Quick Insights into Industrial REITs

Industrial REITs

Snippets from the book "DIY Guide to Winning with REITs"

Industrial assets are properties such as business parks, flatted factories, show houses, and warehouses. While these kinds of reits may offer higher yields relative to other reits, they do come with risks. Below are a few areas of which unit-holders need to be aware when investing in industrial reits.

So common

Which is cheaper and easier to build – a hotel or a warehouse? The answer is, of course, the warehouse.

Building a simple warehouse requires relatively little capital upfront, and it can be constructed fairly quickly and easily as compared to a hotel, hospital or office building. Thus, the barrier to entry is low, and this can lead to situations of market oversupply and volatile rental rates.

The occupancy of industrial space in America during the weak economic environment in 2009-2012 was in the low 60% range, unlike the average occupancy rate of Retail reits, which was above 75%. This goes to show that Industrial reits are much more sensitive to the economy as compared to Retail reits. So, if you’re interested in investing in Industrial reits, the first thing is to understand the domestic demand and supply dynamics in the area/city/country in which the Industrial reit’s assets reside. Ideally, you want to invest in Industrial reits when the demand for goods is healthy, and the supply of new warehouses and storage buildings are lacking.

Quality concerns

Besides the macro factors, let’s focus on the Industrial assets themselves. Smart investors tend to pick industrial properties that are adaptive and well-equipped to serve big-business clients. Easy access to wide roads or highways (for logistic purposes), built-in high floor-loading capabilities, high ceiling heights and wide column spans are some examples of highly desired industrial assets for big companies.

“Logistics continue to play an increasingly pivotal role for companies to gain market share and deliver higher levels of customer satisfaction. With the industry evolving, basic warehousing and delivery are just not enough. Therefore, look out for Industrial assets that are equipped with sensory technology that can monitor people and equipment (heighten safety levels), as well as assets that are equipped with systems that can drive inventory efficiency for their clients.”

I tend to avoid Industrial reits that own small warehouses for the purpose of renting out to small fleeting enterprises. The reason is because the typical industrial tenants are usually non-investment grade; as such, their ability to honor rent payments during difficult times can be quite worrisome for me. As such I tend to focus more on the quality of the Industrial REIT’s leases – who they are leasing out to. Although in reality, it is difficult to find Industrial reits that lease 100% of their properties to reputable MNCs, a 60% or more exposure to the latter will be deemed as a considerably “safer” Industrial REIT investment.

The point is that if the tenants do not have the cash flow to pay, no matter how long the contracted lease term is, it is of no value to the unitholder.

“There is still value in investing in Industrial reits that serve small companies. However, they must have plans to diversify their tenant base; for example, plans to have their logistic centres convert from a master lease basis to multi-tenancy and a management that is active in negotiating higher levels of security deposits from these tenants.”

My theory: Higher yields – perhaps there is a reason

Industrial reits enjoy low property upkeep and repair expense, while still generating relatively higher yields than other reits.

But note that there is a reason for these high yields; my assumption is that capital gains (from these industrial properties) have already been priced into the yield. If you take a step back and compare an office building to a warehouse in New York, which do you think will appreciate in value more during euphoric times? More industrial reit land lease tenures are much lower as compared to the other reits. Meaning to say, the land in which the industrial buildings are built on, have lesser years left, in which the government can take it back once the tenures are up.

Perhaps it’s the way the industrial buildings look, or the difficulty in raising rent even through property enhancement initiative; or it may just be due to perception. Industrial reits give higher yields because their unit price hardly moves upwards.

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