The concept of highest and best use is an important one in property; however, cities are not static and the optimum use of land today may not be the same in a decade’s time. Industrial landlords are aware of this as their sector often – but absolutely not always – ranks below other uses; land zoned for residential or office use tends to be more valuable than that allocated for manufacturing and distribution. However, getting in at the bottom of the value chain opens opportunities for industrial landlords to cash in as cities grow and develop around their assets.
Urban opportunities
China has seen dramatic urbanization over the past two decades and people continue to flock to its major cities; the government estimates that 300 million people will move to cities between 2010 and 2025. This provides an opportunity for landowners in those cities, one of which is logistics specialist GLP, which has created a specialist arm to exploit opportunities for change of use. The I-Park business now has 80 staff and 600,000 square meters of R&D and business park space.
Angela Zhao, co-president – real estate, GLP China, says: “We have been operating in China since 2003 when urbanization was experiencing its most rapid growth. GLP’s portfolio has sites that were previously on the periphery of cities, but which are now part of the city and could be rezoned to drive more value. For example, we redeveloped a manufacturing facility in Beijing into BMW’s largest research and development center, while in Shanghai, the construction of a new subway station near one of our sites has made it suitable to be rezoned as commercial space.”
The potential in GLP’s China portfolio is significant, says Zhao. “We estimate that 10-15 percent of our existing $20 billion portfolio could be rezoned, which could increase its value fivefold. That would increase the overall portfolio value by a third.”
Change of use potential is not limited to rapidly growing developing markets such as China. Prologis, one of the longest established industrial specialists, has a long history of adding value through change of use. The company acquires infill and brownfield sites in the US and Europe with an eye on change of use potential, says Mark Hansen, managing director, investment division. “In an infill environment, change happens as cities grow or new transport links are built. Our base case is industrial and warehousing, but we are always looking for opportunities to add value.”
Prologis’ investment teams look for opportunities to create value through conversions to achieve higher and better uses across its US and European portfolio and such projects net the firm on average around $50 million a year. Sites with planning permission for residential development will be sold to a specialist developer, but in the case of a project such as One Workplace in Santa Clara, California, Prologis carried out the conversion of a warehouse to a corporate headquarters, showroom and distribution center for a furniture business.
Change of use can be extremely profitable: in 2015, Prologis sold a warehouse site in Menlo Park, California to Facebook for $400 million, having acquired the site around seven years previously for $110 million and subsequently gaining permission for office campus, housing and retail uses, and with more density on site. As a minimum, Prologis seeks a 20 percent value uplift from change of use, says Hansen, but often achieves more.
Having industrial and warehousing as a core business can be an advantage for companies such as Prologis. “Our long-term strategy is to maintain industrial use. Therefore, we can wait across cycles for the right time and value to seek change of use,” says Hansen.
In Australia, Goodman Group, which has been developing industrial property for more than 30 years and thus benefits from long-term landholdings, has a substantial number of residential projects in the pipeline and generated impressive receipts from land sales for urban renewal. The company has a pipeline of more than 35,000 apartments in various stages of planning and over the past five years has sold A$2.5 billion of land for alternate uses.
Major deals include the sale of a former industrial estate in Erskineville, Sydney to Hong Kong developer Golden Horse for A$380 million. The site is earmarked for a housing-led mixed-use development. Australian residential developer Meriton bought two Sydney sites from Goodman for a total of $450 million.
Goodman chief executive Greg Goodman says: “Goodman has a number of planning initiatives underway in various urban centers around the world. Cities around the world face challenging planning decisions around land use, driven by this competition for land that’s close to consumers.
“In making these decisions, there needs to be greater recognition of the opportunities presented by transitioning industrial precincts for broader use, where industrial, residential and other uses can co-exist.”
A key factor for logistics real estate owners considering seeking a change of use is their existing tenants. “It is important for us to co-ordinate our efforts, to ensure our customers are happy. Due to our scale and presence, we can find a new space for them in one of our other buildings if necessary, while optimizing sites for new users,” says Hansen.
Cashing in on the data boom
Rapidly increasing demand for data centers is a boon to warehousing owners, as modern buildings can often be fitted out by data center operators, with access to power being the most important consideration. Goodman, for example, converted a 16-story logistics complex in Kwai Chung, Hong Kong to a data center and sold it to PAG Real Estate for HK$1.3 billion ($166 million; €146 million) in 2015.
In markets with robust demand for data centers, Prologis ensures new warehouses have the power and other requirements to allow them to be fitted out as data centers, says Hansen. Tenancy agreements require data center customers to remove their fit-out so the building can be returned to industrial use.
GLP’s Zhao says: “We have capabilities to execute different property types. A warehouse is essentially just a big box and you can put it to different uses, such as fitting it out for a data center, offices or retail – we are even looking at conversions to rental apartments, as there is high demand in the first-tier cities of China for this.”
The world’s largest cities are attracting new inhabitants and putting constant pressure on land prices, all of which means savvy owners of industrial and logistics assets could engineer sharp rises in the value of their portfolios.
Not unidirectional
Increasing demand for warehousing and the development of multi-story facilities means it might trump other uses
Alan Yang, chief investment officer of GLP, says: “Even in developed markets, logistics real estate still has a lot of catching up to do to meet the demands of the consumer. The use of technology and data analytics has enabled better demand and inventory forecasting, which is driving increased demand for warehouses closer to the consumers, in major population centers, not just a singular, large-scale fulfilment center.
“The economics of these sites historically may not have worked for traditional logistics real estate, but they now may be viable given the high level of demand and new innovations in technology and development. As a result, we could see sites which once had a higher value as office or retail or another asset class being redeveloped for logistics.”
“Sometimes industrial is the highest and best use,” says Mark Hansen, managing director, investment division at Prologis. In London, Prologis bought a large site, which was part of the Stockley Park office campus and gained permission to develop 450,000 square feet of logistics space. Also in London, GLP is developing a multi-story warehouse – its first in the UK – on a Docklands site it acquired from Galliard Homes and Cain International. The development is in line with Greater London Authority’s commitment to make land available for ‘last-mile’ distribution close to central London.
Increasing use of automation in warehouses means they can be developed on smaller plots; in land-constrained Japan, multi-story warehouses are often served by lifts rather than ramps.
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