Industrial Real Estate Investing Fundamentals
Industrial real estate has been an overlooked investment class for many years, but that is starting to change. With the growth of e-commerce, internet technology companies, and manufacturing in high-demand industries, there is a rapidly growing need for new industrial spaces. Due to their stable and reliable cash flow, industrial properties are becoming more popular with investors.
Industrial Real Estate Categories
Warehouses
Warehouses are the heart of modern industrial supply chains. These facilities play an essential role in storing and distributing goods.
Typically large spaces with elevated ceilings, loading docks, and accommodations for trucks and cargo carriers, these facilities are usually located in areas zoned specifically for this type of activity, such as industrial parks. As logistics become increasingly competitive, tenants look for ways to minimize their facility’s mileage. Areas with significant logistic advantages are prime locations and in demand.
Additionally, with their large footprints, industrial warehouses and distribution facilities often have the lowest per-square-foot asking rents.
Manufacturing
The second largest category of industrial property is manufacturing. This type usually has specific requirements for infrastructural support but can be less demanding than other types of properties regarding square footage needs.
Manufacturing properties often host assembly tasks with smaller warehousing spaces included as well. To optimize operations and production, these sites typically have storage space for materials, labs to allow research and development, and office space for administrative tasks like payroll and marketing.
A key feature that is necessary for any manufacturing facility is scalability. Some states offer tax incentives to qualified manufacturers with properties that conduct manufacturing, processing, and other industrial activities.
Flex Space
Flex space is the newest and most interesting asset class. These properties are typically located in suburban areas with ample parking for commuters and offer the benefits of both warehouse-like amenities (elevator access, plenty of loading docks) but also private offices to accommodate employees.
Flex buildings are great for hosting a variety of tenants, including small operation manufacturers and research & development departments in corporations. Successful flex spaces are more than just physical space. They must also feature amenities that suit office workers and industrial tenants.
Often with functional build-outs, Flex space offers significant benefits to tenants. They can configure it as needed and adjust proportions depending on changing business conditions.
Leasing costs for flex space industrial properties are significantly lower than the average cost of leasing class C office buildings in many U.S real estate markets, making it an attractive alternative to traditional offices.
Key Considerations
Industrial real estate investing is not a one-size fits all strategy. There are many considerations to make before diving in, including property type and location, current tenant mix or occupancy rate (including average rent), and industrial parks versus single tenants in noncore assets like office buildings without retail space available on site. The process of selecting an investment opportunity begins by identifying factors relevant to your specific situation.
NOI & Cap Rates
- Real estate value is primarily driven by net operating income and capitalization rate.
- For industrial properties, operating income can be maximized by various levers, such as the size of the property and cost reduction.
- Industrial property operators often sign a triple net lease (NNN) with the tenant, shifting payment responsibilities over building maintenance, insurance, and property taxes to the tenant.
Longer Lease Terms
- Industrial lease terms typically last 3 to 15 years with rent escalation annually, making industrial properties more desirable for those seeking a longer investment horizon.
- The stability of an industrial property’s lease term and tenant quality makes it a more favorable investment for those looking to lock in their capital for a more extended period.
Quick Construction
- Speculative development is often attractive to investors and lenders because of its strong underlying fundamentals and quick delivery times.
- Industrial buildings can be completed in less time than other real estate property types, sometimes in as little as 8 to 12 months.
Incentive Programs
- Legislatures often use incentive programs to attract industrial tenants and developers.
- The Foreign Trade Zone (FTZ) program is a set of business-friendly incentives that help businesses reduce the administrative burden of customs entry procedures.
- Warehouses in FTZs can benefit from duty deferral or exemption and reductions on property taxes.
Growth Drivers
E-commerce
Global e-commerce sales growth is a good indicator of the demand for warehouses and fulfillment centers. Global e-commerce sales increased during the COVID-19 pandemic as people became more accustomed to buying things online. The convenience of online purchasing has led to increased competition among vendors, which has led to smaller vendors needing to compete with Amazon’s delivery speed.
Supply Chain Volatility
Industrial property owners may benefit from supply chain disruptions, as companies tend to hold more goods onsite. The need for warehouse space should increase to meet immediate delivery demands and minimize transportation costs. Regionalizing operations may see an uptick in demand for industrial properties.
The Impacts of Inflation
The industrial sector is a vital part of the economy, responsible for large-scale production and transportation of goods and materials. In a recession, the industrial sector could be at risk of the adverse economic effects accompanying such a downturn.
Recessions typically result in lower product demand, leading to oversupply and increased costs. Additionally, recessions often lead to an increased risk of bankruptcies and layoffs. However, some experts believe the industrial sector may benefit from a recession despite these risks.
For example, during periods of low demand and excess production capacity, businesses may be forced to innovate and become more efficient to stay competitive. Furthermore, if recessions come along with lower interest rates or other financial incentives for companies, more substantial firms may find it easier to scale up their operations by acquiring their struggling competitors. Either way, the industrial sector has significant potential risks and benefits associated with a possible recession.
About Our Lending Products
AVANA | AVANA CUSO provides conventional financing to businesses in various asset classes. Our Commercial Real Estate loans range in size from $2.0 to $25.0 Million and generally have terms of five to ten years and amortization of up to 30 years.
Our SBA 504 1st Mortgage Loan is designed to help entrepreneurs acquire, renovate, build, or purchase commercial real estate. These loans allow the small business owner to own their building with a reduced down payment and still retain a low long-term fixed rate while preserving working capital that can be used to grow the business.
Our Commercial Construction loans support growing businesses and help preserve wealth. Our lending experts are there for every step and help guide large projects from start to finish. Our team takes the time to understand the complexities of your industry, market, and project needs and helps communicate with third parties to make sure that your construction project is completed on time and within budget.
AVANA CUSO is one of the most seasoned credit union service organizations (CUSO) focused on commercial real estate.
Our lending experts have a wealth of experience in the Commercial and Multifamily sector and can guide you through each stage of the process.
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Our loans range in size from $1M to $30M and generally have terms of five to ten years with amortization of up to 30 years.