Small real estate investors throughout Southern California are proving that you don't have to be pretty to be profitable. Forget high-rise office buildings, fancy retail stores and luxury apartments. Humble warehouse and manufacturing space are what these buyers want.
Investors have been bidding up the prices for small industrial buildings--structures no larger than about 20,000 square feet--thanks to the improving local economy and its ever-more-entrepreneurial makeup. Small buildings that might have sold for a song just a few years ago are now selling for more than it would cost to build new space, and experts say this niche of the market is likely to hold its value because relatively few new buildings are being constructed.
"This is one of the tightest markets I've seen in a long time," said Chuck Lyons of Fu-Lyons Associates, a Paramount-based developer that has built more than 1.6 million square feet of small industrial buildings during the last 20 years and plans to break ground on another 167,000 square feet in Downey before the end of the month. The company started in the 1970s buying small "incubator" buildings of 1,000 to 3,000 square feet.
"The market for small space is extremely tight, and there is not a lot of new construction planned," said Jim Center, a senior vice president with Grubb & Ellis Co. who specializes in industrial properties. "Most of the development is in big-box projects."
According to those who specialize in this niche, demand for and investor interest in such space is a public secret.
"Nobody talks about it much or notices it much except those of us in the business, but there is space like this throughout the L.A. Basin," said Mike Ibarra, a senior vice president with CB Commercial Real Estate Group. "The tenants are a real mixed bag, everything from people expanding out of their garages to big-name companies needing a small location for light distribution."
Ibarra said such space for the most part is the domain of individual investors, partnerships and family trusts because the properties "fall underneath the radar screen of the [real estate investment trusts]."
Many of these investors have amassed fairly large portfolios of small buildings. Among these is Industrial Realty, a Torrance-based family business that owns more than $10-million worth of such property, according to Mike Quagletti Jr., whose father started the company in 1958 with one building.
Quagletti said he and his father--like lots of investors in small industrial buildings--are loyal to this class of real estate. They prefer it to apartments, retail shops or offices, and they stick with it despite the tug of other investments.
"Real estate is something that's material. You can drive by and look at it and touch it, and it's something that we've always felt is a little bit safer," he said. "I'm not knocking the stock market and mutual funds and other investments, but we're not that kind of passive investor. We like to have a little more control when we invest."
According to broker Center, whether small industrial buildings are a good investment depends on individual investors' age and financial goals, how much risk they are comfortable with, and whether the investors want a passive investment such as a bond or something hands-on such as real estate.
Small industrial buildings can provide annual pre-tax returns of 8% to 9% and good potential for appreciation, provided the buyer can find a property in a good location and doesn't overpay, Center and Quagletti said. Whether the investment is a wise one depends on the investor.
"Buyers have to look at their individual tax situations, what kind of return they'll get after taxes, and whether they believe the property will maintain its value over time," Center said. "That last part is always where the risk always is in real estate."
Getting into the investment is the easy part.
"You have to be prepared to hold the asset for a long period of time unless you're a developer building them on a speculative basis to sell them right away," Center said. "But that's a highly sophisticated specialty, and I don't recommend it for beginners."
Small industrial loyalists also believe such properties are easier to manage than other types of real estate.
"It requires less maintenance, and tenants pay more regularly, assuming you make sure you lease to good tenants," Quagletti said. Small industrial buildings don't require an on-site property manager as apartments do, and the leases typically require the tenant to take care of many of the minor maintenance items that apartment residents would want the landlord to handle.
"You don't have to worry about people calling you up to fix their garbage disposals," he said.