By Richard Prokup, Senior Vice President of Operations, First Industrial Realty Trust, Inc.
Over the last several years, the industrial real estate sector has experienced a substantial recovery in demand. As one of the largest owners of industrial property in the country, First Industrial Realty Trust has enjoyed a unique view into that recovery as landlord to an array of tenants occupying from under 10,000 square feet to more than one million square feet. What we have observed in our portfolio was recovery primarily led by larger tenants requiring bulk and regional distribution centers. As larger spaces have filled up and general economic activity continues its measured upward climb, demand for smaller industrial spaces has increased.
To effectively and profitably serve the needs of tenants in smaller spaces, owners must have the right operational structure and philosophy. Owners must understand each tenant’s business and recommend space options that fit their near-term needs while anticipating long-term requirements. Smaller tenants often have slightly different mindsets than larger companies, and owners that rigidly use a one-size-fits-all approach can lose deals or create tenant dissatisfaction.
Leasing to smaller tenants requires the landlord to move fast and keep the process uncomplicated. While a 500,000 square-foot tenant may plan a move a year in advance, a 5,000 square-foot tenant may only be in the market for a few weeks before needing to make a decision. Therefore, it is important to have spaces in move-in ready condition. Clean or new carpet, a functional layout and well-maintained mechanicals are critical. Having the space in a state where a tenant can envision their business immediately is important, because smaller tenants may not have the resources, time or experience to undertake renovations or conduct endless property visits. In addition, the leasing team must ensure that the tenant truly understands the terms of the lease. For example, if a lease includes interior construction, the tenant may not be aware of the timeframes required to obtain necessary permits and complete the project. In some cities, approvals for construction can take several weeks, which could be a disruption for a tenant with tight deadlines if they are not fully prepared.
Once a prospective tenant is procured, focus must shift to the lease process. This process can be intimidating for businesses that do not have much experience in lease negotiations. To streamline this part of the process and enable smaller leases to be consummated more quickly, First Industrial has developed a prototype lease for tenants less than 10,000 square feet. This lease is fewer than 10 pages long and more straightforward than a traditional lease. From the landlord’s perspective, if a tenant is smaller, its risk profile is different. Provisions such as eminent domain, tenant alterations and the restoration of insurable damage become simpler, in practical terms, and should, therefore, be simpler in the document. Insurance requirements should be adjusted to appropriately reflect the risks associated with the business. A short-form lease can also help minimize misunderstandings and surprises after execution. As a side benefit, shorter leases are usually less expensive because the need for legal consultation is reduced.
Once a lease is signed, landlords must work closely with a smaller tenant to get them into the space and prepare them to take care of the premises going forward. The operations team should meet with the tenant as soon as the lease is signed to review the lease requirements and offer assistance. For example, First Industrial goes above and beyond in order to ensure the tenant has proper insurance coverage and can, with the tenant’s direction, work directly with the tenant’s insurance agent to help communicate insurance requirements. Landlords should review the rules and regulations of the property with the tenant to make sure they recognize regulations such as allotted parking spots, smoking policies, and outside storage guidelines. To have a successful tenancy, the user must understand all of its responsibilities regarding property maintenance and required landlord approvals. If the tenant is responsible for the completion of any lease-related construction, the landlord should review the tenant’s contractors to make sure they are qualified and aware of the lease requirements.
In many industrial leases, the tenant is responsible for the maintenance and repair of HVAC units. A smaller tenant may need help in setting up an appropriate preventive maintenance program. At First Industrial, we establish a go-to vendor for this service. These vendors know our requirements and generally offer better pricing to the tenants than they can achieve on their own. These vendors also do a better job of reporting back to the landlord on potential issues, reducing repair expenses in the long run.
Importantly, expectations for rent payments should be established upfront. Since most leases contain a grace period, some smaller tenants believe rent can be mailed on or after the due date. This can result in late payment fees if the checks get delayed in the mail, even if the tenant believes they are paying timely. Electronic transfer of rent payments is often a better choice for both parties. The tenant can remain in complete control of the amount and timing of the payments, but funds are transferred much faster and more reliably. Establishing ACH payments at lease commencement is beneficial to everyone. Once the tenant has settled into its space, the landlord should always follow up and monitor compliance with the lease and the tenant’s use of the space. To accomplish this, First Industrial operates under a “30-60-90 plan.” This plan requires someone from First Industrial to meet with the tenant at least once every month for the first three months. Tenants appreciate the attention and usually have questions or require some assistance, which helps establish a strong relationship that can provide benefits for many years.
In industrial real estate, it is natural to focus on large users since they can have a significant impact on the portfolio. But, in the same breath, smaller tenants are also critical to maximizing cash flow and preserving the physical integrity of the assets. If the appropriate approach is taken during the initial lease process, landlords will find that the ongoing management of these tenants can be efficient. A great deal of tenant loyalty can be created with smaller tenants by taking good care of them at the onset of the lease, which can positively impact portfolio performance, especially as tenants can grow over time.