Industrial REITs own portfolios of properties crucial to the industrial sector. Manufacturing and logistics companies are increasingly realizing that they do not need to own their real estate. This realization is opening the door for industrial REITs to own more properties and helping to drive their current growth. To take advantage of these investment opportunities investors would benefit from understanding what an industrial REIT is, as well as the benefits and risks associated with it.
Real Estate Investment Trusts, also known as REITs, own income-producing commercial real estate, providing investors with a way to invest in the sector without owning individual properties outright. REIT investors may realize returns through a combination of dividends and capital appreciation. A REIT investment can be considered a way to diversify a portfolio with an asset class characterized by non-correlated opportunity and risk.
There are six major types of REITs: industrial, retail, residential, healthcare, office, and mortgage. Industrial REITs own and operate industrial properties, such as manufacturing facilities, warehouses, production, distribution centers, and others. Profits are earned by either leasing or renting these spaces to businesses.
Many of these leases are long-term contracts, some as long as 25 years, and are buildings often rented under a triple net lease structure. This means the tenant, or tenants, is responsible for covering building insurance, real estate taxes, and maintenance. These agreements are structured to provide the REIT with steady cash flow. Tenants tend to be large companies such as Amazon that need distribution centers and last-mile delivery spaces for their e-commerce.
Recent restructures in the supply chain have, so far, acted as catalysts for demand in industrial REITs. Industrial REITs may include properties such as:
Like all REITs, industrial investment trusts function under a unique legal structure where they are generally required to pay investors 90% of the REIT’s taxable income. This attribute makes industrial REITs compelling for investors who are seeking an opportunity for both income and appreciation, among other reasons.
During the pandemic, several significant factors drove an increase in demand for industrial REITs. Rising online sales led to an increase in the need for more warehouse space, and supply chain issues led many industrial companies to lease more warehouse space from REITs to store additional inventory. Industrial REITs also tend to generate steadier cash flow than other types of REITs. Their focus on long-term triple net leases makes the sector somewhat recession-resistant and keeps operating costs down compared to other types of commercial real estate.
Investing in industrial REITs also gives investor portfolios exposure to another sector. Portfolio diversification can minimize risk, but industrial investment trusts have an extra layer of diversification. These often invest in several industrial properties, so investor returns are not tied to a single property. Since REITs are often affordable, and investors can buy fractional shares if necessary, it is easy to use these assets to diversify.
While the industrial real estate industry needs to build more industrial spaces to meet ongoing demand, there is a risk of overbuilding. Some industrial REITs develop new properties based on speculation, or without securing a tenant before starting construction. The belief is that they will acquire a tenant before the building is completed.
Industrial REITs also face the same two risks common amongst all REITs: interest rates and financing risks. Rising interest rates may drive up a REIT’s expenses if they have floating rate debt or significant upcoming maturities. Floating interest rates change periodically throughout the life of the loan. This means that depending on the economy and market conditions, the rate of interest will either “float” up or down. Thus, higher interest rates can also make it harder for a REIT to finance its operations.
If rates rise too much, it can become too expensive for a REIT to fund expansions such as acquisitions or development projects. Rising interest rates can also weigh on REIT stock prices. These increase the income yield on lower-risk options such as bonds, which means the dividend yield on REITs needs to rise to compensate investors for the higher risk. This results in REITs being highly volatile, heavily reliant on economic conditions and constantly changing macro conditions.
Not all REITs use long-term leases, either. Shorter term leases can significantly affect the growth opportunities associated with real estate investment trusts.
Another disadvantage of the REIT model is that they are challenging to set up and often need large investments. Fewer investors entering a REIT, can also make the barrier to entry even higher.
REITs may provide a low-cost and simple way to invest in commercial real estate, but they are not the only option. Crowdfunding platforms have become popular online, with websites such as CrowdStreet and Fundrise offering investors a way to tap in into the real estate investment market. There are also private equity firms, which offer investment opportunities to accredited or high net-worth investors.
Private Equity Real Estate (PERE) firms are especially appealing to some investors because of their efficiency, tax benefits, and the fact that the properties already exist. PERE returns tend to be less volatile for this reason. This is opposed to REITs, which can invest with plans to develop. It leaves the investment open to risks related to market conditions, especially if issues with the supply chain or difficulty procuring construction permits and companies slow down the creation of an industrial asset.
Another reason PERE firms may be more favorable is that they tend to be less volatile over time as well. Returns are often competitive and still offer the benefits of diversification. PERE firms also have low correlation with other traditional asset classes, so they are more likely to perform well in down markets. This means that even in the case of overbuilding or a slowdown in demand for industrial spaces, PERE firms may still provide returns.
PERE firms are also incentivized for success. It is in their best interests to actively seek favorable investment opportunities. REITs, on the other hand, are often structured as investment companies, which means they outsource a majority of real estate services. Having a constant flow of money may also lead to inopportune acquisitions, with managers looking to secure a deal quickly without proper due diligence, so that funds can be allocated before they’re distributed elsewhere.
Since its founding in 2013, Avistone has managed more than 4 million square feet of flex/industrial properties and hotel rooms located nationwide. We specialize in the acquisition and operation of multi-tenant industrial properties for accredited investors. Our executive management team has more than 160 years of combined experience in acquisitions, dispositions, operations, structured finance, appraisal, land use and asset/portfolio management.
We have the unique ability to integrate extensive capital market knowledge with boots-on-the-ground real estate expertise to successfully acquire and operate properties that offer our investors attractive potential yields and a strong potential total return with relatively low risk.
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