Key Takeaways
- IOS has been growing dramatically and attracting the attention of institutional investors.
- There’s still a lot of confusion about IOS. Here’s how to understand the pros and cons of IOS for owner operators and sale leaseback investors.
- You can’t afford to sit on the sidelines if you want to remain relevant in this space.
Over the last few years, we’ve been coming across more and more sale leaseback (SLB) candidates in the industrial outdoor storage sector (IOS). Despite its potential, IOS is still a big question mark for buyers, lenders, sellers, and even local politicians.
A number of new funds have launched in the last 24 months focused on the IOS space. But, many lenders and other players in the space are still confused by it. There are a number of intricacies specific to the asset class such as coverage ratios, zoning classifications, site use, and even which factors are technically required to qualify as industrial outdoor storage real estate.
On the SLB side, the valuation methodology for IOS is different from valuation methods used for many other traditional asset classes. For a typical industrial deal, you’re assigning market rents based on building square footage, from which you can calculate annual rental amount and then apply your cap rate to arrive at a valuation.
For IOS, by contrast, the land is the main driver of income potential, versus the building. Therefore, we actually assign rents based on a per acre/per month figure, which varies depending primarily on the location. The building(s) that sit on the land are a nominal amount of the total value of the property and the square footage is often incorporated into the rents assigned to the land. Then there are other considerations you don’t typically see in a traditional industrial deal. For instance, is the land paved or dirt? Is the property fenced in? Are there security cameras on the perimeter and throughout the property? These criteria typically must be satisfied in order for a property to quality as a suitable IOS candidate.
While IOS sites are not beautiful to the eye, there’s a lot to love about this confusing asset class. First, there are high barriers to entry due to a limited supply of land with this type of zoning. Second, local politicians tend to dissuade the new development of this type of industrial asset given concerns around optics. Third, IOS assets typically require less in the way of capital upgrades and maintenance to prevent obsolescence. Finally, they generally have lower operating costs and taxes compared to other real estate asset types.
According to a Commercial Property Executive report, the demand for industrial storage space surged during the pandemic as e-commerce took off. These assets continue to play a “significant part of the supply chain as more businesses seek locations for last-mile delivery and also want to be near ports and major industrial corridors,” the CPE report said. CPE added that IOS sites are mainly used by third-party logistics companies for truck terminals, trailer storage, tank washing, container storage, pallet storage or as equipment yards, with trucking and trailer parking being the heaviest users.
What exactly is industrial outdoor storage?
Industrial outdoor storage facilities, aka industrial service facilities (ISF), are land-intensive concrete properties based in designated industrial zones, with less than 20% of the property covered by a building. They are usually built close to large airports, ports, railroads, major highways and other transportation hubs. If you look at a map and see a big industrial site with a lot of land, a small building structure, and the land is used for trailer or truck parking, or for storing or washing equipment, then it’s probably an IOS property.
Investment considerations
IOS has long been considered the ugly stepchild of CRE that many don’t understand. Thus, there have been higher cap rates associated with these assets than for a traditional industrial building. The difference could be 50 to 75 basis points in a comparable location. Lenders have traditionally struggled to price IOS because this sector has its own valuation methodology. If you’re only assigning value to the building on a property and not considering the value of the land, which is operational and generating rental income, then you’re greatly undervaluing that asset.
Adding to the confusion around the asset type, many groups have succeeded at understanding IOS and a niche asset class has emerged, even drawing institutional capital. To that end, major players such as Zenith, Alterra Property Group and J.P. Morgan Global Alternatives, have recently launched funds to raise capital for IOS. Still though, industrial brokers and SLB advisors haven’t been as active in the space just yet, contributing to the lack of liquidity in the asset class. This is perhaps helped by the fact that many of these properties are owned by small local operators versus larger platforms. Many of these businesses traditionally work with local real estate agents versus national firms. With this lack of sophistication, you see inefficiency in the market in terms of pricing, cap rates, lease terms, etc.
However, as investors start pouring money into IOS to take advantage of this yield play, will cap rates start to compress? If you’re among the first to get smart about IOS there will probably be a big long-term payout for you. As the market becomes more efficient, cap rates will have to come down and lenders will have to get onboard. This will open an entire buyer universe of private fund investors if these assets become more financeable. That all bodes well for early movers.
Why Ascension
While the upside potential for IOS is considerable, deals can be complex to value and execute properly. When IOS is not viewed through the right lens, the bid-ask spread between buyers and sellers can remain far apart, preventing deals from getting done. And while IOS may not yet be fully understood by the market, the asset class is just as viable for SLB deals as for any other type of industrial or commercial property.
Conclusion
If you’re an owner operator or private equity owner of a business operating out of industrial outdoor storage assets, let’s discuss how we can help monetize your portfolio through an IOS sale leaseback.
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