Industrial property: what is it?
Industrial property is one of the three main asset classes of commercial property.
Most of us are familiar with residential real estate, and what it means to invest in it, but not everyone knows a lot about commercial property.
Commercial property is built and used solely for business purposes. There are three main types of commercial property: retail, office and industrial.
What is industrial real estate?
Industrial property is used for industrial purposes. It sounds simple, but it comes in all shapes and sizes and covers a huge range of business types.
Industrial properties can generally be broken down into three sizes: small, large and enormous.
Small industrial sites include single or double-storey buildings zoned for industrial use. These often have flexible interior space, usually a mix of warehouse and office space. ‘Flex’ spaces are used by small businesses such as mechanics, research laboratories and start-ups.
Large industrial properties include medium to large warehouses and factories that are designed to manufacture or store goods. They include distribution companies such as third party logistics (3PLs).
On the larger end of the scale are the ‘big box’ industrial spaces. These enormous industrial spaces are used as logistics and distribution centres that hold and then distribute finished goods to stores and/or directly to customers. If you think of the type of warehouse Amazon would have, you will get the idea.
What are the benefits of investing in industrial retail estate?
Investing in industrial real estate can be good business for the savvy investor. Some of the key benefits include:
Higher rents = higher yields
One of the attractive aspects of investing in industrial property is the higher rental incomes and yields (the annual return on investment) they offer.
Industrial property is usually valued in relation to the square metres available and can offer yields of 8%, compared to say just 4%-5% on a house.
Another advantage is that most industrial leases include fixed annual price increases, which are often linked to CPI.
Industrial tenants are usually willing to sign long lease agreements (up to 10 years in some cases) that provide investors with much greater security than a typical residential lease.
Net leases mean tenants pay most outgoings
Most industrial leases are net leases. This means the tenant pays for costs that would normally be paid by the owner. These include insurance, utilities, maintenance and repair costs.
Generally speaking, a good tenant will maintain the building to a high standard, as the appearance reflects on their business. This means industrial buildings can be relatively low maintenance as the tenant is likely to attend to any maintenance issues quickly themselves.
What are the risks?
It’s important to understand the risks involved with investing in industrial property. Here are a few of the key risks you need to consider (and this is by no means an exhaustive list).
Industrial properties are much more vulnerable to market conditions than residential property, so the risk of vacancy is higher. If a business closes and economic conditions are grim, it can take a long time to find a new client. Investors should be prepared for long periods of vacancy.
Expensive to invest
Banks view industrial real estate as a riskier investment than residential, so the cost of borrowing is higher. Banks usually demand a bigger deposit (around 30%) and interest rates will often be higher than for a loan for residential property.
The industrial sector is constantly evolving and innovating. This means industrial buildings can quickly become obsolete if the clearance height is too low, access is limited or the floor space unsuitable for modern machines.
Even the location can become undesirable if road tolls are introduced nearby or better located logistics spaces open up.
The key here is flexibility and location. The more flexible and better located the space, the more attractive it will be to businesses.
Due to the amount of capital needed to invest in the industrial market, most investors are the large players with deep pockets. That doesn’t mean smaller investors are excluded.
Owner-occupiers often see the advantage of purchasing their industrial space. Read more on whether you should buy or lease your business space. A-REITs (real estate investment trusts) are another way to enter the market with relatively little capital.