure in their careers and less protective of their territories, these executives require greater intellectual and advisory contribution from their brokers.  They seek results and process-driven professionals, not just compliant task executors.  To serve this key constituency, we need to be better informed about our industry so we can tell them what needs to be done.

The national platform firms organize their industrial teams into specialty practice groups, bringing forward discernable skill sets to address client needs.  Members of these practice groups are compelled to become experts in their fields.  At Newmark, we align people with similar skills and experiences into teams to support a specific segment of the marketplace – manufacturing, logistics/distribution, life sciences, clean/food, technology and alternative energy.  We’re taking Supply Chain and Six Sigma course work, advancing toward LEED certification, participating in TMA and IMA workshops, completing CCIM credits and committing to becoming experts in many sectors of the industry.

The final initiative to consider is bench strength.  Because there are fewer deals circulating in the market, finding deals before they find someone else is critical to growing market share.  Our agency clients need us to return to basic blocking and tackling, so we need a fresh stable of deal-finders eager to work the phones and walk in doors.  As a hiring professional, I am impressed by the quality of young candidates willing to pay dues in exchange for a commercial brokerage career.  A platform comprised of only senior level producers makes money today, but it will be made weaker in the future without a feeder team.

We have added six first-year brokers to Newmark since the fall of 2009, along with five senior and lateral recruits.  We have a diverse workforce ranging in age from 24 to 73, and in professional experience between one and 30 years.   Diversity in thought and experience gives us intellectual capital and an army of performers equipped to handle most client challenges.  And we’re not alone.  A good number of free agents have recently switched teams; earning potential drives the decision long-term, but finding the right offering of resources, support, competitiveness and upward trajectory is the immediate trigger for change.  Now that the economy is showing some stability and resilience, brokers looking for a better mouse trap finally have the courage and confidence to make the leap.

Change tracks on a “J” curve – there is an immediate drop off, but then a rapid ascension that if properly executed, surpasses the stagnation of the change event.  Now is a good time for brokers to rethink their individual methods of doing business, because we have time, activity is still weak and clients need stronger, smarter brokers. Consider becoming a better version of yourself now, so that you are fully unpacked and ready to go when our real estate brokerage lives are good again.