Industrial Real Estate Investing: The Complete Guide
Though industrial real estate may be overlooked by more popular sectors, such as residential and retail, industrial properties are critical to global commerce for various industries and products. From manufacturing to distribution, industrial real estate holds much variety for investors and businesses that may be worth looking into.
As an income-generating asset class, industrial properties support a large range of uses and mixed-zone building opportunities that may suit your current and future investment goals. This complete guide reviews the benefits and drawbacks of industrial real estate investment.
What Is Industrial Real Estate?
Industrial real estate is a general term used to describe one of the primary categories in the commercial property market. Industrial real estate supports trade, e-commerce, and supply chains globally and ensures the efficient movement of goods and materials across various markets. This category is one of the most versatile and specializes in providing properties for non-public commercial use.
Industrial properties include:
Research and development
Hybrid warehouse/office flex spaces
Think of these properties as where the behind-the-scenes work goes on, such as for scientific research, parcel deliveries, mechanical engineering, or transporting goods. These properties can be both small and large and can range from hundreds of square feet to hundreds of thousands of square feet.
Industrial Building Classifications
All industrial buildings will have a specific class grade attached to them. Each of these class grades will describe a different type of industrial property investment, as some of these assets may be more likely to see capital appreciation while others are better suited for capital preservation.
Though your return on investment (ROI) will be influenced by many different property factors, identifying these industrial real estate differences can help you make a better-informed decision as you move forward during your search.
Class A Industrial Properties
Class A industrial buildings are typically the newest and most prestigious structures in their market, which include buildings built with high-quality materials and top-of-the-line mechanical and utility systems. These industrial properties may also feature convenient amenities and have prime locations that prevent low vacancy rates. These properties are sometimes called “investment grade” because they often meet the quality and size standards that make them an attractive option for large institutional portfolios, such as insurance companies or retirement funds.
Class A industrial properties may be more likely to attract high-income earning tenants and credit tenants. Credit tenants tend to provide more cash flow reliability because of their exceptionally good credit and high assurance for making payments on time. This means investors may benefit from fewer outstanding asset issues and risks. An example of a Class A property might be a state-of-the-art logistics facility located near an interstate or airport.
These buildings are typically constructed in the last 15 years, but this can vary by city. Even after the 15-year threshold, extensive renovations that modernize a building can maintain a building’s Class A classification or even elevate a building’s rating.
Class B Industrial Properties
Class B properties tend to be older buildings, but they can also be new buildings without all the attractive features of a Class A building. These properties may have more signs of age with some depreciation but are generally still of good quality. Though the rental income on these properties is usually lower than what Class A owners will see, some investors use Class B industrial properties as investment opportunities to fulfill their Class A potential.
If the property is in a desirable location, investors may be able to use a Class B building for immediate cash flow as the land appreciates. The cap rate on these properties can sometimes be higher due to the purchase price, but some buyers may view Class B properties as a higher risk as they aren’t guaranteed to attract credit tenants. In turn, investors may be able to find attractive deals on these properties. These value-add properties are typically found in areas such as suburbs or the edge of financial districts and tend to be four stories tall or less.
Class C Industrial Properties
Class C industrial buildings are around generally 20 or more years old. As with any older building, Class C properties could have maintenance issues, lower rental rates and may even require significant repairs and renovations. Class C properties may also be located in less-desirable areas, which could make quick passive investment opportunities less of a possibility. However, these properties have some ideal uses that make them profitable, depending on the investor, location, and market.
Since these properties sometimes need to be converted into higher-value assets, they’re more suitable for investors willing to put the time, money, and effort into these improvements for better returns. Class C industrial real estate can also present redevelopment opportunities for investors looking to turn these properties into self-storage facilities or mixed-use real estate.
11 Types of Industrial Real Estate
If you’re interested in adding industrial real estate properties to your portfolio, it’s important to understand the different types of real estate in this category and the potential each property presents for investors. Consider these 11 types of industrial properties.
1. Industrial Land
Industrial land is zoned for industrial use but does not have a permanent building or structure on the premises. Land gives an investor the flexibility to pursue multiple routes to gain the most from their property. Industrial land real estate may be used for industrial business that does not require an on-site building, such as for storing mulch and gravel, parking heavy equipment, or conducting surface operations.
Investing in industrial land allows you to build and develop anything that meets the local market’s demand. Real estate investors looking for a larger project or to develop something creative can benefit from this type of industrial real estate that makes it easier to develop a Class A building from the ground up.
2. Industrial Build-to-Suit
Another option for industrial land is the option of advertising the development for a build-to-suit agreement. This means the investor pays for the upfront construction costs on the land for a structure that meets the tenant’s needs and leases it to the tenant once the project is complete.
Industrial land is ideal for investors who want to advertise to businesses looking for a space for their company without having to worry about vacancy rates. With the build-to-suit option, investors already have a secured tenant in place while adding value to their property with a new building.
This option offers less risk than constructing a speculative building. A speculative building is where the investor builds a property for the purpose of immediately putting it on the market. With speculative construction, the property could be vacant for some time before the investor finds a tenant or sells the building.
However, there is additional risk involved with build-to-suit properties if the existing tenant that the property was built for moves out. If the property has build-outs specific to a certain business, it can be undesirable for other companies. For example, an industrial building that has many office spaces or special equipment hookups may not be relevant to other tenants, which can make these properties difficult to lease afterward.
3. Bulk Warehouse
Bulk warehouses are generally one of the largest industrial properties on the market. These warehouses tend to be between 50,000 and 100,000 square feet, but they can also be larger. These industrial properties are used to distribute many different types of products regionally and require accessibility for trucks, so they’re often located close to highways.
Bulk warehouse tenants tend to store bulk goods as part of the primary supply chain for various distributors and retailers, but they may also ship goods directly to consumers. Bulk warehouses are usually located outside of metro areas because of their incredibly large space, although some companies have started planning multistory industrial bulk warehouses to reduce acreage.
4. Flex Warehouse
As the name suggests, a flex warehouse is an industrial building that can adjust to accommodate a wide range of uses. Flex warehouses often have an office space connected which can vary in size to fit the needs of a small local business or a larger regional distributor. These warehouses are generally built for more than one use for a business, such as showroom retail sales, light manufacturing research and development, and small warehouse and distribution needs.
Flex warehouses are further characterized by their lower ceilings and more office space availability compared to other industrial properties. Unlike bulk warehouses, flex warehouses can be found in both populated urban areas and rural locations. In urban areas, flex warehouses are commonly infill industrial real estate, though infill properties are not always flex warehouses. Infill industrial properties tend to be highly sought after by commercial real estate investors since they can accommodate a wide variety of tenants.
5. Heavy Manufacturing
Heavy manufacturing industrial real estate is for companies making heavy-duty materials and goods. These spaces tend to be more isolated than other types of industrial real estate or in a heavy industrial area largely due to the use of power, chemicals and heavy machinery. Heavy manufacturing properties are usually owned by larger national companies or local owners because these properties tend to be highly customized for the current tenant and their product requirements.
For example, automotive manufacturing and renewable energy companies are some of the tenants that would suit this industrial product. Heavy manufacturing properties tend to take up tens to hundreds of thousands of square feet in usable space in addition to electrical power necessities, truck loading areas, and equipment storage.
Tenants of heavy manufacturing properties often occupy the site for long terms because relocating such a large operation is inconvenient and any new location would require a renovation to meet their needs. Investing in a heavy manufacturing plant can be a positive opportunity for real estate investors due to their consistent, predictable cash flows — especially with a tenant already in place.
6. Light Assembly
Light assembly industrial spaces tend to be much smaller and simpler than heavy manufacturing properties. These properties have a fair amount of crossover with flex spaces. Light assembly industrial properties are easier to reconfigure when changing tenants because they don’t require the extensive physical space required for heavy manufacturing. These industrial buildings may include a storage component for housing goods and products before they are shipped.
Generally, light assembly warehouses are only used for assembling and shipping out materials to distribution centers, not manufacturing them, which is why they require less space. The equipment used in light assembly is relatively small and portable, which means the remaining space in the building can be used for office spaces or other various needs.
7. Cold Storage
Cold storage, also known as refrigeration warehousing, is intended to store perishable products and food in an industrial space. These properties are sometimes used as distribution centers for restaurant and grocery chains. Because the items must be kept at a certain temperature, these warehouses require insulation and heating, ventilation, and air conditioning (HVAC) system setups to support and maintain the climate.
For investors looking for a potentially less risky option, cold storage may be worth researching as the demand for this type of industrial warehousing has increased significantly in the last few years as consumers expect grocery delivery and fresher food. To meet the growing demand for this convenience, grocers and restaurant owners are learning how to become more efficient and offer same-day delivery through strategic warehousing locations and well-planned distribution channels. Similar to heavy manufacturing properties, cold storage warehousing tends to be build-out intensive and supports high tenant retention.
8. Data Centers
Data centers are highly specialized and complex industrial buildings located centrally to major communication lines. These lines allow for access to a large power supply capable of supporting extensive telecom switching equipment and computer servers. Data centers require computer systems and networking equipment to access large amounts of data and for many other reasons, including:
Data centers may also provide cloud storage and applications, enable e-commerce transactions, run websites, and many other tasks that require extensive computer processing. Data center industrial properties generally have reinforced floor slabs to support the weight of backup generators, specialized HVAC systems, and other equipment. Because of the technological needs of businesses today, investing in a data center can be a reliable and highly suitable option for investors.
9. Industrial Showroom
Industrial showrooms have a mix of office spaces, warehousing, and showrooms. These hybrids between warehousing and retail allow manufacturers to showcase their products in a retail setting while having access to shipping and distribution. Industrial showrooms tend to use the majority of the space for selling products.
These properties are often located along interstates to achieve easy access and high visibility. Industrial showroom real estate may be attractive to small business manufacturers that produce custom goods because they can showcase their production process to customers and reduce shipping and warehousing costs. Some examples of industrial showrooms are car dealerships or home furniture and appliance companies.
10. Research and Development
Research and development (R&D) sites are for companies that improve existing products and create new ones. This category of industrial real estate accommodates a large variety of users in high technology industries, such as biotechnology, chemicals, electronics, and computers.
Today, you may see many R&D spaces converted into campus-like business locations or industrial parks with open space, surface parking, shared architecture design, and landscaping. R&D properties often vary depending on the tenant as they are generally highly specialized to fit the needs of the user, including specific electrical layouts, plumbing, and ventilation for scientific developments. If there is a high demand for companies in the area looking for a space where they can create and test in open square footage, investors may find this option appealing.
11. Multitenant Industrial
Multitenant properties generally come with varying size units, from about 1,000 square feet to more than 10,000 square feet, usually with about 10% office or retail frontage built out. On these properties, tenants can run their businesses out of the retail or office space and maintain a warehouse for storage or light distribution.
The main benefit of this arrangement is the significant savings for businesses compared to traditional retail centers. Having multiple tenants in one location can also help with diversification, so if one tenant moves out, there is less risk involved for investors than with a single-tenant industrial space.
These types of industrial properties often have a very diverse tenant base and are used by a wide range of businesses, from local mom-and-pop tenants to large national and international businesses looking for small local real estate solutions. Multitenant industrial properties provide an alternative for investing in single-tenant real estate for a long-term lease, so it may provide more flexibility and stability.
How to Choose Which Type of Industrial Real Estate to Invest In
With so many options for industrial real estate investing, it can be a challenge to know how to choose the property type that’s right for you. Adding a new investment to your portfolio is exciting, but it can also be daunting. Be sure to consider the following factors:
Just as the property you choose for your investment portfolio is important, the market you choose to buy in is of equal significance. The market’s vacancy rate can pose a risk to your investment, but if you are an investor with a risk-ready mindset, you may take a chance on markets with higher vacancy rates for the potential of higher returns.
The type of tenant you want can also influence your decision, as each type of tenant and business has its own positives and negatives. For instance, a large credit tenant with a long-term lease or multitenant diversification may be ideal for your investment needs, while a build-to-suit or research and development space may not be what you’re looking for just yet.
Many industries contribute to the demand for industrial real estate, such as distribution, manufacturing, e-commerce, and food production. It’s critical to know where consumer and business trends are heading before deciding on a property.
When looking for assets that meet your criteria, it’s always best to think ahead and imagine how the property will fit into the market down the line. Look for key features that can help maintain the value of your property even if the market changes, such as strong infrastructure, transport links, redevelopment opportunities, and exit strategies. Consider the type of tenants who will be looking for your space.
Pros and Cons of Industrial Real Estate Investing
As with the considerations above, you’ll also want to be informed of any potential benefits and drawbacks of investing in industrial real estate. Keep the following pros and cons in mind when searching for property and narrowing down your decision.
Industrial real estate can potentially bring several positive aspects to your investment portfolio. Here are some of the top advantages of investing in industrial real estate:
If you’re looking to add to your investment portfolio, industrial real estate may be a flourishing market in the coming years. The study of demand for industrial real estate in the U.S. shows that nearly 1 billion square feet of warehouse space will likely be needed by 2025 to accommodate the fast-growing e-commerce industry. This soaring warehouse and e-commerce demand brought vacancy rates for industrial properties to an all-time low in 2021. This means there will likely be more development and expansion opportunities in this market for real estate investors.
2. Longer Rental Terms
Industrial leases are often longer than residential and self-storage contracts since many of these properties are highly specialized to meet the tenant’s needs. Moving to new locations can be logistically challenging and costly for them. Industrial real estate lets you focus on dealing with businesses instead of individual people, so you may end up with a lease that extends for 10 years or more. For real estate investors, this potentially means more predictable and consistent passive income and fewer landlord responsibilities than short-term lease terms.
Because the warehouse and e-commerce demand are interconnected, real estate investors can take advantage of the fact that e-commerce has grown by over 50% between 2019 and 2021. Online purchases have flourished, and with them, the need for more manufacturing, shipping, and distribution properties. With these numbers rising, many businesses may need to turn to industrial real estate to opt for fulfillment centers over traditional retail locations.
4. Lower Maintenance
Industrial properties don’t always require as much upkeep as some commercial property types. It’s common in industrial real estate to use triple-net leases, which means the maintenance of the property is the tenant’s responsibility. Likewise, these properties generally have longer lease terms, so real estate investors will likely have lower tenant turnover. They also won’t need to renovate or do much with the properties as often as they might with an apartment or office building.
One of the top benefits of industrial real estate is the variety of property types available to investors. When it comes to large, open spaces like flex warehouses, these properties tend to be leased plain and empty, which means you can open up your property to many different kinds of tenants who have various equipment, production, and storage needs.
Compared with some commercial real estate types, industrial properties can often be used for many different purposes. Real estate investors looking to invest in industrial properties may have more diverse tenants, from manufacturing companies to logistics businesses.
6. Potential for Stability
All investments have risks, but due to the consistent demand for industrial real estate, these properties may hold value or even appreciate over time. If you’re a real estate investor, industrial properties may be worth looking into as the need for warehousing, fulfillment, distribution, and sales centers continue to grow.
As mentioned above, industrial real estate also offers plenty of diversity, which means it may be easier to find one that can perform well even with market fluctuations and produce a steady income.
As with any investment, it’s crucial to remember that industrial properties come with their fair share of potential pitfalls. The following are some of the drawbacks of investing in industrial real estate:
1. Tenant Risk
While having a consistent tenant for several years or decades can be beneficial, it can also present a downside. If your tenant struggles to pay rent due to financial trouble, the responsibility will fall on you to resolve the issue, which could result in costly litigation or other legal fees. Essentially, single-tenant occupied warehouses and industrial spaces can work very well or become a headache. It’s critical to choose the right tenants for your space, whether it’s single or multitenant, to try to avoid these issues in the future.
2. Long-Term Vacancy Risk
Long-term leases have their benefits because they can potentially provide more income stability, but it can sometimes be difficult to find a new tenant after a completed lease. For instance, if your tenant of 10 years vacates your industrial property that was built to accommodate their specific manufacturing needs, you might have to invest a significant amount of capital to make the space compatible with other types of tenants and their unique business specifications.
3. Oversupply Risk
In any market, there is always the risk of demand decreasing due to many factors. Though the current and future demand for warehouse space appears to be quite strong, this doesn’t mean it will always remain this way. For example, suppose many real estate investors build the same type of facility to support e-commerce, such as fulfillment centers. This can cause the market to soften and significantly impact rental and occupancy rates, thus reducing property values. Tenants could opt to move their operation to a different location altogether, such as a state with a lower tax rate.
4. Less “Flipping”
With the long-term nature of industrial real estate, there tends to be less opportunity to gain quick profits through flips. Flipping generally refers to the practice of purchasing a revenue-generating asset and reselling it for a profit in a short amount of time. When it comes to industrial real estate, this term often describes how quickly property owners can “resell” their property to a business by way of a lease agreement after vacating the previous tenant.
As some industrial spaces have specific build-outs, it means longer potential holdovers as the space is remodeled to undo the previous tenant’s alterations and meet the next tenant’s needs. This can lead to several months without a tenant and, therefore, without income.
5. Less Availability
Though the industrial real estate sector has tons of variety, there are fewer industrial buildings to choose from compared to other commercial buildings. In the U.S., there are approximately 5.5 million other commercial buildings, while there are only about 350,000 industrial buildings. Granted, industrial buildings usually take up much more space, but this could mean that real estate investors have fewer to choose from in this market.
Other Ways to Invest in Industrial Real Estate
Owning and managing an industrial building or property can be suitable for your needs, but it’s only one way you can invest in industrial real estate. With other passive investment avenues, investors can purchase a share in a given property with little to no day-to-day responsibility for the operations.
A Real Estate Investment Trust (REIT) is a company that operates, finances, or owns income-generating assets for various industries, such as healthcare. These companies pool money from investors to purchase and manage properties and pay a majority of taxable income to shareholders through dividends.
Becoming a REIT investor means you will own a share or shares in the company, but you will not own the real estate directly. REITs can be public or private. Publicly traded REITs are a bit easier to invest in because they are liquid, meaning you can invest in them like stocks, usually through a secondary market or repurchase program. You can also easily sell your shares in a publicly traded REIT.
Public non-traded REITs (PNLRs) operate like listed REITs, except they are not traded on a national exchange and generally face redemption restrictions that limit their liquidity. With PNLRs, liquidity options vary in terms of secondary marketplace transactions or share repurchase programs. This type of REIT can provide investors access to inaccessible real estate investments with favorable tax benefits.
Private REITs are not on any stock exchange, and shares in these types of REITs are generally only available to accredited institutional investors. A private REIT is an illiquid investment, unlike a public REIT. The upfront expenses of investing in a REIT can sometimes be low, with high returns compared to other companies that pay dividends. While this is a passive income option, the IRS taxes these dividends as portfolio income at the capital gain tax rate.
Delaware Statutory Trusts
Another way to generate passive income is with a Delaware Statutory Trust (DST). With this method, you can become one of several investors who own an interest in the trust, which is a separate entity that will purchase and manage one or more properties. Distributions from a DST vary depending on the type of investment and what the trust arranges, such as quarterly or annual returns.
Remember that not every DST investment will provide consistent payouts, and investors are not guaranteed returns, particularly if the asset fails to perform as expected. However, DSTs can be an excellent way for investors to break into real estate because it tends to require less capital upfront.
Learn More About Industrial Real Estate Investment Opportunities From 1031 Crowdfunding
While the information provided above has been researched and is thought to be reasonable and accurate, all real estate investments are speculative in nature and involve a substantial risk of loss. It’s important to consider your circumstances and conduct thorough market research before taking on any new investment. At 1031 Crowdfunding, we aim to help real estate investors access more opportunities that suit their investment profile needs.
Our registered representatives have experience with various investment structures in this continually changing industry, including public non-traded REITs and DSTs. We can guide you through the entire process to identify a wide range of industrial investment opportunities that may be right for you. Register for a member account today to learn more about investing with confidence.
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