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. However, many lenders and other players in the space are still confused by it. There are intricacies specific to this asset class, such as coverage ratios, zoning classifications, site use, and factors required to qualify as industrial outdoor storage real estate.
On the SLB side, the valuation methodology for IOS is different from other traditional asset classes. For a typical industrial deal, market rents are assigned based on building square footage, from which you calculate the annual rental amount and apply a cap rate to determine valuation.
For IOS, the land is the main driver of income potential, rather than the building. Rents are assigned on a per-acre, per-month basis, with variations primarily based on location. The building(s) on the land contribute nominally to the property’s total value, with square footage often incorporated into the land’s assigned rents. Other considerations unique to IOS include whether the land is paved or dirt, whether it’s fenced, and whether security cameras are installed throughout the property. These criteria typically must be met for a property to qualify as a suitable IOS candidate.
While IOS sites may not be visually appealing, there are significant advantages to this asset class. First, there are high barriers to entry due to limited land availability with appropriate zoning. Second, local politicians often discourage new development of this asset type due to aesthetic concerns. Third, IOS assets typically require fewer capital upgrades and maintenance to remain viable. Finally, they generally have lower operating costs and taxes compared to other real estate asset types.
According to a Commercial Property Executive report, demand for industrial storage space surged during the pandemic as e-commerce expanded. These assets continue to play a significant role in the supply chain as more businesses seek last-mile delivery locations near ports and major industrial corridors. The CPE report notes that IOS sites are mainly used by third-party logistics companies for truck terminals, trailer storage, tank washing, container storage, pallet storage, or equipment yards, with truck and trailer parking being the heaviest users.
What exactly is industrial outdoor storage?
Industrial outdoor storage facilities, also known as industrial service facilities (ISF), are land-intensive properties within designated industrial zones, with less than 20% of the property covered by buildings. They are typically located near airports, ports, railroads, major highways, and other transport hubs. If you see a large industrial site with extensive land used for trailer or truck parking or for storing or washing equipment, it’s likely an IOS property.
Investment considerations
IOS has long been considered a misunderstood asset class, often carrying higher cap rates than traditional industrial buildings—typically 50 to 75 basis points higher in comparable locations. Lenders have traditionally struggled with IOS valuation, often undervaluing these properties by focusing solely on building value rather than the income-generating potential of the land.
Despite the challenges, many groups have successfully understood IOS, creating a niche market that has even attracted institutional capital. Major players like Zenith, Alterra Property Group, and J.P. Morgan Global Alternatives have recently launched funds to raise capital for IOS. However, industrial brokers and SLB advisors are still relatively inactive in the space, contributing to the asset class’s lack of liquidity. This is partly due to the fact that many properties are owned by small local operators who tend to work with local real estate agents rather than national firms. This market inefficiency leads to variations in pricing, cap rates, lease terms, and more.
As more investors recognize IOS as a valuable yield opportunity, we may see cap rates start to compress. Early movers who gain an understanding of IOS now could benefit significantly in the long term. As the market becomes more efficient, cap rates may decrease, and lenders will become more involved, potentially opening the door for a broader range of private fund investors.
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 correct lens, the gap between buyer and seller expectations can be significant, preventing deals from closing. Although the market may not yet fully understand IOS, this asset class is just as viable for SLB transactions as 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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