How to manage an industrial portfolio? How to compensate managers? Chad Griffiths, Partner at NAI Commercial Real Estate, has been working in the space for over a decade and shares his insights.
Tell us a little about you.
I started in industrial real estate in 2005, I started as a broker and always had an objective of building my portfolio. In 2014, I bought my first property with a partner, and we have added a property every year since 2014. We're closing on a property this week, which will take our portfolio to about 150,000 square feet worth of industrial property.
How do you manage an industrial portfolio?
Industrial has three main categories: manufacturing, warehouses and flex. Before I started investing in industrial, I had some single family houses and a fourplex, it was not nearly at the scale of some investors but I saw that as you scale a residential or multifamily portfolio, it becomes more management intensive. An example is a property that we bought two years ago, a $3 million building and there's a single tenant in there, a fortune 1000 tenant that occupies the building of a manufacturing facility. A $3M multi-family building by comparison, has maybe 20 units and it's much more management intensive. The industrial you have one tenant, the multi-family you have 20. The way our lease is structured is NNN: the tenant is responsible for paying all the operating costs on the property. Generally it includes repairs and maintenance. Instead of them calling us for every little thing that goes wrong, they just fix it. In two years, I've been to that property a couple of times, my partner and I self-manage that one. We also have other properties with more tenants, and we have property managers in those ones. Even though it's a lot easier to manage from a time, energy, focus standpoint, there are times when I think you do want to have a professional property manager.
When should you get an onsite manager, and how often do they need to go there?
The deciding factor for us is largely down to how complex the situation gets. Even though you're not dealing with the same amount of tenants, things come up. The scale of having 10 tenants versus one tenant, where you have one point of contact, it's very easy for us to follow up with a general manager or a regional vice president or somebody responsible for that area, they take care of most of the things that go wrong. If there was a unit heater or something like an electrical issue, then we get involved and have a contractor come to address it. But it's just much less time intensive to look after one tenant. The one where we have 10 tenants, there's smaller tenants, they need a little bit more hand holding, because they might not know how everything works. There's also a common area, so anytime you're dealing with tenants having to interact, then you potentially have issues.
One of our buildings has a second floor offices with tenants in there, so there's a common washroom. If the washroom isn't kept clean, then one tenant calls and complains, then they argue with who's responsible for it. That property does require more day to day attention. I think it largely comes down to how much time someone wants to devote to that building. I don't think we're best suited to actually be property managers, we're more focused on growing the portfolio, trying to manage it from an asset level standpoint. From an asset standpoint, there are a couple of different ways you can look at management: you're managing the tenants, which is that is your cash flow, I'm a big believer that real estate is only worth some function of the rent that's coming into it and you need to protect that. It involves having a really good relationship with the tenants. But you still need to also manage the asset. And that could be something like refinancing. You have to wear that asset manager hat on how you're maximizing the investment potential of that opportunity.
There are different hats that you have to wear dealing with smaller tenants. It's difficult to scale unless you have some systems in place, or you are willing to hire a property manager. We are a perfect case study of it, we do both because there are times where it makes sense to do it. It keeps our costs lower. On the larger properties inside the portfolio, having that property manager dedicated to handling issues as they come up means that we don't have to be involved in every single call of a washroom not being cleaned. The upside with tenants like that is that it's not after hours. All the calls that we have, or our property manager receives on our behalf, are business hour calls. Even with that, I think that there's upside to being in the commercial or industrial space versus being in that multifamily space where you're potentially dealing with problems at midnight.
In the multifamily and also in self storage space, management is typically based on a percentage of income, let's say five to 10% if you have a single family home, is it the same for industrial or do you pay them by the hour? Do you pay them a salary, or is it a percentage like other asset classes?
They'll usually be some hybrid of these two, 5% seems to be a pretty common number that gets thrown out there. But it also depends on how much work is involved. If we hired a property manager to manage the one that we self manage, it would be a lot easier for someone to manage versus having to manage the same type of property with 10 tenants, even though they're same: same price, and potentially even the same amount of rent coming in. One is just going to require a lot less work than the other. It really comes down to what you negotiate with a property management company. There will typically be things in there as well that they will charge for additional work that they have to do if they have to meet contractors on site, or if they have to be involved with any of the discussions. These are all points for negotiation. If you are considering going the property management route, I recommend talking to a few people, because there's a huge difference in property managers from the ones that treat it like a robotic idea of "everything is very mundane", it's the same process they do to everything as a low level of service, all the way to some property management companies that really do try to add value to the equation and provide you with more than you'd expect from a lower service robotic element. Just as like you would do in any other professional services, it's good to get recommendations. That would be the first thing that I'd start with, talking to other industrial property managers that you're using, get some recommendations, and then talk to a few of them and find one that you think would be the best fit for you and for the tenants.
Is there anything else with regards to managing an industrial property or portfolio that you think is important for people that are getting into this asset class?
Probably the most important thing beyond being an interface with the tenants, and that can be an owner or a property manager, somebody needs to interface with the tenants and all the issues that they have. That's mission critical. Once you have a tenant in there, you need to secure that relationship, make sure that they're happy, keep that tenant in there as long as possible, that is a better idea than turning over new tenants all the time.
Beyond that tenant relationship, it's also very important, most industrial leases will be structured in a NNN basis. The tenants pay base or net rent to the landlord, then they also pay for all the operating level expenses of the property. That's usually property taxes, building insurance, common area maintenance, landscaping costs, snow removal in areas with snow, and that's a budget. When a landlord gives a tenant their numbers in advance at the beginning of the year, the base rent is contractually agreed upon, that could be $10 a square foot for the whole term of the lease, there could be escalations, but that's already known. Whereas the operating costs, all the landlord can do at the beginning of the year is an estimate. They'll say this is what we think property taxes are, here's what we think insurance will be, here's what we think snow removal costs will be. And they try to do their best to come up with that budget number. And that's what they start collecting from the tenant. At the end of the year, they have to reconcile all those bills, this is how much we actually paid on all these things, add up how much they paid out of how much they collected, and they either need to give an invoice for any amount that is still owing, or they give a credit or refund back to the tenants.
As you can appreciate those two events, first coming up with a budget, second coming up and reconciling all your bills, these can take a lot of work. Quite often new owners of properties don't have a baseline to say, we can expect that we're going to spend $5,000 a year just on landscaping for the building, they can guess on that, but unless they have a track record to say, last year was 4,800, the year before is 4,600, that's why we can confidently say $5,000 this year, they're really guessing. Because that operating cost is collected in advance, when the time comes to reconcile and you either have to send an invoice or send a credit, no tenant will ever complain about getting a check in the mail. But a tenant will not be happy if they get a $10,000 invoice at the end of the year because it was poorly projected at the beginning.
That starts to blend into managing your tenants, you have to manage your asset, and a property manager is really fulfilling a lot of roles to really optimize the value of the asset. Every investor is buying real estate because they want to have the best return that they can get, and to do that, you need to you need to fulfill all these different hats like we've talked about: financing, due diligence, dealing with your lenders, dealing with your insurance company, dealing with municipalities, etc. But at the end of the day, we're all trying to maximize the return on our investment, and making mistakes like that is not good. And I hear this happens, surprisingly, quite often, especially with tenants that didn't have a good understanding of how the triple net leases worked, and they get an invoice for $10,000 at the end of the year. If they didn't expect that coming, and didn't even have a good understanding of how that worked, that can be a huge sticker shock. I can say from people that I know that it severs that relationship between the landlord and the tenant automatically.
From a property management perspective, you just want to ask the question, if I'm going to hire someone out, what do I want that person to do? And if I'm going to do it myself, am I prepared to spend all the time to get everything right, so that I'm maximizing this from a property management perspective. I think you could look at it as, property management and asset management are hand in glove, you need to be looking at both of them simultaneously. Having a property manager can be very beneficial. If for no other reason than freeing up the owner to not have to deal with the day to day operating level conversations that happen. But it can also help them with budgets, if you need to see a quarterly statement to see how things are going. Most people, especially people that have been successful enough to be able to invest in industrial, or commercial real estate, are savvy people, much like yourself . You're a very smart woman, you could easily self manage your properties and figure out how to do it. The only thing that I'd ask is, Is that the best use of your time. And it might just be something that you want to have that operating level control, you want to be the face with the tenants, you want to control that whole conversation, and that's perfectly fine, we do it on some properties. But there's also times where we feel that our time could be better spent elsewhere, and bringing professional property managers that have more systems in place, they're organized from a level where they do this methodically, that it just becomes second nature to them. And it's no different than if you want to buy or sell a property, you could do it without a broker. If someone wants to go and represent themselves in court, they can do it without a lawyer. If someone wants to get a tooth removed, they can do it without a dentist. But I don't want to do any of those. I want the dentist, I want that lawyer, I want that broker. And in the majority of cases, it makes sense to have a professional property manager.
Do you manage the dates on these leases? Or do you put that responsibility on the property manager?
It's a great question and it speaks to the complexity of a commercial industrial lease as well. Coming from the multifamily space people are probably used to dealing with very short, concise leases. It's probably state mandated, or in a lot of areas, it's the same form that everybody uses. It's intentionally very simple because the average resident doesn't want to be overwhelmed and inundated with all this dense legal language.
I'm working on an industrial lease right now, it's 58 pages long. This is the most boring, dry document you could possibly read and is so dense with legal language. There are so many things that are there, it's common to see an option to renew, there might be a right of first refusal to purchase the building or to lease a neighboring space. There are so many things that can be contained in a lease. If somebody wanted to buy one industrial property, they want to buy 3 million industrial property of a single tenant, you can get your head around all of this. I think it is possible for someone to manage one building by themselves. They could comfortably do it because they could have a lawyer help them with the lease language to really understand all the things in there, they can put all the key dates into a couple of different places to have reminders, they can navigate their way through it. But can you imagine having 10 buildings, or 10 tenants, where you have 10 leases, with this dense language, they're all going to be personalized for each company. They're all somewhat unique, and you have to look and extract all this key information to stay on top of it. You understand this problem as soon as you start scaling, it becomes that much more cumbersome to self manage.
It's hard to self manage a large apartment building like that because you're always dealing with things. You could self manage a freestanding industrial property on your own. But as you increase your number of portfolios it just becomes so much more work to have to keep on top of it, that's probably where you make the decision to bring on a property manager. To answer your question directly, what we do is we have dates in our CRM that tracks everything. We know when all leases are coming up, when the options to renew are coming up, or if there's any rights of first refusal, we track all of that. It becomes a system. And property managers that do it on our behalf. They have similar types of systems as well.
The CRM we use is Zoho, which is similar to Salesforce. Mike Lipsy once said that the best CRM is the one that you use. I've become very comfortable with Zoho, I've probably been on it for four or five years now. It's very simple, it doesn't have bells and whistles, it's not overwhelming, it's just a great tool. I have it open on my computer right now. I'm always looking at it.