Acquisition vs. Development in Flex Industrial

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min read

I get asked this all the time. Should I acquire real estate, or should I develop it? There is a case for both. But before I make either case, here is the rule I lead with. If you can achieve the same outcome in one step instead of four, take the one step. Development is a complex process with risk built into every stage. And as my mentor Sam Zell always said, "you must get paid for your risk". I have done developments where I was too optimistic on my assumptions, and the project cost me time and energy without delivering the reward that would have justified all that complexity.

Why default to acquisition?

For the majority of investors, acquisition should be the target. When you acquire an established property, you are buying something with a track record. You can see how the asset is actually performing, where the inefficiencies are, and how you might improve them. All of that minimizes uncertainty, and uncertainty is what kills investments. You do pay for that stability. A stabilized, cash-flowing asset costs more than a patch of dirt. But over the long haul, acquisition is simpler and easier, and simpler and easier is usually where the smart money lives.

Why the stated numbers are never the real numbers

Here is where acquisition earns its reputation for being easy, and where beginners get hurt. The numbers a broker markets are almost never the numbers you will actually operate. Watch for these:

Property taxes get reassessed after the sale. The taxes in the marketing package reflect the seller's old basis. Once you buy, the assessor often resets to your purchase price, and your tax bill climbs.
Repairs, maintenance, and payroll are understated. Many properties need more upkeep than the seller admits, and some need real eyes and ears on site. That cost rarely shows up in the marketed underwriting.
Tenant improvements and leasing commissions. When a tenant leaves, you face downtime, lost income, the cost to improve the space, and a commission to lease it again. One of the biggest hidden expenses in the business.

The trade-off is worth it, though, because of what you get in return: certainty of the rent roll. You can underwrite every tenant one by one and confirm they run a stable business with a good history of paying. You are buying a known quantity.

What development really costs

Development is a different animal. To a degree, you are shooting in the dark, and the only thing that reduces the odds of missing is homework. You are studying the signals of future demand: new housing going up, new LLC registrations forming, new roads and schools being built, dense infill with little competing product. If the demand and the growth are not both there, a development will fail. Full stop.

The cost of a ground-up project breaks into three buckets: land, including the site work to make the dirt buildable; hard costs, the actual vertical construction; and soft costs, the entitlements, engineering, and approvals. One factor that swings the math hard is what the city will require to approve your project. Many municipalities demand facade upgrades or specific materials, concrete or CMU instead of metal, which drive your costs up. That is painful going in. But remember, those same requirements are exactly what create the barriers to entry that protect your asset once it is built. The biggest factors hit before a single dollar of rent comes in: initial tenant improvements, leasing commissions, and your carry cost, the operating expenses and interest on your development loan while you lease up. Every month of delay is a month of carry with no income.

What is the Replacement Cost Rule?

Both paths answer to one referee, and it is the rule I want you to carry out of this chapter. On the acquisition side, the rule says buy below replacement cost. If your basis is under what it would cost to build the same asset new, no new development can undercut your rents, because the new builder has to charge more than you just to break even. On the development side, the rule flips. Your all-in cost to build, land plus hard costs plus soft costs plus carry, has to land far enough below the stabilized value of the finished property to pay you for the risk and the time. If building it costs about the same as buying it stabilized, do not build. You would be taking on all the risk for none of the reward. That is the Zell principle in practice: get paid for your risk, or do not take it.

A side-by-side, for the shape of it

The figures below are illustrative and broad, meant to show the concept, not to quote a real deal. Take a hypothetical 50,000 square foot small bay park with a stabilized value of about $11,000,000, or roughly $220 per square foot, once fully leased.

Small Bay Industrial · Illustrative Comparison

A Side-by-Side, for the Shape of It

The figures below are illustrative and broad, meant to show the concept, not to quote a real deal. A hypothetical 50,000 SF small bay park with a stabilized value of about $11,000,000 (≈ $220/SF) once fully leased.

Stabilized Asset

Acquisition

Stabilized small bay industrial building

Purchase Price: $10,750,000
Price per Foot: $215/SF

Occupancy, Day One: 90%+ · Stabilized asset
Upfront TI & Carry: Minimal
Cash Flow: Day one
Risk: Lower risk · You paid for certainty.
Value Creation: Smaller margin

Pay for Certainty

Higher basis, less new value, but immediate cash flow and lower risk.

Ground-Up Project

Development

Small bay industrial building under construction

All-In Cost: $8,750,000
Price per Foot: $175/SF

Occupancy, Day One: 0% · Ground-up project
Upfront TI & Carry: ~$1,250,000 · $500K TI and leasing, $750K carry
Cash Flow: 24–36 months
Risk: Higher risk · Time the market, build on budget, lease it up.
Value Creation: ~$2,000,000 · If it executes

Get Paid for Risk

Lower basis, potential to create a couple million dollars of value, but only if it executes.

Read that and the whole trade-off is right there. The acquisition costs more per foot and creates less new value, but it pays you on day one and the risk is low. The development goes in at a lower basis and can create a couple million dollars of value, but only if you time the market, build on budget, and lease it up. You are being paid for that risk through the spread. If the spread is not there, the Replacement Cost Rule tells you to walk.

A middle path: buying at certificate of occupancy

There is a middle path I am fond of. You buy from a developer right when the certificate of occupancy is issued. The developer takes their profit the moment the building is complete, and you, the acquisition partner, take on the lease-up risk without having to carry the land or the construction financing. You inherit a brand-new building at a clean basis and go to work filling it. It captures some of the lower basis of development without the full weight of the construction risk.

"If you can reach the outcome in one step instead of four, take the one step. Development carries risk at every stage, and you must get paid for it." — Jeremiah Boucher

It comes down to what you are optimizing for. If your priority is stability, go with acquisition. If your priority is long-term potential and higher returns, and you have the team and the timing to earn them, go with development. Most investors, most of the time, should start with acquisition and earn their way into development. Next in the series: the part most investors never look at, and the part that decides whether they get their money back. Capital structure.