Light industrial proves a promising real estate asset class

Guest comment by Theo Soeters and Bert-Jan Scheffer

The logistics and industrial sector can be grouped into sub-sectors.

Traditionally, institutional investors and debt providers have preferred to invest in larger warehouses greater that 15,000 square meters (roughly 150,000 square feet), often close to transportation hubs and corridors. This type of building offers relatively good liquidity and an underlying tenant base consisting of well-known, larger multinational companies.

Although occupier demand has been strong, driven by the sectoral tailwinds, larger warehouses represent a bulkier reletting risk, which is exacerbated if the property has a substantial component of office space. These larger buildings are typically constructed outside of town, where there is greater availability of land with development potential, so these assets carry a risk that tenants leave at the end of the lease term for a newly developed property next door.

Meanwhile, there is a large market segment that consists of smaller warehouses ranging from 5,000 to 15,000 square meters with a tenant base that consists predominantly of small- and medium-sized enterprises, or SMEs.

Property ownership in this sector is historically dominated by private investors and owner-occupiers. As a result of the ownership structure and the diversity of buildings in terms of quality, size and layout, the light industrial market segment is less transparent and more difficult to explore.

Still, it provides ample opportunities to exploit historical undermanagement of fundamentally good quality buildings with a potential to drive rents. This is because tenants generally have solid profit margins and are bound to a specific urban location, or proximity to existing workforce. These occupiers also have a need for professional advice aimed at improving the efficiency of their building, which offers opportunities for the landlord to drive rents and explore further value potential.

Historically, light industrial properties provide a yield premium of 100-250 basis points over large logistics assets, and this trend is only expected to continue. There are three reasons for this: lower investor appetite for smaller, more granular light industrial properties; more work to manage this type of asset; and higher perceived credit risk of the SME tenant base.

“Historically, light industrial properties provide a yield premium of 100-250 basis points over large logistics assets”

However, the yield premium appears outsized when taking into account diversification benefits from building a portfolio and creating a diversified pool of tenants. Furthermore, given the often more urbanized locations of light industrial properties, there is embedded downside protection of land value, which constitutes a bigger proportion of the total capital value of a property versus an out-of-town logistics warehouse.

Land constraints in urban areas limit the risk of new supply of space. When such light industrial strategy is implemented by an investor with access to granular and local expertise, this seems to make for a very attractive risk/return opportunity.

Theo Soeters and Bert-Jan Scheffer are managing directors at Edmond de Rothschild REIM