Industrial strength fear
By Andrew Gomes
Advertiser Staff Writer
By Andrew Gomes
Mapunapuna and Kalihi Kai are home to hundreds of businesses from construction supply firms to automobile body shops, but many are wondering how much longer they can afford to be in two of urban Honolulu's largest industrial communities.
Hawai'i's recent real estate boom has given the owner of 10 million square feet of land in the two gritty neighborhoods a basis to ask some tenants to pay between double and triple their current rent — a proposal that has delivered an economic shock to small and large business owners.
The move by Massachusetts-based HRPT Properties Trust, which owns more industrial land in Hawai'i than any other private entity, also stands to push up industrial rental rates in other parts of O'ahu and possibly may force longtime businesses to relocate or raise prices that would be felt by consumers.
"It's a pretty serious deal," said Gus Cossette, an HRPT lessee who owns three Kalihi Kai warehouses subleased to about 10 businesses including a tour bus firm, an electrician and a truck repair business. "Our tenants can't pay this. They'd be out of business."
HRPT, which paid the local Damon Estate $480 million for the Mapunapuna and Kalihi Kai property and a few other parcels in December 2003, said the rental income it seeks is tied to the fair market value of land that has more than doubled in the last several years.
"We're not forcing our will on the market," said company spokesman Tim Bonang. "It's just what the market is. Land values in Hawai'i have increased."
The issue of soaring ground rents stinging businesses is a painful, resurgent issue in Hawai'i where huge concentrations of commercial real estate are owned by a few entities, such as Kamehameha Schools and Queen Emma Foundation, that lease their land subject to periodic renegotiated rental rates.
The arrangement, largely preserved because many of the biggest land trusts don't want to sell their property, gives many businesses little control of property costs when land values rise.
After the Japanese investment bubble helped drive Hawai'i real estate prices through the roof in the late 1980s, similar instances of ground rent shocks exacerbated by an economic downturn drove lessees out of business or out of their buildings.
Now a block of HRPT lessees in Mapunapuna and Kalihi Kai are facing similar and scary timing of inflated land prices/rent and a slowing economy.
HRPT lessees are concerned enough that several of them — including Servco, Plywood Hawai'i and Grace Pacific — recently formed a tenant association to share information and resources in an effort to address HRPT's move on a consolidated front.
DOUBLING THE PRICE
According to several lessees, HRPT sent them letters asking for annual rent of $9.25 per square foot of land, which for some tenants would be more than double their current rent of around $4 a square foot.
Lessees said they received the $9.25 offer inexplicably a few months after an earlier offer made by HRPT between $5 and $6. Both offers included a provision for rent to automatically increase 3.5 percent every year for the term of the rent period that varies by lessee.
Cossette said his tenants can't absorb such an increase, and that he would lose $600,000 a year from his warehouse rentals if he absorbed the hike. "It's a real tough deal," he said.
It isn't clear how many HRPT tenants are presently renegotiating rent with the landowner, according to Melissa Pavlicek, a local attorney and the state director of the National Federation of Independent Business who was hired as executive director of the HRPT tenants group called Citizens for Fair Valuation Inc.
Some HRPT tenants have reached rent agreements in recent years, but many fear rent offers on the table now will set a new floor for industrial rates affecting the broader market.
Typically, HRPT leases require rent adjustments every five or 10 years, though some tenants previously negotiated other terms.
When HRPT bought the Damon property, the company said it had 186 leases, many of which involve subleases to multiple businesses that typically must absorb rental rate increases.
"I have this chunk of change rolling down the hill, and it's going to hit me in the face," said Fred Smoot, owner of Phoenix Pacific Inc., a distribution business dealing in traffic signals and communications equipment.
Smoot said he's operated at his Mokauea Street site for more than 20 years, subleasing the property from California-based STI Industries.
Stan Solomon of STI said he rents three parcels from HRPT on which the rent is up for renegotiation, potentially affecting several subtenants including suppliers of business phones, steel, wire and fabric.
"It's tough," he said. "I don't want to see my tenants go out of business."
Some lessees, who asked not to be named for fear that it would make negotiations more difficult, speculate that HRPT is trying to reclaim the leasehold interest in its land at no cost by asking for such a steep rent increase — a so-called economic eviction — with the goal to redevelop the property for higher and better use.
Bonang of HRPT said the company has no intention of rebuilding until after most leases expire between 2022 and 2027. He added that the prospect of the city building a commuter rail line through part of HRPT's Mapunapuna property parallel to Pukoloa Street doesn't change the company's plan.
HRPT is a publicly traded real estate investment trust that's required to pay stockholders a percentage of income every year, so the company has an incentive to maximize tenant rents. "Our focus is income as investors," Bonang said.
The company, Bonang added, probably will take a piecemeal approach to redeveloping or improving its Mapunapuna and Kalihi Kai property after leases expire. No leases expire before next year. Of the 10 million square feet, nine leases covering 400,000 square feet expire next year.
Historically HRPT has negotiated agreeable rent increases with tenants in most cases, according to Bonang.
In cases where mutual agreement cannot be reached under the old Damon leases, the issue is to be decided by an arbitration panel of appraisers — one appointed by HRPT and one by the tenant, with a third picked mutually by the first two appraisers if necessary.
Under common commercial property leases in Hawai'i that call for determining rent through arbitration, rent is calculated at a percentage — usually 6 percent to 7 percent — of the land's fee-simple value. Fee values are largely determined by sales of comparable property.
In Kalihi Kai, local real estate brokers said some industrial land has sold for values between $125 and $150 a square foot that might justify annual rent close to $9.25 a square foot.
Mark Ambard of industrial property brokerage firm Ambard & Co. said $9.25 a square foot for annual land rent roughly translates to $1.54 a month per square foot of warehouse space and would be difficult for many industrial businesses to afford.
Also, whatever rent HRPT collects from a lessee, sublessees would naturally pay more to afford some profit for the sandwich lessee.
With a proposed 3.5 percent annual increase, which Ambard said is unusual for Hawai'i industrial property, the $9.25 rate would rise to $10.61 in five years and to $15 in 15 years.
"These guys are going for blood," Ambard said of HRPT. "I don't see it as evil. This is how the game is played. We are not a socialist society."
If HRPT gets what it wants, Ambard said weaker industrial users would likely be displaced to more remote industrial areas such as Pearl City, Waipi'o or Kapolei to make way for businesses able to pay HRPT's rate.
"Industrial (business) historically has been pushed to the edge of the trade area," he said. "It's just a natural progression."
Several HRPT tenants bristle at what they view as a lack of understanding or flexibility with which they say Damon officials treated them. For instance, in one previous round of difficult rent increases, tenants said Damon allowed them to pay reduced rates in the first few years in return for higher rates in the later years of a 10-year period.
Ambard said other commercial property landlords such as Kamehameha Schools (formerly known as Bishop Estate) have riled tenants with tough negotiations in the past, so in a sense the situation is not new but the landlord is.
"HRPT is not Damon," he said. "They are not kama'aina. They are in here for the money."
Local commercial real estate broker Steve Sofos of Sofos Realty Corp. said the strategy of lessees banding together has not always been productive. "A lot of lessees have tried to do that, and the success has been very iffy," he said.
But Sofos also said he believes most HRPT lessees will end up with rent they can live with. "I'm optimistic they will resolve the issue," he said. "At the end of the day, I think they're going to work it out and HRPT will be reasonable."
Reach Andrew Gomes at email@example.com.