Insights from Experts: Joe Downs on Industrial Real Estate & Investment in KC

Joe Downs, Vice President & General Manager
Years with Opus: 15 years
Project Credits: Ceylon Luxury Apartments, Citizen Park Luxury Apartments, 56 Commerce Center, District Flats, Park East Tower, Dardenne Town Square
Event: 2018 Real Estate Trends & Investment Criteria Forum (Kansas City)

Joe's Responses to Questions Posed to the Panel

Q: Do you anticipate a tightening of the underwriting criteria for both construction and permanent financing? 

Joe: We are mostly optimistic for the financial lending landscape to remain strong. I don't see underwriting terms loosening, but there currently does not appear to be any reason they should tighten either. Given the investment drivers of historically low interest rates, steady rent growth and rising property values, we expect the support to continue pending any major shift in the economy. Lenders have eyes wide open looking for a signal of the next economic downturn, using lessons learned from 2008. We anticipate capital sources to have the same, if not more, debt capital available in 2018 because fundamentals of the economy look good and overall economic health is strong. The capital partners we tend to work with most are local/regional banks and institutional companies; and we expect our capital market sources are likely to selectively increase total allocations in 2018. 

Q: Is the industrial sector likely to benefit from investor asset reallocation?

Joe: Maybe not; it depends on how the investor views the value of the asset in terms of the RE price cycle. We know that property prices are high, in general, and growth in property value outpaced inflation in 2017. For 2018, property values should hang in there given the rising cost of construction, lack of available infill land and relatively low cost of money.

The KC industrial market certainly provides investors with a stable asset class, displaying strong market fundamentals. Investor and tenant demand put 2017 cap rates near record lows. But transactional activity in KC (in all market sectors, not just industrial) is driven by the amount of available product for sale rather than a lack of demand to purchase.

On a national level, investors likely will continue to be cautious and conservative in each sector, seeking acquisitions of reasonably priced assets and selling-off properties in markets with high valuations. This frees up more funds for reallocation (acquiring properties at better value). So the question is, will the industrial portfolio provide the opportunity to “buy right" in 2018.

Q: Is the new construction in Kansas City addressing the needs of all industrial users?

Joe: Yes, there seems to be an attempt to meet a broader range of needs for space. For a while, KC seemed to be locked in on building the bomber distribution center and attracting the national players. Now we're seeing more developers building in the sub-400,000-square-foot range and servicing the regional local players in the 25,000-square-foot to 200,000-square-foot size range.

Q: Is there specific design or characteristics for which there is some demand that we are not building?

Joe: We as developers have to be pretty in-tune with what tenants demand in their design. Given the amount of spec product we're putting up, I think we're doing well to anticipate their needs. I haven't had anyone come to Opus and say our building lacked key design characteristics.

Q: North Kansas City has been successful in repurposing industrial space. Is that success a function of the location or the existing stock of buildings?

Joe: Both the location and the stock of buildings could be contributing to demand for older industrial product. North Kansas City (NKC) has great access to every major interstate in the metro. It could be viewed as a “sleeper" transportation hub.

Though most of the NKC industrial buildings are primarily functional, the product is commonly older warehouses and manufacturing spaces built from the 1940s to the 1970s. I've read there are new modern buildings which have been developed on some of the last remaining infill lots and on the redeveloped sites of demolished, functionally inefficient spaces.

While most of the recent transactions in NKC are local businesses, I could see NKC being prime for strategic “localized" distribution for online retailers. In many markets, urban infill industrial product is finding new life as distribution companies look to identify strategies for delivering their products to the end-user quicker. This shift towards a “leaner" distribution model has created new life for smaller warehouses closer to the center of the population base. Perhaps we could see some of that happen in NKC in 2018.

Q: Is there a shortage of available sites and entitled land for industrial development?

Joe: Naturally there is a tight supply of infill industrial property. However, Wyandotte County, south Johnson County, eastern Jackson County and Platt County all have plenty of dirt prime for industrial development.

Q: How have construction costs (shell and TI) increased as a % or $/SF during the past cycle? Is this a function of raw materials and labor costs or the design of the product?

Joe: In taking a look at the major trade categories for industrial—structural precast, structural steel, roofing and concrete slab on grade—we saw a 3% increase in precast and a 2% increase in steel material. Roofing and concrete slabs were bought for less on the second building because of an expanded bidders list and more timely bid and award. For the first building at 56 Commerce Center, our bidding was on a compressed schedule, and we struggled to find contractors who had capacity to meet our schedule. While subcontractors remained at capacity in 2017, we were fortunate to find the right contractors at the right price early enough that we were able to award the work before they were over capacity.

Q: What about soft costs as a % of hard costs? What is the primary cause of increasing soft costs? 

Joe: For soft costs, I would speak about the percentages for GCs on the D-B side. Contractors play lots of games with their general conditions including pushing some of it to hard construction costs. Same with design: because we have an in-house firm, we pay true cost versus a market cost. From a development standpoint, project soft costs would increase year over year simply because a lot of that is related to salary which tends to increase 2 – 3% per year.

Generally, we project our soft costs to be around 2% higher due to increasing labor costs of supervision, management and design professionals. On the first building at 56 Commerce Center, our general conditions ended up at 7% (inside rates, this would be more like 8% to 9% outside rates) of the overall costs, and our design costs ended up at 2.3% of the overall costs (again, this is inside rates design, outside rates would have been around 2.75% on design).

Q: How have tenant and user requirements for building amenities changed?

Joe: While many TI requirements are particular to the tenant operations, one thing that is common is the request for LED lighting. The costs have come down on LED to match the fluorescent more or less, and there is about 20% energy savings for LED. This goes for site lighting, too.