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industrial real estate

What Is Industrial Real Estate?

A deep dive into the industrial real estate sector.

Feb 05, 2021 by Matthew DiLallo
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Industrial real estate is crucial to supporting the global economy. These properties serve as essential venues for producing, storing, and distributing the goods and products the global economy needs. Thus, well-located, high-quality industrial real estate is key to keeping the global economy running smoothly.

What is industrial real estate?

Industrial real estate refers to properties used to develop, manufacture, or produce goods and products and logistics real estate that supports the movement and storage of products and goods. These buildings aren't as glamorous as other types of real estate, like a glimmering skyscraper, well-manicured multifamily community, or crowd-drawing shopping center. However, industrial real estate is vital because these properties are the workhorses of the industrial economy.

What are the types of industrial real estate?

Industrial real estate covers a broad group of properties types, including:

  1. Flex/office space used to research and design new products
  2. Light manufacturing facilities that make a variety of products for retail consumers and businesses
  3. Food manufacturing facilities that make and process foods and beverages for restaurants and grocery stores
  4. Temperature-controlled (i.e., cold-storage) facilities used to store and distribute food and beverage products to restaurants and grocery stores
  5. Growing facilities that produce medical-use cannabis for the healthcare industry
  6. Warehouses, fulfilment centers, sortation centers, and last-mile delivery stations vital for distributing goods to retail stores and businesses, as well as supporting the operations of e-commerce companies.

Meanwhile, as with other real estate property types, there are three classes of industrial buildings:

  1. Class A: These properties are the youngest, in the best condition, boast having the best amenities, are in a prime location, and attract high-quality tenants. Examples of class A industrial real estate are a modern logistics facility near an interstate supporting an e-commerce giant or a state-of-the-art food manufacturing facility.
  2. Class B: These properties are either a bit older, a little run down, don't have the amenities of other properties, are in secondary and tertiary real estate markets, or are leased to lower-quality tenants.
  3. Class C: These properties have the lowest rating on those factors, so they are either candidates for renovation to bring them up to A or B quality or redevelopment to another property type, such as residential or self-storage.

Industrial real estate lease terms tend to vary by property type and quality. For example, purpose-built state-of-the-art industrial manufacturing facilities usually fetch triple net leases, with initial terms extending as much as 25 years. Meanwhile, lease terms on logistics properties range from 3 to 10 years, depending on location, property type, and tenant.

Ways to start investing in industrial real estate

Investors have multiple ways to add industrial real estate to their portfolio, including:

  1. Purchase vacant land and develop an industrial facility.
  2. Buy an industrial property from another real estate investor or acquire it in a sale-leaseback transaction with the operator.
  3. Invest in a real estate investment fund focused on industrial properties.
  4. Participate in an industrial real estate property syndication deal on a crowdfunding platform.
  5. Buy shares of an industrial REIT, or real estate investment trust, in a brokerage account.

These options vary in investment size, risk/reward profile, and holding period. For example, ground-up development of an industrial property can be very risky and costly (in the millions of dollars) for a beginning investor, especially if building the property on speculation. If this investor can't secure a tenant or runs into permitting issues, they could lose their entire investment.

However, investors stand to earn a higher return on investment for a successful development project. They could also make a quick buck if they sell a fully entitled, tenant-secured industrial development to another investor. Meanwhile, real estate funds and crowdfunding syndications have lower initial investments -- usually between $25,000 to $100,000 -- but often require investors to hold for 10 years.

Industrial REITs offer the most flexibility. Investors only need to purchase one share, which often costs less than $100. Meanwhile, they can sell their shares at any time. Another benefit of REIT investing is that it allows investors to own a diversified portfolio of industrial properties across the entire sector or a pure-play REIT concentrated on one industrial property type or region.

Examples of industrial REITs include:

  1. Americold Realty Trust (NYSE: COLD): An industrial REIT focused on operating temperature-controlled warehouses vital for distributing food and beverages to grocery stores and restaurants.
  2. Innovative Industrial Properties (NYSE: IIPR): A REIT focused on owning properties used to cultivate, process, manufacture, store, and sell products derived from cannabis.
  3. Prologis (NYSE: PLD): A global industrial REIT focused on modern logistics properties that meet the warehouse and distribution real estate needs of business-to-business and retail/online fulfillment customers.
  4. PS Business Parks (NYSE: PSB): An industrial REIT focused on multi-tenant industrial, office, and flex space (an office and warehouse combination with several uses including office, assembly, showroom, laboratory, light manufacturing, and warehouse).
  5. Rexford Industrial (NYSE: REXR): Whereas Prologis operates a globally diversified logistics portfolio, Rexford concentrates on owning industrial properties solely in Southern California.
  6. STAG Industrial (NYSE: STAG): A diversified REIT that owns properties across the entire U.S. industrial real estate market, including light manufacturing, warehouse, and flex office space.

As that list shows, there are several ways to invest in industrial real estate using REITs.

What are the pros and cons of industrial real estate?

There are many benefits to investing in industrial real estate, including:

  1. Significant demand: Some speculate the U.S. may need more than 1 billion square feet of additional warehouse space by 2025 to support fast-growing e-commerce demand. This outlook suggests more expansion/development opportunities for investors.
  2. Longer rental terms: Industrial leases are usually 3 to 10 years but can be up to 25 years, whereas residential leases are a year and self-storage properties are month to month. As a result, these properties tend to generate stable income for years.
  3. Lower maintenance: Industrial properties don't require as much upkeep as other property types. Most leases are triple net, meaning maintenance is the tenant's responsibility. Meanwhile, overall longer lease terms imply that an industrial building owner won't need to renovate the properties as often since there's lower tenant turnover.

However, these properties have some drawbacks, including:

  1. Tenant risk: Many industrial buildings only house a single tenant. If that tenant runs into financial trouble and can't pay rent, it will impact the investor's ability to meet their debt obligations.
  2. Long-term vacancy risk: If a tenant vacates a purpose-built industrial facility like a manufacturing building, it won't be easy to find a new tenant. The owner might need to invest a significant amount of capital to make the property suitable for other tenants.
  3. Oversupply risk: Given anticipated future demand for warehouse space, real estate investors are building many properties on speculation. If they construct too many and the market softens, it could significantly impact occupancy and rental rates while reducing property values.

Industrial real estate can be a good investment

While industrial properties aren't as glamorous as other types of real estate, they're vital to the economy. This means tenants usually sign long-term leases that supply investors with stable cash flow. Add in the sector's growth potential, and real estate investors won't want to overlook this essential property type.

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Matthew DiLallo has no position in any of the stocks mentioned. Bank CD rates owns shares of and recommends Innovative Industrial Properties and Stag Industrial. Bank CD rates has a disclosure policy.