Industrial Real Estate for Beginners

Perhaps once considered the unsexy portion of the average commercial real estate investment portfolio, industrial real estate is finally getting the attention it deserves. Buoyed by the convergence of a perfect storm of market factors, industrial is now Canada’s top-performing commercial real estate asset class.

Dynamics influencing the current success and positive outlook for the industrial real estate sector include:

• Meteoric growth in consumer e-commerce spending coupled with the expectation of radically shortened delivery times for purchased goods.

• Diversification and addition of storage and distribution networks – including by foreign investors – in response to lessons learned from supply chain disruptions during the COVID-19 pandemic.
• There is an increased need for secure and climate-controlled data storage, in conjunction with data proliferation from the increased digitization of both leisure and work tasks, the rise of cloud computing, and advances in the Internet of Things (IoT) and artificial intelligence (AI).
• Heightened demand for industrial real estate that continues to outpace supply and that threatens to devour a considerable portion of the new space scheduled to come online over the next two to three years.

What is Industrial Real Estate, and Where is it Located?

Industrial real estate comprises properties where goods are manufactured, stored or shipped.

Canadian municipalities have comprehensive zoning bylaws and maps that divide cities into different land use zones. Bylaws specify each zone’s permitted uses (industrial, commercial, residential, etc.) and the required standards (building size, height, location, water, sewer and sanitation requirements, noise restrictions, etc.).

Industrial zones are typically located close to major highways, rail lines, navigable waterways and seaports to allow for easy receipt, transfer and distribution of goods. Because industrial processes can create significant noise and environmental risks, industrial areas are also usually a substantial distance from residential and commercial zones.

Types of Industrial Real Estate

Industrial diversity is key to a stable economy. With it, a community’s economic health isn’t tied to a single industry or market sector. Without it, communities are more vulnerable to external shocks that can undermine long-term economic growth.

The wide breadth of industrial real estate types supports Canada’s growing economic diversity, allowing for an almost infinite number of products and services to be manufactured, distributed and exported in order to create sustained, job-intensive and inclusive growth.

Industrial real estate also provides investment opportunities, and although individual sources may classify them differently, the four basic types of industrial real estate include:

Industrial Land

Industrial land is property zoned for industrial purposes that doesn’t have a permanent structure on its premises.

A physical structure isn’t always required for an investment of this type to succeed, as industrial land can be used as an outdoor storage or parking site for products or equipment so long as they aren’t unduly affected by the elements.

Owning industrial land also allows investors to negotiate a build-to-suit (BTS) agreement with a lessee. In this arrangement, the industrial real estate owner pays all the upfront construction costs to create a building or facility that meets a tenant’s specific business requirements, then leases the building and property back to the tenant when construction is complete.

While the upfront capital investment can be sizeable, investors’ risks can be lessened by locking tenants into a long-term lease.

Heavy Manufacturing

Industries that either create large and heavy products, use large and heavy equipment or utilize numerous and complex production processes all qualify as heavy manufacturing.

Industrial real estate devoted to these needs can require, among many other things, hundreds of thousands of square footage for plant facilities, vast amounts of water and power, ample loading docks to receive parts or raw materials, plus nearby access to highways or rail lines for transportation of goods.

Because facilities on these properties are not easily converted between potential new lessees or owners. Because manufacturing tends to involve greater environmental risks, many investors naturally shy away from this sort of industrial real estate. However, the opportunity could be significant in sectors where one or more competitors could easily retrofit the facilities for their own use – as in the pulp and paper or packaged goods industries.

Again, while the upfront investment can be consequential, investors can lessen their risk with thorough sector analysis and long-term leases.

Light Manufacturing /Or Assembly

Because light manufacturing and assembly properties are usually configured similarly to warehouses, they can easily be converted for other purposes if a tenant leaves.

Although equipment will need to be removed before leasing to a new prospect, investors in industrial real estate of this type can limit their risk by requiring tenants to return the building to its original state when the lease ends.

Warehouse

Because companies can design, configure and retrofit warehouse space for practically any use, warehouses represent a key industrial real estate investment option.

Types of warehouses include:

• Public
• Private
• Smart
• Climate-controlled or Cold Storage
• Hazardous Materials (HazMat)
• Distribution Centres
• Research And Development (R&D) Centres
• Data Centres
• Showrooms
• Flex Space
• Co-warehouses

You can find out more about each warehouse type here.

Five Reasons to Invest in Industrial Real Estate

While industrial real estate may not possess the sex appeal of other commercial real estate investments, as other sectors have struggled to bounce back after the pandemic, growth in the industrial sector has surged.

Benefits of investing in industrial real estate include:

Higher Lease Yields and Stable Cash Flow

Because industrial properties usually rent with double- or triple-net (NNN) leases, more of the costs associated with maintaining the property are offloaded to tenants, resulting in an increased return on investment. Also, because tenants tend to lease for prolonged periods, industrial real estate provides a relatively stable and predictable rental income.

Portfolio and Sector Diversification

Industrial real estate offers a wide variety of investment opportunities, from industrial land and manufacturing properties to warehouse spaces. Because of industrial’s relatively higher level of flexibility compared to multifamily, office and retail holdings, investors can quickly reconfigure their properties to capitalize on emerging trends and better respond to market fluctuations.

Unabated Demand

The unabated demand for industrial real estate, coupled with an all-time low in the availability of properties in Canada, indicates a positive outlook for the sector for several years to come.

Long-Term Appreciation

Like most commercial real estate, well-maintained industrial properties have the potential to appreciate over time. Coupled with a lower tax rate on lease income, investors can realize significant profits over time.

Tax Advantages

Industrial properties offer various tax advantages, including deductions for building depreciation, mortgage interest and expenses associated with property management, maintenance and repairs. Investors can also defer capital gains taxes through strategies like a 1031 exchange, where they can reinvest the proceeds from the sale of one industrial real estate property into another without immediate tax consequences.

Ready to Invest in Industrial Real Estate?

Industrial properties have emerged as a compelling option for savvy real estate investors looking to create long-term financial rewards from high-demand and relatively low-involvement assets. However, with the diverse range of investment vehicles available in the industrial sector, finding the right property type can be challenging.

Enlisting the help of a commercial real estate professional with extensive local market knowledge, plus negotiating expertise, can aid you in securing industrial property that aligns with your investing budget, goals and risk tolerance so you, too, can capitalize on the opportunities industrial real estate investing provides.