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Picking the Right Industrial Investment
Find out about some key considerations before making an investment in industrial use commercial real estate.
Few property sectors have realized the significant gains of the industrial sector since the beginning of the pandemic. Investors have been quick to get in the game — industrial investment sales in 2021 through November jumped up by 58%, even compared to a record 2020. But is now the right time to make your first industrial investment? What property aspects and characteristics separate the strong opportunities from the weak?
A Strong Market Getting Stronger?
Although e-commerce businesses had been growing for years prior to 2020, the abrupt drop in on-site retail activity caused e-retailer growth to surge worldwide. In 2021, an estimated 19.6% of global retail sales were handled online, according to a Statista report. That’s a huge leap from the 13.8% reported two years earlier, and online retail sales are only expected to continue surging.
As shoppers continue to choose web browsers over shopping malls, industrial real estate investors will reap the rewards. A January 2022 report from CommercialEdge highlighted that industrial rents have increased by 5.1% year-over-year, driven by surging demand for storage and distribution space alongside incredibly tight vacancy rates — particularly in coastal markets.
Of course, as rents climb, so too does the value of industrial real estate. Average sales prices on a per-square-foot basis jumped nearly 30% from 2020 to 2021, which could represent a significant barrier to entry for would-be investors. However, the gains have been largest in modern, Class A properties. While Class B and C assets have also increased in value, not all facilities are created equal. So, what factors set a strong industrial investment apart?
It’s All About Location
As always, the old location adage rings true. However, industrial investors should consider certain, unique aspects of a warehouse’s location that may be irrelevant in other sectors. First of all, how close is your prospective investment to a highway? While having railroad access or a port nearby can play a critical role, highways are the backbone of the transportation industry and should be considered accordingly. Also, are there any public infrastructure improvements underway in the metro area you’re considering? Anything that improves access to and from your property — whether today or in five years — will drive value.
Of course, that is not to say that investments far from an interstate can’t offer a significant investment upside. Consider the spike in demand for last-mile distribution space in the past few years. Because transportation costs tend to outweigh storage costs, a number of small warehouses in a major metropolitan area could be a much cheaper option for tenants compared to renting one large space in a mega warehouse well outside a city.
To Dizzying Heights
One of the most important measurements in the sector is a building’s clear height — defined as the height on the interior of a structure that can be used for product storage. Most properties constructed before the 1980s had clear heights of less than 20 feet, but today’s modern distribution centers commonly offer 36-foot clear heights or more, dramatically increasing the amount of cubic space available in the facility.
For this reason, while square footage does play an important role in industrial real estate, cubic footage is just as important. Consider this: A 50,000-square-foot property with 36-foot clear heights has 50% more cubic space than a structure with the same footprint but only 24 feet of clearance. As clear heights are not easily changed — you would need to rebuild the structure, essentially — pay close attention to this figure when looking at an investment opportunity.
It’s What’s Inside That Counts
Beyond its height, the physical characteristics of an industrial building can vary widely depending on a structure’s age and initial purpose. Some questions to ask yourself:
How many loading doors does the building have?
Are the docks equipped with bumpers and levelers to ensure smooth operations for your tenants?
How spaced out are the columns throughout the facility?
Is there enough office space built out?
What are the key factors to consider when selecting an industrial investment property?
The key factors to consider when selecting an industrial investment property include the location of the asset, proximity and ease of access to major transportation corridors, the exterior elements of the property such as the loading area, parking, and truck courts, and the potential for improvements such as adding parking spaces, expanding the building, and technological and energy-efficiency improvements.
The location of the asset is one of the greatest determinants of its success or failure. Proximity and ease of access to major transportation corridors is generally a key factor. An industrial structure that’s near a major seaport, intermodal terminal, or freight railroad line will realize significant benefits.
Elements on a property’s exterior are a key determining factor in a good industrial investment, as is the land itself. Does the facility’s loading area offer sufficient space for a truck — or multiple trucks — to maneuver? Is there ample parking on-site? If necessary, are truck courts secured and fenced off?
While a lack of exterior space may inhibit some improvements, understanding what’s possible and what’s not is critical in assessing a property’s long-term investment viability. For example, ask yourself: Could parking spaces be added later if necessary? Is there room to even expand the building itself? Technological and energy-efficiency improvements, like solar panels atop a structure’s roof, could also be an effective way to boost your asset’s value.
What are the advantages of investing in industrial real estate?
Investing in industrial real estate can offer a variety of advantages, including value-add opportunities, potential for a strong return on investment, and tax benefits.
Value-add opportunities can be found in industrial real estate investments, such as repositioning a dated industrial facility. This can be one of the surest ways to earn a strong return on your investment, particularly in markets where there’s limited land available for development and soaring demand.
In addition, commercial real estate is known for the variety of tax benefits it can offer investors. From accelerated depreciation to mortgage interest deductions and tax advantages for an investor’s heirs, these benefits can lead to a massive difference in returns, especially over an extended period of time.
What are the risks associated with industrial real estate investments?
Industrial real estate investments are generally considered to be a higher-risk investment due to the potential for tenant default and the longer lease terms. Leasing velocity is much slower than in multifamily or single-family residential real estate, and so a vacant building may take longer to completely fill than a residential property. Additionally, there are other exterior and interior considerations for industrial investments, such as the need for top-of-the-line loading equipment, that can represent a significant value-add opportunity for an industrial real estate investor. Repositioning a dated industrial facility can be one of the surest ways to earn a strong return on your investment, but it also carries a higher risk.
What are the best strategies for financing an industrial real estate investment?
The best financing option for your industrial real estate investment will depend on your specific needs and financial situation. It is important to research all of the available options. Some may be a great fit, while others may not pencil out.
Many types of financing may be available to you, including:
- Conventional loans
- SBA loans
- Bridge loans
- Mezzanine loans
- Equity financing
- Crowdfunding
For more information about what loan may be right for your situation, head to our portal and our advisors will connect you with a wide variety of lenders to get a quote at no charge.
What are the tax implications of investing in industrial real estate?
Investing in industrial real estate can have a variety of tax implications, depending on the type of investment and the structure of the investment. Generally, industrial real estate investments are subject to the same tax rules as other types of real estate investments. This includes income taxes on rental income, capital gains taxes on the sale of the property, and depreciation deductions.
Income taxes on rental income are generally calculated based on the net income from the property. This includes any rental income, minus any expenses associated with the property, such as mortgage interest, property taxes, insurance, and maintenance costs. Capital gains taxes are calculated based on the difference between the sale price of the property and the original purchase price, minus any depreciation deductions taken.
Depreciation deductions are generally calculated based on the cost of the property, minus any land value. This deduction can be taken over a period of time, usually 27.5 years for residential properties and 39 years for commercial properties. This deduction can be used to reduce the amount of taxes owed on the income from the property.
It is important to note that the tax implications of investing in industrial real estate can vary depending on the type of investment and the structure of the investment. It is recommended that investors consult with a qualified tax professional to ensure they are taking advantage of all available deductions and to ensure they are in compliance with all applicable tax laws.
While newer assets — particularly those built in the past two decades — may meet most smaller tenants’ requirements, it is important to assess the needs of your market’s industrial users in defining your investment criteria.
Most interior characteristics of an industrial facility — columns generally notwithstanding — can be upgraded or reconfigured. While not a small expense, making meaningful improvements to a dated property by updating ventilation systems, adding LED lighting, or even increasing office space can mean the difference between an older vacant warehouse and an older occupied warehouse.
But the Outside Is Also Crucial
Elements on a property’s exterior are a key determining factor in a good industrial investment, as is the land itself. Does the facility’s loading area offer sufficient space for a truck — or multiple trucks — to maneuver? Is there ample parking on-site? If necessary, are truck courts secured and fenced off?
While a lack of exterior space may inhibit some improvements, understanding what’s possible and what’s not is critical in assessing a property’s long-term investment viability. For example, ask yourself: Could parking spaces be added later if necessary? Is there room to even expand the building itself? Technological and energy-efficiency improvements, like solar panels atop a structure’s roof, could also be an effective way to boost your asset’s value.