Investing in industrial real estate can be daunting for some, particularly those who are unfamiliar with what to look for when purchasing an industrial property. The information below may help calm some anxiety but open the door for additional conversations and knowledge.
What is industrial real estate?
In general, Industrial Real Estate is considered within "Commercial Real Estate"/CRE property types. Contained within this group is are: warehouses (storage, distribution centers, cross-dock facilities) manufacturing facilities (raw product refinement, assembly locations), and miscellaneous locations such as labs, showrooms, and telecom hubs. Industrial real estate is considered one of the strongest and most appealing asset classes right now because of the lower cost to operate over time when compared to other product types (i.e. office) and generally offer stable cash flow becuase of their utility and lower impact to an operating company's P&L. The next few paragraphs will hopefully outline the key points to consider before purchasing an Industrial asset.
Here are key considerations that Cornwell recommends you to consider before moving towards closing.
Market Changes
Vacancy is one of the greatest risks to real estate investors and it is therefore critically important to research investment opportunities that are within areas with low vacancy rates and strong underlying demand for space. It is also advisable to consider the number of vacant industrial buildings in an area, as markets that are over-built will be have a longer lease-up period due to demand being lower than the market supply. Net absorption is the net change in occupied space taking into consideration vacated space and new space supplied to the market. Positive net absorption highlights that more space has been leased than vacated in the market. It is a key driver of rental growth in real estate markets. The measure highlights a lack of alternative availability, so it is best to own industrial space in an area where there is either 1) high demand but limited inventory or 2) limited opportunity to build new space to ensure continued upward pressure on rents and low vacancy.
Tenant Mix, Risk Allocation
If an investment opportunity is currently occupied and you are purchasing existing leases with additional term, you should consider tenant’s payment and financial history to ensure that they can continue to pay rent and operating expenses. It is imperative that you try to understand the business of each tenant so you can understand if your property and the space they occupy not only complements their operations but is also is within their budget. We strongly advised to hold a security deposit, usually between one and three months of base rent, to help mitigate any damage the tenant may bring to the property or to help avoid default. As related to risk allocation, having more than one tenant at an asset (multi-tenant occupancy) is advantageous as it reduces the impact to the property operation and payments if one tenant defaults. Similarly, it can be advantageous to have tenants in different industry sectors - thus reducing the exposure to a particular sector of the economy for the same reason.
Lease Terms
Industrial tenants typically sign leases ranging from 3 to 10 years. Longer leases provide more certainty of income through the investment horizon by reducing the risk of future income being eroded through void periods or tenant roll-over. When determining the lease terms, it is important to consider what the average rent is in the property's sub market for that product type. If the subject property is leasing for significantly higher rents than the overall market, it will take much longer to secure a tenant upon vacancy and that may lead to significant value loss if you are looking to dispose of the property in the future. Conversely, if the current rent being charged to the tenants is significantly below the prevailing market rates the property is underperforming and would require active management to bring the current rent to market levels. This will involve taking on additional leasing risk in order to maximize returns, however the rewards could be significant.
Property Condition
All properties will have issues - its inevitable and unavoidable. Our Team will always, regardless of the market conditions, recommend a thorough property review by a third-party prior to a purchase. This review will determine any deferred maintenance that will become an immediate issue requiring additional capital as well as help an owner budget for longer-term maintenance items that will arise in the future. Some other items to consider are: the previous owner's completed work on the property, any current issues with craftsmanship to assess if anything will need to be repaired or redone in total, and assess if any key items such as the roof are nearing the end of their operational life cycle. No investor should go into a property without a capital reserve as the best laid budget should always include a plan for unforeseen expenses.
Asset Location
Properties located near key transportation hubs are critical to consumer and tenant supply chains and are more desirable to businesses overall. The iterations of the internet and consumer technology have brought with it significant e-commerce trends leaving industrial assets located near residential areas more able to service the increasing demand for shorter delivery times. Tenants in dense urban areas are often able to afford higher rents, so your return on investment may be largely contingent on the location of the industrial property.
Property Design
Industrial properties with a typical office-to-warehouse ratio of 10:90 and a simple configuration where units can be easily split or divided are most desirable as these spaces can cater to a wide range of tenants. Flexibility of space is key when appealing to a wider tenant mix and reducing the risk of the space being vacant for longer periods of time. Additionally, a standardized buildout and uniform building materials and finishes can reduce the overall cost to own and operate a property.
Redevelopment Opportunities
Before purchasing a property, it may be important to review the relevant zoning for any restrictions that may be critical to any adaptive reuse of a site. A low site coverage ratio on the purchase may provide an opportunity to expand the asset square footage in the future and increase the income that is generated. Be sure to thoroughly understand any zoning restrictions and have a clear vision of redevelopment opportunities and potential restrictions.
Key takeaways
Cornwell's investment team undertakes thorough analysis on every deal before we make an investment decision. When it comes to purchasing an industrial property (or portfolio of properties), it is important to conduct careful due diligence and be fully aware of the risks associated with the investment. While there are a number of benefits to owning income-generating industrial property, it can be a major financial burden if proper investigations are not undertaken prior to purchasing an asset.
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