Investments: Achieving higher yields than retail - Analyzing the move from retail to industrial

April 21, 2014 - Spotlights

Marilyn Kane, Iridium Capital Group

Sean Shanahan, Iridium Capital Group

As buyers of net-lease property, we at Iridium Capital always look at the key components of term, yield, and credit quality. For the past several years, these have been fairly consistent across the retail net lease spectrum. However, in the past 6 months, as more and more buyers have entered the market, and demand has risen, prices have also risen. This rise in prices has lessened the overall yield of retail properties relative to where they were just a year ago. Where do investors who wish to continue to invest in net-lease properties, but are still searching for higher yield, look? The answer may be in investing in industrial properties.
Industrial properties, unlike retail, are generally unfamiliar to the average investor and may seem like a daunting investment possibility. However, in reality, there are many industrial properties tenanted by the same household names as those in retail. FedEx, CVS, AutoZone - all have net-lease industrial properties. The key component between the retail and industrial properties of these tenants is their use. Most locations for FedEx, for example, are generally a FedEx/Kinkos retail shop. Once packages leave those retail locations they work their way through a network of industrial drop locations around the country. Autozone, which sells after-market auto parts, needs a distribution network that utilizes warehouses to supply its stores with the inventory they need; to do so an industrial property is fundamental to the operation.
Industrial properties can consist of land, warehousing, manufacturing (both light and heavy), repair shops (such as for FedEx trucks), and distribution. They tend to be larger than retail properties, generally ranging from 40,000 - 400,000 s/f. The properties are utilized for a specific purpose that is generally not oriented towards a consumer. Because of that, these facilities do not need to be in "prime" real estate locations. Industrial properties are often grouped in areas just outside of major urban populations, and while the real estate may not look as attractive as a parcel on "Main St.," its function is just as important.
Due to their large size, industrial properties tend to be priced higher than retail, ranging from $5-50 million, with certain properties being more than $100 million. However, they tend to also have higher cap-rates, making them "cheaper" buys and allowing for higher yields. This is partially due to their price, which keeps many buyers out of this market. Cap-rates for investment-grade tenants are often over 7%; combined with easily sourced financing, yields of 10-13% are achievable.
A main difference between industrial and retail properties is the lease itself and the responsibilities of the landlord. It is very common for industrial properties to be NN, or modified NNN, with the landlord responsible for roof and structure - a factor which can be unappealing for some investors. Most of these properties are of relatively simple construction with a steel exterior and hollow core, so maintenance is often minimal. In addition, most newly constructed buildings come with a standard 10, 15, or 20-year warranty on the roof and structure, effectively protecting the owner.
Industrial properties are an often overlooked category of net-leased real estate, especially for the individual investor. However, if an investor can become comfortable with some of the nuances and needs for industrial properties, she can achieve higher yields than retail, with comparable credit. In addition, since most industrial properties serve a purpose much larger than their local facility, such as a regional warehouse or distribution hub, these properties may have a higher probability of renewal when the lease is up.
Marilyn Kane is president and Sean Shanahan is CFO at Iridium Capital Group, New York, N.Y.
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