A Beginner’s Guide to Industrial Real Estate
“Great news! I heard industrial real estate is going to lead the market in 2020”, Sam said enthusiastically as he swiped my credit card.
Sam is the owner of a coffee shop I’ve gone to for years, and he genuinely takes an interest in his customers.
I was curious how much he knew about industrial real estate, so when he started making my latte I asked: “when you hear ‘industrial real estate’, what comes to mind?”
“Hmmmm”, said Sam, pausing to think as he poured the steamed milk.
“Oil refineries I suppose, or maybe a big factory”. He had a slight inflection at the end, leading me to believe he had not given it much thought before.
I wondered if Sam’s sentiment was common.
Later that day I asked a few other people what they think of when they hear the term industrial real estate.
Here are some of the more memorable responses:
“Is that like an a mechanic’s garage?”
“A big Amazon warehouse.”
“A factory where stuff gets made.”
“One of those big building by the airport.”
Interestingly, each one of them is right, but collectively their comments do not tell the full story.
SO WHAT IS INDUSTRIAL REAL ESTATE?
There is a considerable amount of academic research surrounding industrial real estate, such as estimating cycles, pricing, or supply / demand. Beyond academia is significantly more business research on the topic, with many publicly traded and private companies providing extensive insights into values such as rental rates, vacancy rates, absorption, sales prices, and new construction statistics.
There is more micro and macroeconomic data than you could shake a figurative stick at.
All this detailed information and research exists because industrial real estate is big business. A recent estimate put the value of industrial real estate in North America over $1.5 trillion. The even greater economic contribution by all the companies occupying these buildings is immeasurable. Indeed, it would not be a stretch to suggest the majority of a country’s GDP can be directly or indirectly tracked back to industrial activity.
On the premise that industrial real estate plays a fundamental role in the overall economy, the available academic and business research may be far too in-depth for those looking for a more simplified explanation on what industrial real estate even is.
While there is more information in the nooks and crannies of the internet, the sites many would instinctively go to first don’t offer a lot of help. For example, Wikipedia doesn’t even mention industrial real estate as one of the major categories under commercial real estate, and Investopedia only provides a quick (and woefully incomplete) description.
The availability of mainstream books and textbooks does not offer much help to beginners either. I have combed through countless books on the subject and can attest to the limited amount of information pertaining to what industrial real estate is in the first place. One researcher noted this limitation and went so far as to note “information on the unique characteristics of industrial real estate was not documented”.
This introduction to industrial real estate is intended to provide some foundational knowledge to those looking for more information on the subject.
FIRST WE NEED TO TALK DUCKS
Before getting to the meat of this article, let’s first start with some abductive reasoning (where we can make a conclusion based on a set of observations). The most common example of this is the duck test:
If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.
Well if a property looks industrial, functions for industrial purposes, and is zoned industrially, then it probably is an industrial property.
This may sound trite on the surface, but those three points are fundamental to the discussion about what industrial real estate really is.
APPEARANCE
Industrial properties are typically single-storey properties, although it is not uncommon to have multiple stories for the office component. There are certainly exceptions, but most industrial buildings are constructed with functionality in mind, with aesthetics a secondary consideration. The architecture adage about simply needing four walls and a roof can aptly pertain to many industrial properties.
There are a virtually unlimited amount of different configurations and building styles, but generally speaking the properties are built to accommodate certain tasks. Warehouses, for example, need to provide adequate clearance for semi-trailer trucks to maneuver in and out with cargo. These properties also need high enough ceilings to handle shelves and racking.
A manufacturing facility, conversely, might be constructed specifically to handle heavier electrical power, or overhead cranes, or excess exterior yard space.
While there are certainly exceptions, industrial buildings can often be identified simply because of the utilitarian approach taken to the design and construction.
FUNCTIONALITY
If we accept the notion that “Industrial Real Estate” has etymological roots tracking back to industry in general, it may be helpful to properly define industry.
I found a definition from the Industrial Council of the Urban Land Institute:
“Industry is the gainful activity involved in producing, distributing, and changing the form of raw materials, or of assembling components and parts, packaging, warehousing, and transporting finished products.”
On the functionality of an industrial property, there are five main categories:
Manufacturing — buildings used for the assembly, production or manufacturing of raw, semi-raw, or finished materials. Often called manufacturing facilities.
Warehousing — buildings used for storage, distribution and logistics. Often called distribution centers.
Flex — this category could easily be called “Other”, but Flex is the industry-standard term to describe industrial-zoned properties used for other purposes than manufacturing or warehousing. Examples include laboratory space, showroom, or even straight office space. It could also include buildings used for less common purposes, such as a bottle depot or a church.
Infrastructure — Buildings, structures, and facilities designed to deliver key services to businesses and households. This category includes (but is certainly not limited to) oil refineries, power plants, power lines and sub-stations, garbage landfills, recycling centers, railroad intermodal and freight yards, cellular-telephone towers, water tanks, and grain elevators.
Special Use — Buildings constructed for a specific use. Examples include self storage or cold storage. Existing buildings may be retrofitted for these uses, but they are often purpose-built for the intended use.
In most North American cities, manufacturing and warehousing uses account for the majority of the industrial real estate market, but the scale of the other industrial uses mentioned above should not be underestimated either.
ZONING
An interconnected characteristic of industrial properties is the zoning. Each municipality will have unique zoning codes, rules or bylaws (with the specific terminology varying between areas), so it is necessary to ensure the intended use is permitted under the specific industrial zoning.
Zoning ordinances will also vary from city to city, but the primary objective is to ensure the property is zoned for industrial purposes, and more specifically, zoned appropriately for the intended use.
SO IS IT AN INDUSTRIAL PROPERTY?
Back to our duck analogy, it may be possible to identify a duck simply by hearing it quack. Or something that looks to be swimming like a duck could turn out to actually be a swan.
This might seem a bit silly, but along those lines industrial properties can be susceptible to similar confusion.
Consider a property which does not look industrial, yet still functions for industrial purposes and is also zoned industrial. An example could be a self-storage facility located in a modern building in the downtown core of a city. Some new industrial buildings are being built to architectural standards that greatly exceed the preconceived image we may have of traditional industrial properties.
Or conceivably there is a property that functions for industrial purposes (such as a laboratory space) but is actually in a commercial-zoned property. Any confusion is compounded by the lack of consistency across municipalities in North America. It may seem a bit absurd, but two seemingly identical properties in two different markets may have significantly different zoning attributes.
As indicated by Society of Industrial Realtors (which has now been expanded to be the Society of Industrial and Office Realtors) in their seminal guide from 1971, there are further pitfalls when looking solely at the zoning:
“Because zoning is a powerful land-use control that prescribes either what may be done or what may not be done — or both — in substantial areas of the United States, one way to identify “industry” is to ascertain the kind of land uses and building uses that are permitted in an Industrial Zone.”
You’ve likely realized there are virtually endless scenarios that could creep up, and it simply isn’t necessary to explore every potential exception if you’re only reading this article for informational purposes. If you intend on being more involved with industrial real estate, whether it be as a tenant, landlord, owner or investor, I would highly recommend getting in touch with local professionals to assist with the process. Brokers, architects, lawyers and municipal planners can be tremendous assets in the process of buying, selling or leasing industrial real estate.
If you want to learn more about industrial real estate, I would also recommend the following course from NAIOP:
Modern Industrial Development On-demand Course
It is surprisingly difficult finding a course on industrial real estate that isn’t lumped in generically with other commercial real estate asset classes, but the course above offers some detailed analysis specific to industrial real estate.
SO IS SAM CORRECT?
Back to Sam’s comment about industrial real estate leading the market in 2020.
Well, there is no shortage of articles predicting industrial real estate will outperform other asset classes.
‘Rock star’ industrial could push CRE investment to $50B: CBRE
Could COVID-19 Benefit the Industrial Real Estate Market?
Industrial Real Estate’s Positive Prognosis
These predictions attempt to look at the industrial market through a macro-economic lens, however, so I would caution against looking at these broad sweeping statements as an indicator for how sub-categories or local markets might fare.
After all, if a particular market has heavy exposure to the oil & gas market (and a disproportionate amount of manufacturing facilities by extension), it’s reasonable to expect that market to not perform as well as a major logistics hub that caters more heavily to distribution facilities.
I am bullish long-term that the manufacturing component of the industrial real estate market will also return, but demand for oil & gas needs to first return to normal levels.
Lastly, I would caution that we are currently in the middle of a fake economy. Until the massive amounts of government stimulus and debt deferrals are weaned off, it will be very difficult to predict what the actual economy will look like.
Industrial real estate ultimately plays an integral role in the global economy, which means it is susceptible to the ebbs and flows of every facet of business.
Finally, here is a video I made which illustrates industrial real estate in more detail:
https://www.youtube.com/watch?v=fJUt2ZRkrPQ&t=59s
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Additional notes:
Each of the main categories above could be broken into further sub-categories, but it goes beyond the scope of a basic introduction to industrial real estate.
Each company will have their own unique set of requirements for a building. The process of examining these requirements and identifying compatible properties is known as site selection. It is one of the most critical components of the process of leasing or buying industrial real estate.
In densely populated cities a recent trend has emerged where there are multiple levels of the warehouse space.
Zoning codes, rules and bylaws can vary within different municipalities. A thorough review of any respective municipality is an integral step in fully understanding the industrial market. Even though a specific property might be suitable for the intended use, it must have compatible zoning. To add another layer of complexity, there is often sub-categories of industrial zoning, each with distinct uses allowed. A property could also be “non-conforming”, implying the building or use does not fit under the current zoning ordinance. It is common in these scenarios for the use to be grandfathered until the company moves out, or the building is demolished or damaged. Again, this is a very general comment so it needs to be researched further in any specific municipality.
References:
Hayes, B. (2014). Infrastructure: A guide to the industrial landscape. New York: W.W. Norton & Company.
Kinnard, W.N., & Messner, S.D. (1971). Industrial Real Estate, Second Edition. Society of Industrial Realtors.
Jones, C. M. (1968). Industrial Real Estate (Book Review). Appraisal Journal, 36(2), 311.
Peiser, R. B. (2019). Professional real estate development: The uli guide to the business. S.l.: Urban Land Institute.
Principles of Industrial Real Estate Brokerage. (1962). Los Angeles, CA: University of California.
Schneider, B., & CityLab. (2019, October 02). How to Understand Municipal Zoning Codes. Retrieved June 15, 2020, from https://www.citylab.com/design/2019/08/zoning-ordinance-definition-history-explained-city-laws/594913/
