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Planning for Expansion in Secondary Markets

With increased demand for industrial space in primary markets, expanding or relocating business may find that secondary markets can meet prospective needs while offering financial benefits over core MSAs.

Directory 2015
If you are looking to expand or move your business, secondary markets can offer an ideal location and financial benefits that may offset lingering economic constraints from the recession. As these markets have yet to take off like core MSAs, businesses can still find interesting opportunities. The benefits of moving into one of these markets are appealing, namely reduced rents and more available space, which mean better ROI for your business.

Fortified by a more stable national economy, conditions are ripe for secondary markets. The industrial sector, in particular, has been impacted by the boom in Internet-based shopping, which has fueled a need for many more distribution facilities. This has resulted in an increased demand for industrial space in primary markets, intensifying competition as vacancy drops and rental rates hike, causing business owners to look at secondary and tertiary markets for a low-cost alternative to fit expansion needs. The swell in demand has also had a positive effect on construction. With a rise in build-to-suit projects constructed for the specific needs of the distributor, new facilities are popping up all over the country.

Identifying Secondary Markets
To understand how a secondary market is classified, it is important to look at the definition of a primary or gateway market first. Traditionally, primary markets have been narrowly identified as the top five metropolitan areas in the United States: Los Angeles, San Francisco, New York, Chicago, and Washington, D.C. From this definition we can identify secondary markets, which are often defined as geographic locations outside of these major metros, such as Atlanta, Austin, Baltimore, Minneapolis, Nashville, Orlando, Phoenix, Pittsburg, Salt Lake City, and St. Louis, to name a few.
Expand This 62,776-square-foot former Shasta Beverages warehouse, located near Phoenix Sky Harbor International Airport, is rail-served, has seven grade-level truck doors, and can accommodate a variety of uses.
Close This 62,776-square-foot former Shasta Beverages warehouse, located near Phoenix Sky Harbor International Airport, is rail-served, has seven grade-level truck doors, and can accommodate a variety of uses.
This 62,776-square-foot former Shasta Beverages warehouse, located near Phoenix Sky Harbor International Airport, is rail-served, has seven grade-level truck doors, and can accommodate a variety of uses.
When identifying the specific secondary market to enter, the first step is to analyze where prospective need would intersect with value. Phoenix, for example, was one of the markets hardest hit by the recession, and is still fighting a vacancy rate of 13 percent, as reported in the third quarter of this year. Under these conditions, business owners are more likely to find reasonable rental rates for a location near an international transportation hub, than for a building of the same size in a primary market.

However, it is not always necessary to travel hundreds of miles away from a major metro to find a secondary market. If you look at the composition of Southern California, you’ll find secondary- or tertiary-market characteristics right outside of Los Angeles in Palmdale or Lancaster.

Working in secondary markets will underscore how important good brokers and property managers are when seeking out the right property. In navigating the new markets, we have found that identifying brokers with a real pulse on the local markets early on in the search will benefit long-term. And while working with a firm with a national presence can be a comfort and probably isn’t a wrong choice, it may not be the “best” choice. Properties within these markets that will fit your needs are not considered “low hanging fruit” so your brokers need to be willing to work hard as your partner.
Oftentimes you’ll find that industrial spaces located in secondary markets have a geographic advantage for supply chain hubs, with easy access to interstates, rail, and international airports...
Building “Specs”
Once a specific market has been selected, the next step is to prioritize your facility needs list to match the business’ operational needs.

The old adage still rings true; it is all about the location. The surrounding area and nearby amenities should rank high on the needs list, as the facility’s proximity to services like supply chain hubs will greatly impact productivity. Does your business work primarily with rail or air shipping? This is also important to take into consideration when searching for a new facility. Oftentimes you’ll find that industrial spaces located in these markets have a geographic advantage for supply chain hubs, with easy access to interstates, rail, and international airports; but ensuring that the building has the right access or loading docks to these services is also crucial.

Next on the list is building specifications. In secondary markets, new construction is less prevalent. As you look at a potential acquisition (or move in), consider the age of the property, and inspect the facility’s dock doors, ceiling heights, power, sprinkler systems, HVAC, and the roof systems. Look for historical wear and tear and flood plains. Sometimes things are cheap and/or vacant for a reason. Industrial spaces are crafted for a variety of different uses, and to different specifications, so it is important to hone in on these details to find the diamond in the rough.

Leasing vs. Owning
Plans for expansion often include a discussion surrounding property ownership. Many business owners have also come to see the “light” that owning their own real estate is a drain on their ability to grow their business.

Prior to the recession it was fairly common for business owners to want to own their own property. Why not? Times were good and values were increasing. When the economy stalled, these owners were suddenly faced with the reality that too much of their operating capital was tied up in a depreciating asset. The fact remains, business owners should not simply analyze their purchase as the market is on the upswing, but must also anticipate the inevitable downturn, and that’s when the fundamentals come into play.
Plans for expansion often include a discussion surrounding property ownership. Many business owners have also come to see the “light” that owning their own real estate is a drain on their ability to grow their business.
Whether you’re an owner of a new online store, distributor, or a manufacturing company, owning the building out of which you operate your business can come with long- and short-term benefits, as well as innate challenges. Although your first thought as a business owner will be to purchase a particular building based solely on the specific needs of your operation, it’s important to take a step back and evaluate the property as an investor would. At BH Properties, we not only look at the “return on investment” but the “return of investment” in that we seek to purchase a property for which we can increase the value and, in turn, more than recover our initial investment at the point of sale. There’s also the cost and risk of ownership of a vacant property from taxes, security, insurance, and financing.

Leasing is an important option to consider when entering a new market. The cost of purchasing a new building can sometimes hinder the allocation of capital. Ownership comes with high operating costs, and not all real estate can be easy to sell when the time comes — as we’ve all experienced during the recession. These costs can often be offset if you choose to take the leasing route. If you’re planning for the short term, it goes without saying that the main advantage to leasing is that your initial expense to use the facility is much less than if you were to purchase at the onset. Deciding whether it is worthwhile to purchase or lease should be based directly on your business model and plans for future expansion.

Leaseback arrangements are another option to consider. Short for “sale-and-leaseback,” this financial transaction entails the owner of the property selling the asset and then leasing it back long-term from the new owner. This concept provides a variety of benefits to the business owner. During the recession, this option became popular among business owners, enabling them to focus their attention and capital on their businesses. At BH Properties, we handled a number of these transactions over the past few years that enabled the owner/operators to access cash from the sale of their real estate and become tenants in place with buildings they had owned for years.

Over the years of our involvement with industry in secondary markets across the country, we have come to value a few critical components to both the physical nature of our investments and of our support teams, both internal and external. If a market is new to you, partnering with a local “boots on the ground” team will save you time and capital that you’ll be able to better invest into your new building, whether you choose to buy or lease. There is no denying that certain secondary markets are heating up. Some places are on fire, while some should be put to the match. The key for business owners in these markets is being able to tell the difference between the two. There’s no substitute for knowledge. Know your property and know your submarket.
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