Spotlight on the industrial sector
You invested in commercial real estate, but are you fully aware of the hidden physical risks when leasing to tenants that can undermine a healthy long-term return on a property investment?
The best way to manage a property portfolio over time is to put a risk management plan in place that proactively addresses potential maintenance problems before they arise.
This is particularly important within the industrial sector—and even more so with triple net lease terms—where the lines may blur between property owner and tenant responsibilities. Tenant responsibility to maintain an asset often goes unmonitored, which can lead to unexpected battles over potentially large repair costs late in the lease period.
So, what can you do today to reduce the likelihood of these problems taking place, and to maintain the value of your physical asset for long term growth and profitability?
Physical risk—Why proactive management matters
Physical risk in commercial real estate refers to the components of a building that degrade or require replacement over time. Such components include the building envelope (including roof and façade), heating and cooling systems, water and electrical systems, and more. While physical risk can increase due to climate change, including exposure to extreme temperatures or high winds, buildings and their components also simply break down and wear out. Depending on the leasing arrangement between property owner and tenant, or a tenant’s repairs or replacements, or lack thereof, repair costs on the physical asset or replacement of systems can quickly eat into profits.
Since industrial property owners often have hold periods of 10 years or longer, paying close attention to the condition of expensive capital items is critical, especially if the building you acquire is older.
Managing physical risk means being proactive with maintenance and understanding the life cycle of the building’s components. It’s essential to have an appropriate maintenance plan in place to help minimize ownership costs and ensure the physical asset can maintain its value over time.
Nuances of industrial leasing structures - how they affect owner’s risk
It’s common for industrial properties to be let under a triple net lease. Unlike office or retail spaces — where the property owner is responsible for the repair and maintenance of the building structure and systems — in a triple net lease arrangement, responsibility for repair and maintenance generally falls on the tenant.
Triple net leases offer property owners a stable long-term investment (typically 10-15 year lease plus potential extensions to a single tenant) with the ease of little to no property maintenance responsibilities.
However, not all tenants keep up with maintenance responsibilities as they should. If you haven’t been keeping an eye on your tenant, you may only discover at the end of the lease that the tenant has moved out, neglected the property, and you may have to foot the repair bill. Even the best tenants may slip up on their responsibilities if there’s no mutually agreed-upon benchmark for the initial state of the property.
Steps to take to proactively manage your tenants
The proactive approach to monitoring tenants is to conduct regular reviews or surveys throughout the lease term. While they are well worth it, these surveys aren’t cheap, so they need to be planned wisely.
Our consultants usually suggest:
- Conducting a ‘move-in’ survey with the tenant to establish a benchmark for the current state of the property.
- Documenting any resulting conditions or relevant information from the move-in survey in the lease agreement, along with a maintenance plan
- Establishing a reasonable timetable of review periods and keep up to date with them.
- Conducting a ‘move-out’ survey three months to a year prior to the end of the lease to identify repairs that need to be made before occupancy ends.
We can’t over-emphasize how proactive approaches to property and tenant management are the best way to protect your investment and secure long-term ROI, because they identify potential issues early on—before they become expensive problems that impact your profits.
Learn how EBI helps you minimize property and other risks with insights from our experts.