There is a lot of discussion within the industrial real estate community about optimal clear eave heights in modern developments. What is the cost/benefit of 36 feet versus 32 feet? In order to better understand these trends, a study was conducted by Colliers International in November 2015 of the class “A” industrial buildings between 300,000 and 600,000 listed in Loopnet for the United States.
There were a total of 104 buildings in the survey. The data was further broken down into the following categories:
- Existing – 65 buildings (63 percent)
- Under construction – 22 buildings (24 percent)
- Proposed – 17 buildings or (percent)
To make a further differentiation on what is happening with these buildings regarding clear height, we drilled down a little further with these results:
- 72 percent of existing buildings have 32’ clear height
- 73 percent of the under construction buildings have 32’ clear height
- 82 percent of proposed buildings have 36’ clear height
This tells us that the industrial market nationally is moving toward a 36’ clear height standard.
What are the additional costs of move a building from 32’ clear height to 36’ clear height? There are three main construction components of an industrial building that need to be upgraded. According to Richard Prokup, Senior Vice President with First Industrial Realty Trust, in the article “Moving to new heights? Understanding 36-foot clear” in RE Journals.com in 2013, the costs factors in higher clear height buildings are:
- Slab upgrades - $.45
- Structural steel - $.35
- Fire sprinkler system - $.45
The results are added costs as of $1.25 per square foot of building area. While this is a generic estimate, it does not apply to all markets. For instance, in areas prone to high winds and storms like South Florida, the tilt-wall panels must also be increased in size to accommodate the higher wind loads per code. Construction costs over all are rising nationally so a reasonable estimate considering all these factors is that the added costs may be up to $1.50 per square foot.
Is there demand for 36’ clear height from tenants? Warehouse users less than 300,000 square feet often find clear heights 30’ or less to be sufficient. E-commerce is one type of user that is driving up clear height. Many E-commerce users need additional clear height for mezzanines. In general, according to Mr. Prokup, a distribution facility can achieve increased capacity of 10 percent to 25 percent in a 36’ vs 32’ clear space . John Morris, SIOR, Industrial Services Lead for the Americans with Cushman & Wakefield, also estimated the increased cube capacity to be 12 percent to 25 percent in his article “Six Predictions Regarding the Industrial RE Market Recovery and How They Have Played Out” in the 4th Quarter 2014 issue of Area Development magazine.
How much then does the base rental rate have to increase for the developer to obtain the same rate of return as a 32” clear building incorporating the additional costs and will tenants pay the additional rental rate?
Let’s assume that a 300,000 square foot 32’ clear height building has a proforma rent of $4.85 NNN for the developer to achieve the required return on investment to take the risk of constructing a new building.
The rental rate must increase by $.13 per square foot for the developer. Conversely this is a 3 percent increase in rent to the tenant. Considering the additional 10 percent to 25 percent cube capacity that can be obtained from a tenant’s operations the additional lease costs is proportionally small.
Lastly, there is the value concept from a developer’s standpoint. If an industrial developer is building today he most likely will plan to sell the property once it is leased up within two to four years. Even the institutional investors and REIT’s do not hold property as long as they used to and often turn portfolios in the five to seven year range. There are no current data that delineate the difference in exit cap rates between 32’ clear and 36’ clear buildings.
We asked six national industrial developers and REIT their opinion on cap rates for current acquisitions. The consensus was that the financial strength of the tenant; lease term; location and functionality of the building (big truck courts, extra truck parking) have more effect on cap rates than the eave height today. Buildings that exceed 300,000 square feet are often single tenant facilities that meet all of the previous criteria and can command a higher rental rates. Thus the value may be greater because of the increased rents not because of a lower cap rate assigned to the difference in eave heights. Respondents also made it clear that heights in the future are expected to be 36’ for buildings over 300,000 square feet.
In conclusion, national trends for larger bulk distribution buildings exceeding 300,000 square feet indicate an increase in clear height from 32’ to 36’ since this transition can have advantages for both tenants and landlords.