Investors Have Newfound Appreciation for Bringing Industrial Outdoors
As institutional capital steers clear of the wobbly office market and cap rates remain low for industrial and retail assets, investors seeking yield are now chasing a lesser-known and decidedly less glamorous asset class – Industrial Outdoor Storage (IOS).
“I've got a client that has hundreds of these outdoor industrial outdoor storage locations, and they get letters from investors daily,” says Bo Hargrove, SIOR, partner at Rich Commercial Realty in Raleigh, N.C. “There are a lot of private equity groups just throwing out numbers and offers, trying to deploy capital, because it's hard to find this stuff and a lot of it is owner-occupied. You wouldn’t believe how many letters come through [each week]. It’s mind-blowing.”
WHAT EXACTLY IS IOS?
Unless you’re an industrial broker or involved in the logistics industry, industrial outdoor storage is probably not on your radar, even for astute observers of the commercial real estate industry. “It was never really even a ‘thing’ up until the last three years or so,” says Hargrove, who has been involved with the asset class since 2014. “And the phrasing, ‘industrial outdoor storage,’ wasn't something you had heard of until the last few years. Now it’s caught the eye of the investment world, which is really what has made it a ‘thing.”
IOS properties – also referred to as ‘drop lots’ and ‘low-coverage industrial service facilities’ – are commonly used for truck and trailer parking and storage, construction or heavy equipment yards, container and pallet storage, tow company yards, and uses like landscaping and equipment rental businesses. The assets usually have some form of industrial or office building on the property, but the lion's share of the site is usually a large concrete, gravel, or asphalt lot, with the material choice dependent on the heat ranges of the market. Many are fenced in with lighting and security cameras to prevent theft or vandalism. Despite the surge in investor interest, the vast majority of properties are owned by users or local/regional private investors.
DEMAND DRIVERS
The demand for industrial outdoor storage, an asset class with an estimated market value of $200 billion, coincided with the acceleration of e-commerce at the start of the pandemic. IOS has become an increasingly vital component of the supply chain for retailers and logistics operators. But the primary driver appears to be the ever-shrinking supply of available land that can be used for IOS as it is redeveloped as “higher and better uses,” particularly in or near major metros.
Most of those uses are industrial, especially warehouse/distribution facilities, which IOS sites, given their size (typically two to 15 acres but often much larger) and location, make ideal targets for industrial redevelopment. Although construction starts for industrial space slowed considerably in 2023 as demand for industrial space has normalized (204.3 million sq. ft. of industrial space broke ground through August of 2023, down from 614.1 million last year and 586 million in 2021, according to Commercial Edge), that explosion of new development – much of it built on spec – has taken a lot of land off the market. That land is also being re-purposed to develop retail, apartments, and other asset classes.
“The amount of industrial development has absolutely added to the demand side of IOS,” says Scott Hensley, SIOR, president and an industrial specialist at Piedmont Properties/CORFAC, who has been working with IOS for nearly 30 years in Charlotte, N.C. “The growth of a city like Charlotte, with so much of it being gentrified in areas where a lot of the heavy industrial uses in our market used to be – whether it’s a brewery or an apartment building – it’s absolutely a case of diminishing supply and increasing demand.”
If you’re going to do a deal, you need to have somebody on your team that has in-depth knowledge of the market, because so many deals are done off-market and the pricing and inventory changes quickly.
Further complicating the matter is that IOS sites are not easily replaceable. Hensley says that developers are not likely to take a raw, undeveloped greenfield site with trees that has never been graded to convert into a usable IOS site because it’s cost-prohibitive. Even if developers can locate a site zoned for heavy industrial to redevelop into IOS, there is likely to be resistance from the city or town. Local authorities nationwide are imposing new zoning regulations and land use restrictions that restrict or prohibit industrial development, including outdoor storage. “It's not a use that municipalities necessarily want,” says Hensley. “It doesn't significantly add to the tax base, it’s not very attractive, and they typically generate a tremendous amount of traffic compared to a smaller industrial building, so it’s difficult to get sites rezoned for this use.”
With the limited supply and robust demand, the availability of existing IOS properties stands at under 3% nationally, well below the overall industrial sector’s record low of 3.6% according to a recent Marcus & Millichap report. Rents vary by market, with land-constrained metros fetching the highest rents, but IOS rents have increased by nearly 30% on average since the end of 2019, while industrial rents overall rose 24% during the same span. While per-square-foot formats can be used for smaller leases, rents are generally quoted per acre, ranging from $2,000 up to $35,000 per acre in the most land-constrained and in-demand areas.
STRONG DEMAND, LIMITED SUPPLY ATTRACTS INSTITURIONAL DOLLARS
With that kind of rent growth and the supply unlikely to increase, institutional investors have taken notice. Pete Richardson, SIOR, director of leasing at Plano, Texas-based Primera Companies, has been involved with IOS since 2004 and has long felt that it was an asset type that “would eventually end up in a REIT, and I think some people are starting to look at that pretty hard.”
In recent years, institutional capital has aggressively pursued industrial outdoor storage sites. Alterra IOS, the industrial outdoor storage arm of Alterra Property Group, has acquired nearly $2.5 billion in assets and continues snapping up properties in this under-the-radar asset class. Zenith IOS, which began partnering with institutional investors advised by J.P. Morgan Global Alternatives in 2022, is targeting over $1 billion in total assets across the United States.
“With the other asset classes, the pricing is not as attractive (to institutional capital), and the cap rates have gotten pretty compressed,” says Richardson. “You’ve also got a lot of these properties that are local user-owned, and when these guys are retiring or selling their business – their basis was pretty low when they bought these properties – they're making pretty good money selling them.”
Hensley notes that up until the last three years, there was little to no institutional ownership of these sites. “They were kind of mom and pops, and they're still mom and pops with a lot of owner-users,” he says. “What I think happened was that [investors] saw opportunity. When you have a fragmented market like that, oftentimes nobody's really pushing rental rates or values because they've had the real estate forever. They're happy making their return of X. So, I think investors started aggregating this product, and they can now control the market and have been able to dictate and drive up rates.”
Richardson says he has “done a ton of business” with investors (institutional and high net-worth individuals) who purchase properties from local operators, invest in site upgrades, raise rents, and then sell the properties at a significantly higher price. One investor purchased 26 acres in South Dallas, re-graveled the surface, leased it up in about seven months, “and then turned around and sold it for a huge multiple” – and that deal was not an outlier. Another client purchased an eight-acre site, renovated the 1200 square-foot building on the site, and doubled the asking rent from the previous lease just three years earlier.
BUYER BEWARE
The lure of outsized returns has also attracted some private equity investors with little experience with the asset class. “There are a number of private equity firms out there that may not have any experience in this space or even in industrial real estate…but decide that it looks good on the spreadsheet,” says Hensley. “Their model has been ‘to go out and buy as many of (these sites) as they can as quickly as they can, aggregate a portfolio of sufficient size, and then sell it to a true institutional investor like BlackRock.”
Many investors are also acquiring properties and anticipating significant rent increases when the leases roll without understanding what it takes to operate an IOS site. “And now that they’re operators, they’re realizing that there’s a learning curve, and I don’t know that all of them will be successful,” predicts Hensley.
For investors (or users who are thinking of acquiring their own site to control costs), using a broker with local market knowledge and extensive IOS industry experience is a must, says Richardson. “If you’re going to do a deal, you need to have somebody on your team that has in-depth knowledge of the market, because so many deals are done off-market and the pricing and inventory changes quickly.”
This article was sponsored by the SIOR Foundation - Promoting and sponsoring initiatives that educate, enhance, and expand the commercial real estate community. The SIOR Foundation is a 501(c)(3) not-forprofit organization. All contributions are tax deductible to the extent of the law.
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