Why Growing from Micro-Bay to Small-Bay Industrial Isn’t Always Simple
By Brent Pennington, CCIM | Tenant Representation, Metroport Commercial Group
Why growing from micro-bay to small-bay industrial space isn’t always simple. On paper, the progression seems straightforward. A business occupying a 2,500 square foot micro-bay grows, needs more room, and wants to move into a 7,500 or 10,000 square foot small-bay industrial space.
If the company currently occupies a combination of office and warehouse space, it may assume the larger facility can simply be configured in roughly the same proportions. Add several offices, perhaps a conference room or dispatch area, and use the balance for warehouse or production. In practice, it isn’t always that simple.
I have encountered this issue several times recently with growing industrial users. They needed more warehouse capacity but also needed additional offices for sales, dispatch, project management, or administration. We identified larger industrial spaces that appeared to fit, but proposals involving significant additional office finish-out were rejected by landlords.
Why? The issue wasn’t the tenant or even the use. It was the economics of putting a relatively higher percentage of office finish into an industrial building.
The Office Percentage Changes the Equation
Consider for example a company occupying a 3,000 square foot micro-bay with 1,500 square feet of office and 1,500 square feet of warehouse. That’s a 50% office configuration. It would probably work very well for a service company, contractor, distributor, or other business combining administrative employees with inventory or field operations.
Now suppose that company grows and needs 10,000 square feet for a growing support staff in addition to warehouse space. Even a 40% office ratio would mean approximately 4,000 square feet of finished office. What was a relatively modest office component in the micro-bay has suddenly become a substantial construction investment in the larger space.
The tenant is no longer asking for a modest office with a couple of desks. They are asking the landlord to build out 4,000 square feet of fully finished commercial interior. At construction costs ranging from $120 to $180 per square foot for commercial interior buildouts, that request requires $480,000 to $720,000 in upfront tenant improvement capital. On a standard five-year lease, amortizing that capital is challenging and would push the effective rental rate well past the top of the submarket.
This exposes an important difference between micro-bay flex and more conventional small-bay industrial space. The business may have outgrown its micro-bay space, but its space configuration hasn’t necessarily grown into the economics of small-bay industrial.
Tenant Value and Building Value Aren’t Necessarily the Same
The additional office may be entirely justified from the tenant’s perspective. The company may genuinely need private offices, a conference room, dispatch space, restrooms, HVAC, additional meeting space, and other improvements to operate effectively. Those improvements can have considerable value for that tenant.
The landlord, however, would have to look beyond the current lease. The question is not simply whether the improvements are useful to today’s tenant, but whether they will also be useful to future tenants. That creates an important distinction: Tenant improvement cost and residual building value are not the same thing.
A landlord can invest substantial capital creating office space that is very valuable to one occupant without increasing the long-term value or marketability of the industrial suite by an equivalent amount. In many cases, it can make the space more difficult to lease later without expensive demolition work.
Why Landlords Push Back
Industrial buildings generally derive much of their flexibility from open space. A relatively simple office component can accommodate a broad range of warehouse, service, distribution, light manufacturing, and contractor users. As the office or showroom percentage increases, the building becomes more specialized, reducing the number of industrial users whose operational needs may align with the existing configuration.
A future tenant who needs mostly warehouse space may look at a suite with extensive offices or even mis-sized office for a future tenant’s use and see space it doesn’t want or need but will still be paying rent on. The landlord may then face the choice of offering a concession, waiting for another high-office industrial user, or spending additional money to remove some of the improvements.
This creates greater capital exposure risk. The owner may spend money to construct the office for the first tenant and then spend money again to remove or reconfigure it for the next one. That’s why a landlord can like the tenant, like the credit, like the use, and still reject the proposed improvements.
The Same Rent Doesn’t Necessarily Mean the Same Deal
Imagine a landlord considering two tenants for the same 10,000 square foot industrial suite.
One tenant needs 1,000 square feet of office and 9,000 square feet of warehouse. The other needs 4,000 square feet of office and 6,000 square feet of warehouse. Even if both tenants agree to the same face rental rate, they are a very different transactions from the landlord’s perspective.
The second tenant would require substantially more upfront capital. That investment must be recovered over the lease term, and the landlord must also consider what happens to those improvements after the tenant leaves.
A five-year lease may simply not provide enough time or rent to justify a large office investment. The landlord can try to recover the additional capital through higher rent, but eventually the economics can reach a point where the resulting rental rate no longer makes sense for the tenant.
The issue therefore isn’t simply, “Will the landlord build the offices?” The better question is, “Can the economics of the use of capital support the offices?”
The Landlord’s Underwriting Calculation
Consider how an asset manager evaluates two proposals for the same 10,000-square-foot bay:
| Underwriting Factor | Tenant A (Standard Industrial) | Tenant B (High-Office User) |
| Requested Office Ratio | 10% (1,000 SF) | 40% (4,000 SF) |
| Initial Tenant Improvement Outlay | $30,000 to $50,000 (refresh/paint/carpet) | $450,000 to $650,000 (new construction) |
| Leasing Risk & Capital Amortization | Low upfront capital exposure | Heavy upfront capital; extended payback period |
| Re-Leasing Pool at Lease End | Broad (general warehousing, trades, assembly) | Narrow (specialized flex or administrative users) |
| Decommissioning / Demolition Exposure | Zero to minimal | High ($15 to $25 per SF to demo and restore open slab) |
Even if Tenant B offers the same face rent, the net effective return for the landlord is substantially lower. Furthermore, if Tenant B vacates at the end of five years, the owner faces carrying costs during an extended vacancy or paying out of pocket to demolish walls, cap electrical drops, reconfigure the fire suppression system, and restore the warehouse floor for the next occupant.
The rejection is not an arbitrary decision by the landlord. It is an underwriting decision driven by capital allocation and risk management.
Growing Tenants Can Get Caught Between Product Types
This is where the issue becomes particularly interesting from a tenant-representation standpoint. A business may no longer be a typical micro-bay tenant because it has grown beyond the available suite sizes. But it may not fit neatly into conventional small-bay industrial either because it still needs a relatively high office percentage.
The requirement hasn’t disappeared. It has fallen between two common product configurations. A company needing 10,000 or 12,000 square feet with 40% office and 60% warehouse is still an industrial user. But its search would need to look different from that of a company needing 10% office and 90% warehouse.
That would mean targeting flex or service-industrial properties specifically designed for higher office percentages like a single tenant building rather than trying to force a conventional warehouse building to accommodate a configuration it wasn’t intended to support.
What Can a Growing Tenant Do?
The first step is recognizing the tenant’s issues early. A tenant shouldn’t assume that because a landlord is asking a certain rental rate for 10,000 square feet of industrial space, the landlord will also fund whatever office configuration the tenant requires or that a landlord would allow the configuration at all. The office or other user requirements should be part of the search criteria from the beginning.
- Existing second-generation space can be particularly valuable. Finding a suite where a previous occupant already installed a similar amount of office can eliminate a substantial portion of the economic conflict between tenant and landlord.
- A longer lease term can also change the calculation. If the landlord is willing to fund additional improvements, a longer commitment provides more time to amortize that investment. Depending upon the transaction, another alternative may be for the tenant to fund some portion of the improvements or amortize additional improvement dollars through the rent.
- Tenants with substantial and highly specialized improvements may also reach a point where purchasing a building deserves consideration. Ownership doesn’t eliminate the cost of the improvements, but it changes the analysis because the business isn’t asking a landlord to invest capital in improvements that may have limited value to the next occupant.
Don’t Overlook the Lease Language
If the tenant funds or installs substantial office improvements, another question becomes important: what happens when the lease ends?
Permanent walls, electrical modifications, HVAC improvements, plumbing, floor penetrations, and other alterations can create restoration obligations. A tenant could spend significant money installing improvements at the beginning of the lease and then face another significant expense removing them at the end. Those obligations should be understood during lease negotiations rather than discovered when the lease term is ending and the tenant is preparing to move. Many years ago, I experienced this in one of my companies. We had to remove all the fixtures and wall coverings and restore the walls to texture and paint.
The same principle applies when combining suites. If walls are opened or building systems are modified, the lease should make clear whether the tenant will eventually be required to return the property to its original configuration.
Small-Bay Industrial Has Limits
Small-bay industrial is an important and necessary part of the industrial ecosystem. Its relatively small footprints and flexible configurations serve thousands of contractors, distributors, service businesses, manufacturers, and other industrial users. But flexibility has limits.
As companies grow, the relationship between office or any other specialized finish out and warehouse space can become a surprisingly important site-selection issue. The configuration that worked naturally in a 2,500 square foot micro-bay may become expensive and difficult to reproduce in a 10,000 square foot industrial suite.
For a growing tenant, that means the search may take an extended amount of time and shouldn’t begin only with square footage, clear height, loading, and location. Office percentage and the economics of reproducing that office configuration may be just as important.
The lessons from operating experience and working with clients on past transaction are straightforward: moving from micro-bay to small bay isn’t always just a matter of finding a bigger box. Sometimes the business grows faster than traditional real estate configurations, and the solutions need to be broader than just size.
Frequently Asked Questions
Can I add significant office space to a small-bay industrial building?
It depends on the landlord, but their willingness usually depends on the economics, not just the tenant’s need. A modest office percentage, in the neighborhood of 10%, is usually straightforward. A high office ratio, 30 to 40 percent or more, requires substantial tenant improvement capital that the landlord has to recover through rent and re-lease risk, which is why those requests often get rejected more than tenants expect.
Why do industrial landlords reject high-office tenant improvement requests?
It’s an underwriting decision, not a judgment about the tenant. Heavy office finish-out costs money to build, narrows the pool of future tenants who want that much office, and can require costly demolition to restore the space to open warehouse if the next occupant doesn’t need it. Landlords weigh that double capital exposure against the rent a lease term can support.
How much does commercial office buildout cost in an industrial building?
Costs for commercial interior buildouts are continuing to increase but you could use $120 to $180 per square foot for simple office finishes. On a 4,000 square foot office component, that’s $480,000 to $720,000 in upfront tenant improvement capital, a number that must be amortized over the lease term for the economics to work for the landlord.
What’s a reasonable office percentage for small-bay industrial space?
It depends on the use, but 10 to 15 percent office is generally easy for a landlord to fund in standard industrial product. Requirements above 30 to 40 percent office often fit better in a single tenant building or service-industrial product built specifically for that ratio, rather than in a conventional warehouse building.
What happens to tenant-funded office improvements when the lease ends?
That depends entirely on the lease language. Permanent walls, electrical work, HVAC, plumbing, and floor penetrations can create restoration obligations requiring the tenant to remove the improvements and return the space to its original condition. Those obligations should be negotiated and understood before the lease is signed, not discovered at move-out.
Should a growing tenant buy instead of lease if they need a lot of office space?
Probably not in the early stages of growth, but it’s worth considering once the office requirement becomes substantial and specialized. Ownership doesn’t eliminate the cost of the improvements, but it removes the landlord/tenant misalignment entirely, since the business is no longer asking someone else to fund improvements that may have limited value to a future occupant.
About the Author
Brent Pennington, CCIM | Advisor, Senior Vice President
Metroport Commercial Group (eXp Commercial)
Brent Pennington, CCIM, is an Advisor, Senior Vice President with Metroport Commercial Group (eXp Commercial), specializing in tenant representation, buyer representation, and the sale of excess property for industrial business owners and chain operations. A Baylor University graduate with degrees in Accounting and Entrepreneurship, Brent brings a rare combination of financial literacy and operational credibility to every client engagement.
With 35+ years of prior experience as a business owner in manufacturing, distribution, and retail, he understands industrial real estate from both sides of the transaction, as the operator who occupied the space and as the advisor who guides owners through dispositions, acquisitions, leasing strategies, and sale-leaseback structures. That dual perspective gives his clients something most brokers cannot offer: counsel grounded in how a building functions as a business asset. Brent also serves as a mentor to newer commercial brokers and as an expert witness in litigation.
As a member of NTCAR and holder of the CCIM designation, the commercial real estate industry’s most rigorous analytical credential, and Accredited Land Consultant, Brent is a recognized thought leader on North Texas industrial market trends, owner exit strategies, and CRE wealth preservation.
Connect with Brent at 817-999-8266 | brent@metroportcommercial.com | metroportcre.com
The content on this site is provided for informational purposes only and does not constitute legal, financial, tax, or investment advice. Commercial real estate transactions involve complex variables that differ by property, market, and individual circumstance. Readers should consult qualified legal, tax, and financial professionals before making any real estate or business decision. Brent Pennington, CCIM, and Metroport Commercial Group (eXp Commercial) make no representations regarding the accuracy or completeness of information presented and assume no liability for decisions made in reliance on this content. All market information reflects conditions at the time of publication and is subject to change.
