Industrial's New Image
Investors clamor for the functionality and simplicity of warehouse properties.
By Trey Hollingsworth |
stigmatized as the asset type of old dirty factories, industrial real estate
has ascended to prominence in private investors' portfolios. No longer is the
big-box warehouse a distant cousin from the bright, colorful retail center or
the tall glass office tower. Today industrial real estate has stepped into the
limelight as a product that demands consideration for its simplicity of
management and its long life of functionality.
manufacturing plants to the more-common large distribution warehouses,
industrial real estate has several compelling factors that are driving the
higher allocation by individuals and institutions alike.
investors cast geographically wider nets to find acquisitions that meet their
criteria, post-closing ease of management has become a critical issue.
Single-asset industrial acquisitions tend to have fewer tenants, significantly
fewer common area expenses, and often much less common area space - limiting
maintenance and tenant disputes. With single-asset acquisitions, owners have
fewer checks to process, less reconciliation effort, and fewer management
headaches. In addition, the process of re-leasing single-asset industrial space
tends to be much simpler since tenant needs are more uniform.
the early 1990s, most companies organized their distribution networks around
many smaller distribution centers located around the country, but the trend now
has shifted as more companies favor fewer, larger distribution centers in
strategic locations. This shift has led to more single-asset product as the
higher square foot requirements allow developers to build single-tenant
facilities with the scale advantages that once only applied to multitenant
the Elusive Yield
capital abundantly flowing into real estate, the search for yield has pushed
many investors into the single-
category. Typically, the single-tenant facility is the highest level of tenant
risk an owner can take, and that higher risk translates into higher levels of
yield for the investor. With all else being equal, at one time single-tenant
properties added 50 to 100 basis points in returns over multitenant properties,
according to Stan Johnson Co., one of the largest net-lease brokers in the
country. As a sign of the growing demand for single-tenant properties, the
yield spread over multi-
comparables has narrowed to just over 10 basis points as of 3Q06, according to
Real Capital Analytics.
myriad investors clamoring for product, the safer, multitenant office buildings
are transacting at very low capitalization rates and more investors are turning
to single-tenant assets to garner higher yields. In fact, retail and industrial
happen to have the most single-tenant assets in real estate.
sharp, dramatic pullback from industrial assets occurred in the early 1990s
when environmental regulation, litigation, and lawsuits hit their peak. When a
few investors saw their assets exposed to huge environmental liabilities,
anything associated with industrial real estate suddenly was subjected to a
risk premium for potential environmental problems.
then, regulation has softened and better techniques for assessing and
quantifying environmental risk have been developed. Portfolio managers no
longer demand a premium for considering industrial assets. The vast majority of
today's industrial product - warehouses - present very little environmental
concern as they are merely stopover points for finished goods going to the
consumer or products on their way to a manufacturing facility.
seeking assets that they can hold long term are turning to industrial because
the buildings tend to stay functional and attractive longer. Retail corners go
out of style, architecture changes for office buildings, and hotels quickly
reveal their age, but industrial tends to stay functional for much longer, an
especially important fact when considering the initial depressed yields
available in the market. No doubt industrial does decay in its functionality;
for example, clear heights have gone from 24 feet in the 1970s to 32 feet in
the 2000s - but the obsolescence curve is much flatter, and tenants tend to be
much less particular in the aesthetics compared to retail or office.
market one invests in determines much of industrial product's functional life
and whether buying older product yields more than new product. Often, the
biggest determinant in the trade-off between old and new is the cost of new
product construction. If the cost of new construction is high - due to
regulatory involvement, materials costs, and land shortages - then older
product retains an ability to command a higher lease rate despite its age. If
the ease and cost of new construction is relatively lower, then older product
will be unable to maintain its lease rates and will lose value to new
construction much more quickly.
of the investment boom in industrial acquisitions has arisen naturally because
more distribution space is being constructed than ever before. More developers
themselves are recognizing this asset class, and many factors, from globalizing
trade flows to just-in-time supply chains, are driving increased demand from
tenants for warehouse space. As a result of an increased supply, more
industrial product is finding its way into the hands of investors.
course, therein lies the classic "the chicken or the egg" conundrum.
As more investors purchase industrial real estate, cap rates over Treasuries
compress, causing more developers to focus on the class, which will in turn
deliver more product to the investment market.
many asset classes, warehouses located in smaller markets are just as
attractive to users and investors as those in the major markets. According to
several prominent studies, location in a major metropolitan area does not
demand a premium - and sometimes is discounted - by industrial tenants. Major
population centers present problems for warehouse users such as heavy traffic
that slows shipments, labor competition that drives higher wages, and
regulatory issues, depending on what the tenant's product is.
the competition intensifies in large markets, investors are going to secondary
and tertiary markets in search of the right deals for their portfolios. Exit
pricing is the primary concern of investors when purchasing tertiary-
properties as those locations often prove more difficult to sell to
institutions. However, there is almost
no discernable yield difference for comparable product on lease terms longer
than five years, according to Real Capital Analytics.
abundant capital flowing through the veins of the real estate industry, many
investors are finding industrial is the
answer to their real estate asset needs.