The industrial sector has been resilient through the turbulence of the last two years. In the first quarter, the sector had positive net absorption and a 24% increase in new leasing activity according to data from the CoStar Group, even as the industry has seen some consolidation. Economic headwinds and tariffs, however, will test the sector’s durability this year, and as a result, investors are looking for safety.
Harrison Auerbach, SVP and associate director of the industrial at Matthews Real Estate Investment Services, says investors looking to find yield and mitigate downside risk over the near-term may want to explore two strategies: shallow-bay industrial and short-term leases.
A Shallow-Bay Industrial Strategy
Value-add investment strategies have been a popular response to increased interest rates, but creating value in industrial properties—which often have a single, long-term tenant with fixed option periods in place—can be difficult. Multi-tenant shallow bay industrial properties solve that problem.
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Shallow bay industrial is typically occupied by small mom-and-pop, blue collar tenants with short-term, below market leases. That perfect blend of features has created an opportunity for industrial investors to create value by increasing rents.
“Rather than focusing on the going-in yield of the project, an investor will focus on basis and mark-to-market opportunity. They aim to buy below replacement costs and slowly increase rents to market within the first 6 to 24 months after they take ownership,” explains Auerbach, who says they have sold “dozens” of these properties within the last two years.
Often, the rent increases can feel nominal to the tenant, but make a big impact over the whole property. For example, ownership can increase rents by 5%-7% annually on a 10-tenant shallow bay property. That may only equate to $500 to $1000 monthly increase for each tenant. Tenants can absorb that small dollar cost increase, while the owner enjoys a 5%-7% increase across the entire project.
“That's why investors, have gravitated towards this strategy,” says Auerbach. “It's a bit easier to implement healthy rental increases among shallow-bay industrial properties with short-term leases and smaller suite sizes, versus single tenant properties with long term leases and fixed option periods.”
Transition to Short-Term Leases
Short-term leases are critical to creating value in the shallow-bay industrial strategy, but more owners are signing short-term leases as a way to fill a vacancy in the near-term while businesses gauge tariff impacts.
According to Auerbach, businesses are trying to strategize for the next 60 to 120 months, but in the current macroeconomic environment, those predictions can be difficult if not impossible. Signing a shorter-term lease, anywhere from 12 to 36 months, can ease concerns and help tenants move forward through the uncertainty.
“Tenants still may and will likely feel the slight pain in the short term, but planning for their business needs and goals is much more feasible for a 12 to 36 period,” says Auerbach. “Tenants are much more comfortable inking short-term leases while they see how much the economic environment unfolds.” Additionally, it allows owners to fill vacancies with strong rents that have historically increased substantially.
For more thought leadership and insights from Matthews Real Estate Investment Services, click here.
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