‘How to get into industrial real estate’ was the topic of Episode #58 of The Morales Show, in which I spoke with Carlos Serra, an executive of one of the largest industrial real estate firms in Southern California. It was fascinating learning the ins and outs of the industrial real estate niche, which has its own unique advantages, difficulties, and napkin-calculations that one has to do in order to find and execute the most profitable of deals.
What is an Industrial Real Estate Property?
The first thing Serra made sure to point out was the broad scope of the industrial real estate niche, and how it actually covers a number of commercial properties that are not of interest to even your large real estate investor. Industrial real estate can cover manufacturing, storage, logistics, distribution, and warehousing, but for the average real estate investor who is looking to purchase a building, add improvements, and rent it to tenants, only the light-manufacturing and ecommerce-storage sub-niches are important.
It turns out that in the logistics and heavy-manufacturing (think car plants) sectors, tenants are generally the sole occupants of their space, usually try to own the buildings they use, and have extremely long occupancies due to the high cost of setting up all the complex equipment required to do run their businesses. This means that just buying a million-square-foot building and hoping to find a tenant is a bad play even if you have the capital to do so.
Instead, Serra pointed me toward the growing sectors of urban industrial real estate, where small businesses are clamoring for large spaces to engage in ecommerce storage and manufacturing, setting up ‘ghost kitchens’ to profit off the rise of food delivery apps, and even setting up businesses with large space needs like a crossfit gym. These kinds of businesses, he said, will act more like traditional tenants than the heavy manufacturers, with short- to mid-term leases and comfortability with renting in a multi-unit building.
For this kind of industrial real estate, square footages are are usually 10,000 or less, and right now are generally considered ‘infill’ properties -- newer-build industrial buildings that are scattered throughout urban areas, packed in-between residential and commercial properties. Serra believes that the future of infill is going to be in multi-story, multi-tenant industrial properties that will facilitate the explosion of ecommerce that we have seen during the COVID-19 pandemic -- a fascinating foresight.
What are the Benefits of Investing in Industrial Real Estate vs Other Asset Classes?
I asked Serra what makes getting into industrial real estate such an appealing opportunity -- especially when compared to other asset classes. Though he noted that it has a smaller ROI than most real estate niches, what he finds so appealing about it is that it has very strong fundamentals and is a market ripe for entrepreneurship.
Essentially, we are at the end of the previous generation of industrial real estate’s lifecycle. There are millions upon millions of square feet of industrial real estate in this country that has been owned by mom and pop outfits for 30 years or more, who are now looking to retire. In general, Serra says, they have put little money into these properties in the last 30 years other than routine maintenance, making them great opportunities for a value-add play to bring the property up to market rates after getting the building at a fraction of the cost of modernized properties.
Due Diligence in Industrial Real Estate
For anyone looking to get into industrial real estate, you should know that though your due diligence will be mostly the same -- checking a building’s roof, checking its plumbing -- there are a few tricky problems that arise in this unique asset class.
For one, Serra told me, you need to get a proper environmental inspection: it is not uncommon for these buildings to have contamination in the air, water, soil, or even the concrete slab itself. Furthermore, he said, it is not just your building you have to worry about: neighboring buildings can sometimes have spills that enter the ground water and come up into the slab from nextdoor. Just like with a residential home, these environmental problems can be a huge unexpected cost that takes a deal from an amazing opportunity to a big loss.
Another thing Serra suggested investors should look out for was seismic activity compliance. Since these buildings are so large, there are very strict code regulations as to how they should be constructed in order to avoid collapse in the case of a seismic event. However, for some older buildings -- the ones you will likely be looking to buy as a smaller player in the industrial real estate niche -- they may not be up to code. This will either skyrocket your insurance costs or require that you engage in costly upgrades.
Finally, Serra talked about location. While industrial infill is often in undesirable neighborhoods in which square-footage is cheap enough to not be immediately converted into residential units, it can be the case that a neighborhood is so undesirable that tenancy will be an issue. Like with all real estate deals, you should become intimately familiar with the neighborhood so that you can see problems like this coming.
Crunching the Numbers When Getting Into Industrial Real Estate
Finally, I spoke with Serra about how new players in the industrial real estate niche might do some quick math to calculate the value of a property. While Serra said these things vary wildly, he did give me a few rules of thumb:
- Calculate the square footage. In Southern California, it will be worth around $0.90-$1.00 a square foot, while in New York, New Jersey, or Chicago it will be $0.60 or so.
- Determine how much of that will actually be rentable space.
- Determine how much you will be able to charge for ‘common area maintenance charges’ -- basically a flat fee that all tenants are charged for use of the common spaces and utilities in the building such as bathrooms or water.
- Adjust for an average vacancy rate of 3-7%.
All of this will give you your net operating income, which will generally be in the single digits, which is why this space is underexplored yet still doesn’t necessarily translate into higher profits. However, despite this low ROI, Serra is convinced that the need for same-day and eventually same-hour deliveries in the ecommerce space will push the value of these spaces higher and higher over the coming years.
If you would like to pick Serra’s brain about this fascinating real estate niche, you can contact him at 310-703-2064 or cserra75@gmail.com.
