Why you should view warehousing as real estate
Wednesday, March 26, 2014
It is not surprising that real estate and warehousing go together like ham and eggs. Yet, despite its intimate relationship to warehousing, real estate is frequently misunderstood.
Of the tools used in warehousing, often the most expensive and least flexible one is the building that houses the operation. If and when this real estate becomes obsolete, it may be the most difficult tool to dispose of. If the wrong tool is purchased, correcting the error may be slow and expensive. Unlike lift trucks, computers and people, real estate cannot be moved from one place to another.
It is also no accident that most real estate investors are individuals or privately-held companies. Wall Street has never understood real estate, and publicly-held companies tend to avoid investing in property. Most public companies measure their progress by calculating return on assets (ROA). Since the best way to improve ROA is to reduce investment in assets, ownership of property is avoided.
Some logistics service providers (also known as public warehouses) may approach a client by offering to improve ROA by eliminating investments in real estate. Here is a case example of how this works.
The Smith Company is an importer whose ROA is calculated in the figure below. Last month, its new logistics vice president suggested that Smith Company should outsource its warehousing to a logistics service provider, and he identified a company that was willing to purchase its $10 million distribution center.
He then demonstrated, using the figure below, that total assets may be reduced from $106 million down to $96 million, resulting in a capital turnover of 5.1 with ROA increasing from the existing 18.4 percent to more than 20 percent.
Compared to other kinds of real estate, warehousing is relatively attractive as an investment. There is minimal retrofit cost when one tenant leaves and another takes over the space. Maintenance tends to be lower than with other kinds of real estate, and occupancy rates are often higher than with offices or retail space. This means that there is a relatively steady return with fewer maintenance headaches.
Some logistics service providers are leveraging their knowledge of warehouse real estate to create a profit center that includes both construction and land development. Some of these make it a practice to harvest and replant their real estate. As conditions change, obsolescent buildings are offered for sale and replaced with newer warehouses in better locations.
Investing in real estate is a classic "make or buy" decision. If you believe that you can construct or rehabilitate warehouses at a price that is below market, and you are also confident of your ability to sell buildings that are no longer useful, then real estate investment may be a prudent move for your company.
Always consider total costs, as well as the relationship between cost, time and risk. As we saw in two recessions in the past few decades, real estate does not always increase in value.
At the same time, the trend in corporate America is to remove real estate from the balance sheet. Becoming part of this process is often a profitable activity.
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