How to invest
What to Look For When Investing in Industrial Real Estate
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.
For starters, what is industrial real estate?
Industrial real estate is a form of commercial real estate that typically includes warehouses, manufacturers, factories, depots, industrial businesses, storage, logistics and distributions, labs, showrooms, or telecom buildings. Industrial real estate is considered one of the strongest and most appealing asset classes because it is often inexpensive to own, operate and typically provides a more stable cash flow when compared to other real estate sectors such as office and retail.
When investing in any asset it is critical to conduct careful due diligence prior to investing, industrial real estate is no different.
Here are 7 key considerations that the Jasper investment team accounts for before we make our investment decision.
1. Market dynamics
Vacancy is one of the greatest risks to real estate investors and it is therefore important to research markets with low vacancy rates and strong underlying demand for space. It is also advisable to consider the number of vacant industrial units that are available in the area, as markets that are saturated will be subject to longer void periods due to supply outweighing demand. 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 high demand but limited inventory to ensure continued upward pressure on rents.
2. Tenant mix
When considering which tenants to place in your industrial investment properties, carefully review your tenant’s past payment and financial history to ensure that they can continue to make rental payments without being in any financial burden. It is crucial to understand the needs of your tenants and their businesses to ensure the space they occupy not only complements their business need but is affordable. It is strongly advised to hold a security deposit, usually of three months rent, to mitigate any damage the tenant brings on the property or risk of default. Having more than one tenant at an asset, known as split risk, is advantageous as it means that you are not reliant solely on one occupier for the full income of the investment. It is also advantageous to have tenants in different industry sectors, this spreads your risk exposure to a particular sector of the economy.
3. Lease terms
Industrial tenants sign leases typically ranging from 3 to 10 years. Longer leases provide more certainty of income through the investment horizon. This reduces the risk of future income being eroded through void periods. When determining the lease terms, it is important to consider what the average rent is in the industrial property’s sub market. If your property is significantly more expensive than the market rate, it will take much longer to secure a tenant leading to significant rental loss during a potential vacancy period and you risk not achieving a favourable outcome when you look to sell the property in the future. Alternatively if the current rent received from 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 maximise returns.
4. Property condition
Even with the newest industrial properties problems will arise at one point or another. Prior to purchasing an industrial space, carefully review any work that is needed on the asset and determine if you will recoup those expenses through the rental payments or associated capital value uplift resulting from improvements to the building. Review the previous owner's completed work on the property, assess if anything will need to be re-done or if key items such as the roof are nearing the end of their operational life cycle, and ensure sufficient capital is kept in reserve to address major projects or repairs during the life of the investment.
5. Asset location
Properties located close to key transport nodes are critical to tenant supply chains and are more desirable to occupiers. The 21st century has brought with it significant e-commerce tailwinds and as such industrial assets located near residential areas are attractive 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.
6. Property design
Industrial units with an optimal office to warehouse ratio (circa 10:90) and a simple configuration where units can be easily split or divided are most desirable as these spaces can cater to a 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 long periods of time.
7. Redevelopment opportunities
A review of relevant zoning restrictions is important to understanding the future development potential of a site. A low site coverage ratio provides an opportunity to expand the asset in the future and increase the income that is generated. Ensure that you are up-to-speed on any zoning restrictions and have a clear understanding of redevelopment opportunities and potential restrictions.
Jasper’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 industrial property, it can be a major financial burden if proper investigations are not undertaken prior to purchasing an asset.
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CIO & Director, Jasper
Published October 24th, 2019