How did an asset class go from the ugly duckling of the investment world to the darling in such a short period of time? By now, almost all consumers are intimately familiar with online shopping. Online shopping or e-commerce has been the driver for the rapid acceleration of warehouse demand across the nation, resulting in an ultra-competitive environment for potential investors of these properties. Let’s take a closer look at the data to see why investors are so bullish on this sought-after asset class and evaluate where some opportunities lie going forward.

According to CBRE at the end of 2019, U.S. e-commerce sales accounted for 15% of the overall retail sales. For every $1 billion in additional e-commerce sales, the industrial market would need to deliver 1.25 million square feet of warehouse space to meet this demand. By 2030, e-commerce sales were projected to account for 43% of overall retail sales by 2030.

Fast forward to today, and those stats have been accelerated by Covid-19 as most consumers were forced to buy consumer goods and groceries online, many of whom were adopting shopping online for the first time. According to a recent report by JLL, retail e-commerce sales are expected to reach $709.78 billion this year up from $601 billion in 2019. By 2025, some experts believe that e-commerce sales will hit $1.5 trillion, which would create demand of nearly 1 billion square feet from e-commerce users over the next five years. It is important to note that e-commerce users only account for approximately a quarter of the overall industrial market, so the demand from all industrial users will be an even higher number.

E-commerce specific warehouse space requires up to three times the square footage than that of traditional brick-and-mortar retail stores as retailers offer more variety of products online versus in stores, both in the number of SKUs and the physical size of the product. E-commerce has much higher sale returns, and these returns account for a significant amount of the supply chain spend for companies. Distribution facilities handling returns may need up to 20% more space than a traditional facility. These reverse logistics operators often prefer the less expensive second generation space, also referred to as Class B, as many of the Class A building attributes such as higher ceiling height, excess parking and wider column spacing are not as necessary for product that will be stacked on the floor and moved out quickly.

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Other industry sectors, such as automotive, tires, third-party logistics and manufacturing will consider second generation space, because of the increased demand and higher rental costs from e-commerce occupiers’ preference in leasing Class A space. The “rising tide lifts all boats” theory rings true as the demand will have a trickle-down effect to Class B space. Functional and well-located, Class B warehouse space will offer investors an excellent opportunity to achieve higher yields than Class A warehouse. As more tenants look to be as close to dense population centers as possible, we will likely see more infill, vacant big-box retail be converted to last-mile distribution space. Class A bulk distribution will continue to be the most sought after from institutional buyers, and though it has the lowest returns, it will be likely to continue to have the most consistent appreciation.

Conversely, Class C warehouse space and smaller, multitenant industrial that is typically occupied by smaller, local-credit companies is more likely to be negatively affected in the downturn. A recent Goldman Sachs report found that 84% of Payroll Protection Program recipients will exhaust funding by the first week of August, and only 16% are confident that they can make payroll without more assistance from the government. Only 37% believe they can survive another shutdown. While it’s too early to tell how well the smaller companies perform, it’s fair to say that many will struggle or not survive, making this type of investment more volatile

During the peak of Covid-19, many companies utilizing a “just-in-time” distribution strategy to keep only the minimum amount of product needed onshore ran into severe shortages of product inventory. To alleviate these issues in the future, many companies will look at producing and holding a larger inventory. A 5% increase in business inventories in the U.S. could drive additional demand for 500 to 700 million square feet of warehouse space.

The reshoring of industrial manufacturing and distribution has been underway for the last decade but will likely accelerate due to Covid-19. The pandemic has magnified the importance of mitigating risks to global supply chains. A recent Thomasnet.com survey of approximately 1,000 US-based manufacturers found that 64% are likely to bring production back to North America. A gradual increase in production requires an increase in manufacturing and distribution facilities for not only manufacturers but also their suppliers. China has too large of a market share for American companies to pull out completely but look for companies to diversify into other Asian markets as well as Mexico, which could boost demand in Texas border towns.

Warehouse space demand used to be strongly correlated with consumer spending, so it was very much tied to the state of the economy. Presently, market demand is also correlated to how a consumer spends — online shopping — and this provides the industrial market a healthier, more stable, resilient source of demand. Investors are betting this demand will provide stability, rent growth and appreciation into the future.

 Things to look for in an industrial real estate investment

What we look for in an industrial real estate investment

Here are a few items Properties & Pathways puts a microscope over before purchasing an industrial property:

1. Location

Start from the top-down. Where are you going to invest, and why? Which state or capital city? And in which precinct?

For example, Melbourne and Sydney, with their large population spread, have paved the way for logistics and warehouse facilities. Amazon’s two Australian fulfilment centres live in VIC and NSW, and more major last mile logistics companies are making their presence known. If you can find relevant industrial assets in these areas, you could be off to a good start.

It’s crucial the precinct you choose has good access to major arterial roads and transport links.

Trucks and large vehicles don’t want to navigate through intricate CBDs and small streets. They want a clear path to the nearest highway so they can get their long haul underway, and keep transportation and freight costs low.

2. Market

Understanding the leasing market will help you determine what industrial property is ideal for you (or specifically, your tenants).

For example, tenants in your chosen precinct may only want a small office-to-warehouse ratio. They may require high ceilings to allow for large gantry cranes.

Every precinct will have different tenant demand. So, for your asset to appeal to the widest segment of the tenant market, it is crucial you pay attention to these demands before investing in an industrial property.

Consider the usual commercial property investment fundamentals by understanding vacancy rates and market rents in your chosen industrial area. Knowing these factors well will prove to you whether a property’s asking price is fair or inflated.

3. Tenancy profile

Your tenant should have a strong performance history and ideally operate nationally or internationally.

Your tenant should also be relevant, and operating in a buoyant market segment.

For example, with mining returning to strength in WA, it might be practical finding an industrial tenant that serves the needs of major mining firms. Even an industrial occupant who repairs equipment for mining companies could be very fruitful in a mining downturn, when companies stop buying new equipment and repair the gear they already own.

As they say, “Read the room”.

7 things to look for in an industrial real estate investment

4. Lease Terms

Typical industrial property lease terms will range from three to 10 years, with annual rent escalations either in line with the Consumer Price Index (CPI) or a fixed percentage (perhaps, 1 per cent or 2 per cent annual increases).

Rent is a major component of the lease agreement.

If you set your property’s rent higher than the market rent of your chosen precinct, you will struggle to find a tenant to occupy your premises. Instead, understand the benchmark rents in your area and set yours appropriately.

5. Specialised equipment

If you find a property with specialised equipment, such as a cold storage facility or a large gantry crane in the middle of the lettable area, you can bet you’ve just removed a chunk of candidates from your pool of potential tenants. But this might not be a bad thing.

If your property has specialised equipment, then you can appeal to a niche market. You might have the only high-quality automation facility for 20 square kilometres, making your property perfect for a tenant requiring such specialised equipment.

Businesses seeking industrial real estate have a range of needs and some are more specific than others. If you’ve researched the market properly, you’ll know whether or not your chosen commercial property will whet their appetite.

6. Property and site coverage

On your hunt for the perfect industrial property investment, you’ll discover tenants will pay particular favour to:

  • Proximity to major transport links and arterial roads.
  • Suitable ratio of warehouse to hardstand. Also known as site coverage, industrial real estate typically has a greater land component dedicated to hardstand and yard space, and less dedicated to buildings. This will typically suit such common tenants as steel manufacturers, who have a large amount of material and stock to be stored outdoors.
  • Accessibility for trucks and large vehicles.
  • Large and wide roads to accommodate heavy vehicles.
  • Significant roof and gantry height.

Keep tenants happy by ensuring your property design is in line with their requirements. We can’t emphasise this enough: Your tenants’ needs come first.

7. Gentrification

This one goes back to location. Your chosen precinct might be evolving for one reason or another. It might be an old Large Format Retail (LFR) district that is becoming populated with industrial assets. Retail assets have large parking lots and warehouse-style buildings. Many are even saying the future of LFR could be industrial.

future of lfr is industrial real estate

Or maybe the precinct is going the other way, moving away from industrial and toward LFR. That might not be a bad thing if you hold an industrial property in this area. In several years’ time, you could hold one of the last industrial assets in your precinct and name your price to a prospective LFR landlord.

Industrial property success depends on research

There are many factors to consider when investing in industrial real estate. You need to understand what to look for to give your investment the best chance of success. Don’t turn the benefits of industrial property investment into burdens by conducting lazy research.