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Facing Economic Eviction

Rent renegotiations are up for tenants in prime locations near Honolulu’s airport and docks. Will high land values and a slowing economy displace long-time industrial tenants?

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In August 2007, Olelo Television Community, the nonprofit public access television station for Oahu, received a letter from HRPT, its landlord in Mapunapuna. Although Olelo secured a ground lease up until 2044, its lease calls for renegotiations every 10 years, with the next renegotiation occurring in October 2008.

With land values skyrocketing across Hawaii and the nation, Olelo expected an increase, but not this much. HRPT asked for $9.25 per square foot annually; the current ground lease rent is set at $4.20 per square foot. That amounts to a 120 percent increase. In addition, the rent proposal asks for a 3.5 percent annual step rate.

Olelo and a number of other area businesses found the rent “exorbitant, in our estimation,” says Kealii Lopez, president and CEO of Olelo. “Different folks started talking to each other about, ‘What are you going to do? What’s that mean for your business?’ Everyone was clear that it was really untenable for a local business to be able to stay in business based on what was being proposed.”

HRPT (NYSE:HRP), the real estate investment trust based in Newton, Mass., assumed the lease in its $480 million purchase of Damon Estate land in 2003. HRPT is the 11th wealthiest landowner in Hawaii with an assessed land and building value of $924 million. The largest private industrial landowner in the state, HRPT holds industrial lots in Kapolei, Mapunapuna, Moanalua and Sand Island.

Increased land values have been a boon for HRPT  and other landowners but a bane for leasehold tenants. Rental increases are inevitable, but the way rents are dealt with now may set the tone for future lessees on Hawaii’s limited industrial leasehold land. The higher prices can force businesses to relocate or, worse, close up shop forever.

In response to HRPT’s letter, a hui of HRPT lessees including Olelo, Servco and Plywood Hawaii formed the Citizens for Fair Valuation (CFV) in December 2007. Its goal is to obtain fair and reasonable rents by sharing information, educating its members and breaking down the nuances of lease requirements. Michael Steiner, CFV’s executive director, says, “As a team, as a group to come together, you get some great ideas, much better than on an individual basis.” The group hopes the information shared will empower members and equip them with the knowledge to negotiate with HRPT.

Leases negotiated years ago with Damon Estate vary from tenant to tenant, but a few stipulations run through all of them. The lease rate is based on fair market value from comparable land sales. If the two parties cannot agree on a lease rate, the rent is settled through arbitration. The lease language indicates fair and reasonable rates for both parties. Lease renegotiations occur every five to 10 years.

The problem is, now just might be the worst time for a lessee to renegotiate a lease.

Rents in Mapunapuna average $4 per square foot anually.  But the rise in real estate values, low industrial vacancy rates and proximity to Honolulu's airport and harbors have allowed landowner HRPT to ask for $8 to $10 per square foot.

Eye of the Storm

According to a market report by Colliers Monroe Friedlander, Hawaii’s industrial real estate vacancy rate was below 2 percent from 2004 to 2006. An added 500,000 square feet of industrial condominium space pushed the vacancy rate to its current level of 4 percent, which is still well below the 8 percent national average.

Industrial land values have also increased. The same Colliers report estimates industrial land values in the Waipahu, Sand Island and Pearl City areas increased about 30 percent from 2006 to 2008. In addition, industrial land in Hawaii is roughly 50 percent leasehold and 50 percent fee ownership. All these factors contributed to a perfect storm in favor of the landowners, says Scott Mitchell, executive vice president and industrial services manager at Colliers Monroe Friedlander.

“When you have all three things like that converging all at once, it makes it really hard for the lessee because they’re not negotiating from a position of strength,” Mitchell says. “The landlord is negotiating from a position of strength in this market.”

Mitchell himself is a sandwich lessee in the area, leasing land from HRPT and in turn leasing the land to other businesses. (He is not a member of CFV and is not renegotiating his rent until 2018.) He says the lease renegotiations have been untimely, with the last round coming just after the steep run up from Japanese investment. “If you’ve got a run up like you did in the Japanese bubble period that was very steep in a very short period of time and then boom, those renegotiations hit, you’re paying top dollar for ground rent,” Mitchell says. “Guess what? We’re there again.”

This time around land values may drop but the national credit crunch will affect that. “If you can’t sell land, there’s not going to be any sold properties or any comparable sales,” he says.

Furthermore, since most of the land in Mapunapuna is leasehold, fee parcels of land are few and high priced. The supply of fee lands decreases yearly while the demand, especially in the urban core, increases every year. According to Colliers, recent transactions in Mapunapuna and Kalihi have sold for $123 per square foot.

Tim Bonang, director of investor relations for HRPT, says the language of the leases use market sales as the benchmark for renegotiations. “If the market prices for industrial properties had gone up between Point A and Point B in terms of the reset points, obviously the rate is going to go up,” Bonang says. “If the market prices go down during the same A to B period, the lease rate will go down. It resets to whatever the market is, up or down.”
       
Across the board, rent has gone up across all industrial properties. According to Colliers, the average monthly asking base rent for warehouse leases was $0.66 per square foot in 1998, $0.91 per square foot in 2003 and $1.26 this year.

The lease also states that if rent cannot be negotiated between the two parties, arbitration with a panel of three appraisers determines the rent, and the arbitrators will use recent market sales as the basis. “The process, from our view, is pretty cut and dried,” Bonang says.
Because of the added cost, arbitration is an outcome the tenants would like to avoid.

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