Gaylord Container Corp.'s story is a familiar one in the age of offshoring. Undercut by foreign competition, the 80-year-old cardboard box maker sold out to Austin (Tex.) paper-packaging company Temple-Inland Inc. (TIN ) in 2002. But then this month, Temple-Inland sold Gaylord's 17-acre box plant in Antioch, Calif., for $6.5 million to real estate firm Fowler Property Acquisition LLC, which plans to get the land rezoned for residential use. A homebuilder has already offered Fowler $17 million for the land once it's rezoned. No wonder: The site is in one of the country's hottest housing markets, the San Francisco Bay Area.
The combination of the U.S. manufacturing bust and the housing boom has turned industrial plants into prized real estate. Many prime locations on city waterfronts and in downtown neighborhoods are occupied by factories that are closing left and right as competition from Asia drives jobs offshore and manufacturers out of business. But young professionals and empty nesters flocking back to inner cities have "made whatever scarce land is available in urban areas more attractive," says Christopher Jones, vice-president for research at New York's Regional Plan Assn.
Even as the national housing market cools, demand for homes in New York, Los Angeles, and other cities where land is scarce but empty factories are abundant will likely remain strong. "If you must accommodate over 70 million new people between now and mid-century, you're looking at a lot of demand," says Robert E. Lang, director of the Metropolitan Institute at Virginia Tech.
Much valuable real estate is languishing in the hands of private-equity firms. They frequently acquire underperforming manufacturers and close plants to reduce costs. With more than $500 billion in assets, the firms control as much as 15% of U.S. commercial real estate, according to John Troughton, senior broker at realtors Cushman & Wakefield Inc. "These firms are buying things on financial statistics, but they're ignoring the real estate," he says.
So far, buyers are doing better than sellers. Manufacturers are sometimes willing to part with an unused facility for a low price to escape a costly environmental cleanup and battles with city planners. But once new owners decontaminate a site and get it rezoned for housing, its value can skyrocket. In 1997 thermal underwear maker Indera Mills Co. shut its 97-year-old factory in downtown Winston-Salem, N.C. "A lot of our assembly jobs had gone to Mexico," says James Olson, treasurer and owner. Indera sold the plant the next year to local developers for about $1.5 million. One of the buyers, Beau Dancy, bought out his partners, got the land rezoned, and built 33 condos and three offices on the site just as a major effort to revitalize the city's downtown got under way. By 2003 he had sold all the units at prices from $120,000 to $750,000. Now he's building more across the street. "We were probably 10 years too early" in selling, Olson says.
All the same, Indera made out all right. Because the plant was fully depreciated, the company faced a stiff capital-gains charge. To avoid the bill, Indera used a common strategy called a like-kind exchange, which allowed it to put money from the sale toward a new distribution center in Yadkinville, N.C. -- and avoid capital-gains taxes. It even saved money by closing a leased facility in Winston-Salem and consolidating in Yadkinville.
Some developers are so eager to snatch up industrial sites that they will pay top dollar. "We go knocking on companies' doors and tell them: 'You may not know it, but your property has a significantly higher value if we are able to get residential entitlements on it,"' says Dan Flynn, vice-president of land acquisition at John Laing Homes, a Newport Beach (Calif.) developer. Laing has built homes where a lockmaker and truck depot once stood in Anaheim, Calif.
In a typical deal, a developer will offer to buy a site for what it's worth after rezoning and will put down a deposit -- but not pay the rest until the city approves the rezoning. The developer makes its profit from the homes it builds. Telecom equipment maker DiCon Fiberoptics Inc. is in the middle of such a deal. With demand falling, DiCon decided to unload 12 surplus acres earmarked for expansion in Richmond, Calif. The company had paid $4 million for the land in 1998, but last summer builder Pulte Homes Inc. agreed to pay $14.4 million for it, subject to rezoning. "The price was significantly higher than what land would be valued at for research and development or light manufacturing," says Steve Kalmbach, a Pulte division president.
Why doesn't a company such as DiCon also ask for a cut of the profits from the homes? Some companies do discuss joint ventures with developers, but they're rare because companies without development expertise fear they'll find themselves out of their depth. "If they're a manufacturing or financial company, they should stick to what they do," says David Shannon, president at JDL Castle Corp., a developer in Winston-Salem.
Henrietta Development Corp. offered such an arrangement to Archer Daniels Midland Co. (ADM ) when it proposed buying ADM's old grain silo in Baltimore. "We always offer the possibility of a joint venture," says Patrick Turner, president of Baltimore-based Henrietta. But ADM declined the offer. "They concluded that it's not their core business, and they don't want to explain to stockholders if something goes wrong," he says. Henrietta wound up acquiring the 15-acre site for $6.5 million and building townhouses that sell for up to $700,000 in a partnership with Pulte.
Many private-equity firms feel the same as ADM. "We prefer not to own real estate," says Robert Giles, a partner at SilkRoad Resources LLC, a Palo Alto (Calif.) private-equity firm. In September, SilkRoad and private-equity firm Triton Pacific Capital Partners LLC paid $4.75 million for the assets of Pilgrim Fireplace Equipment Co., a Fairfield (Calif.) maker of fireplace tools that had been struggling. The previous owner kept Pilgrim's most valuable asset: a plant in Fairfield valued at about $5 million.
Some businesses that don't need to close down plants are relocating them to cash in. In Emeryville, Calif., once a gritty city across the bay from San Francisco, property values have soared as factories have given way to condos and loft apartments. Pulte bought plants in the city from an equipment-rental business and a liquid-gas company, both of which then relocated to cheaper areas. "They both realized: 'I don't have to be at this location for my customer base,"' says Pulte's Kalmbach.
Not all cities are eager to rezone commercial land for residential use. Some officials worry that their tax base will suffer because businesses pay higher property taxes than residents. What's more, if homes start encroaching on factories, businesses may leave to avoid complaints about noise and fumes. "There's a constant tension between how much emphasis you put on redevelopment and how much on industrial," says Jones, of the Regional Plan Assn. Chicago, for example, has created six enterprise zones where residential building is prohibited. But as long as there are empty plants and eager home buyers, the factory-to-home conversion trend is here to stay.
By Justin Hibbard