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ISFs Could Be the Next Industrial Real Estate Gold Rush

There is an overlooked segment of the U.S. industrial property market potentially more lucrative and larger in aggregate square footage than the heavily publicized warehouse and distribution center asset class that has capitalized on the surge in e-commerce activity.

“Industrial service facilities” (ISFs) is the formal name for stand-alone structures used to store and maintain rigs, trailers, containers and chassis, as well as bulk materials. Fleet maintenance facilities and parking lots are also included in the ISF classification. ISFs, which have been around for years, typically are small structures that occupy between 5% and 20% of a parcel of land that the building sits on. The facilities are embedded deep in a city’s heavy industrial network, near highways and rail lines so the equipment can be utilized at a moment’s notice. Land expansion is limited because few zoning boards will approve the development of these gritty properties in residential or nonindustrial commercial neighborhoods.

Many of these buildings are controlled by high-net-worth individuals and mom-and-pop businesses. Some are as small as 100 square feet, and transaction price tags of $7 million to $10 million (if that) barely register with large-scale developers consumed by the big-box bonanza. If the big boys own any ISFs, it’s usually because they’ve come along for the ride in an acquisition involving millions of square feet of industrial space. Some developers won’t play at all because they are mandated to stick with big-box properties.

Yet from small things a big picture has begun to emerge. An article by real estate data firm CoStar that appeared earlier this month on the website of Houston-based Triten Real Estate Partners stated that there are $115 billion to $130 billion of ISF properties nationwide, according to data from CoStar and the Bureau of Economic Analysis. That compares to $45 billion to $50 billion of Class A top-tier warehouse space, according to the article. By one rough estimate, ISFs in total make up about 800 million square feet.

ISF rents are solid and rising because zoning laws put curbs on new developments. ISF tenants are stable, long-term occupants that, in turn, work with customers that have consistently recurring business. ISFs may not be sexy, but they provide must-have services for supply chains that support multiple industries. ISFs can often command higher rents per square foot of building area than warehouses and distribution centers because tenants derive additional value from the storage capabilities as well as the building itself. In addition ISFs are flexible enough to be considered candidates for conversion to other uses, though for the most part that’s not the developers’ end game.

The lure of consolidating such a fragmented but lucrative category has sparked a mini-gold rush of sorts. Triten recently secured a $150 million investment from an unidentified institutional investor to acquire about $400 million in ISF properties over the next three years, according to the article. On Monday, Atlanta-based Stonemont Financial Group, an industrial developer and real estate investor with 15 million square feet of traditional warehouse space under management, said it established a $1 billion joint venture with an affiliate of New York-based Cerberus Capital Management LP for the sole purpose of acquiring ISFs nationwide.

The venture represents Stonemont’s first foray into the ISF world. Stonemont’s core goal is to “bring this asset into the mainstream,” said Andrew T. Smith, a Stonemont portfolio manager, in a phone interview Monday.

Industrial Outdoor Ventures, a Schaumburg, Illinois-based company that has called itself the only national investor specializing in ISFs, is involved in a deal with investment firm Stockbridge Capital worth between $300 million and $400 million, according to Smith. Industrial Outdoor was unavailable to comment. The earliest deal in the cycle occurred in January 2020 when J.P. Morgan, Chase & Co. (NYSE:JPM) entered into a $300 million joint venture with Philadelphia-based Alterra Property Group LLC to buy up ISFs.

The ISF network has largely been ignored because the smallish deal sizes, on an individual basis, lack the scale that institutional investors crave. However, the promise of big-time roll-up opportunities has made institutions reexamine the sector.

“There is a whole ecosystem revolving around trucks, trailers, parking, and chassis and container yards that is under our nose in plain sight,” Scott Arnoldy, Triten’s founder, was quoted as saying in the CoStar article. “It’s just an incrementally fragmented asset class that the brokerage community is not very deep in.”

By Mark Solomon

Source Article by FreightWaves.com

Industrial Outdoor Storage Veterans Warn Newcomers of Potential Pitfalls

On paper, industrial outdoor storage seems like a slam dunk investment (https://www.bisnow.com/national/news/industrial/industrial-outdoor-storage-new-hot-investmentclass-106490): low cost of operation, huge demand and “sticky” tenants. But those with experience in the area warn against entering it half-cocked.

Because it is so different from other asset classes, industrial outdoor storage requires a unique base of knowledge and experience to distinguish the good deals from the bad. If the volume of investors entering the market is about to rise as high as panelists at Bisnow’s Industrial Outdoor Storage Update webinar on Dec. 9 predict, expertise will be a key differentiating factor.

For decades, IOS has been the exclusive province of either owner-occupiers or local and regional owners. Any investor looking to build a national portfolio will face the same challenges as legacy owners, only at a larger scale and greater complexity.

“The aggregation of a portfolio and the unique challenges to due diligence and management are really not to be taken lightly,” Realterm Vice President of Investment Derek Fish said on the webinar. Realterm has owned and managed IOS properties for more than 30 years.

As with any sort of industrial usage, an environmental review is a crucial element of due diligence, but there are quirks to each site that can seem small but wind up disqualifying for potential tenants: As little as one stoplight too close to the property in question could be a deal breaker, Fish said.

Realterm and Alterra Property Group (https://www.bisnow.com/tags/alterra-property-group), which entered the sector about four years ago and now has a joint venture with JPMorgan (https://www.bisnow.com/tags/jpmorgan) to purchase IOS properties, both have whole teams dedicated to sourcing and vetting acquisitions, Fish and Alterra principal and Chief Investment Officer Matt Pfeiffer said.

“This is a high-volume business for transactions, so you need to centralize all your due diligence, your environmental review, etc., so you’re just dropping a team nationally into every single space so you analyze transactional risk the same way for each deal,” Pfeiffer said. “And if you don’t do it that way, you slow down.”

Brookfield Properties (https://www.bisnow.com/tags/brookfield-properties) started investing in IOS in the middle of last year and doesn’t have a dedicated team yet, but the private equity giant overcomes that disadvantage by having a bigger appetite for risk, Brookfield (https://www.bisnow.com/tags/brookfield) U.S. Head of Real Estate Management Devin Barnwell said. One of the most common risks in the space is in the quality of tenant, given that users tend to stick around long term. Adding value to a recently acquired property with an occupant already in place may not be viable.

“The majority of [tenants in] your portfolio will be regional or local companies that won’t be able to commit to longer leases, won’t be able to share in the capital required for improvements and will be very sensitive to rent increases,” Fish said. “The most common user of IOS is often a low-margin business, so a big increase in rent to market rate could destabilize the tenant.”

A small operator could also be more likely to be a less-than-ideal tenant, which has a slightly different impact in a part of the real estate market that universally functions on true triple-net leases, panelists agreed. Barnwell recommended ensuring that an IOS property has comprehensive insurance coverage.

“There is a responsibility on ownership to make sure that tenants are performing their duties,” Barnwell said. “If they defer maintenance, you may wind up having to spend capital [to fix properties] down the line.”

If an owner has the legal leeway to not renew a low-margin tenant in the hope that it can land an ecommerce (https://www.bisnow.com/tags/e-commerce) merchant — as with distribution centers, Amazon (https://www.bisnow.com/tags/amazon) is by far the biggest source of demand — then a knowledge of the local zoning particulars is a necessity.

“We’ve also seen in certain municipalities that [IOS] might be a currently allowed or nonconforming use, and if that’s the case, what are the changes that could possibly happen?” Barnwell said. “You may need to find a new tenant in six months after your previous one vacates or risk losing your zoning.”

Still, the combined forces of rising e-commerce demand and no real pathway toward an infusion of additional supply ultimately will prove that industrial outdoor storage’s risks aren’t enough to scare anyone off, panelists agreed.

“The costs [of owning IOS property] are insurance and real estate tax, which is very low compared to the carrying costs in other sectors,” Pfeiffer said. “If you’re in a good market or a good location, you should not be afraid to take a vacancy risk. And the tenant improvements are not costly enough to provide meaningful friction in leasing.”

Source Article by Bisnow

Industrial Outdoor Storage Gets Its Moment In The Sun As An Investment Asset Class

Industrial outdoor storage may seem like perhaps the least sexy form of commercial real estate, but it has suddenly become a commodity hot enough to attract interest from massive sources of institutional capital.

IOS, as some in the sector call it, refers to properties that mostly provide uncovered ground to keep items often needed by industrial users with other business nearby, from truck trailers to construction materials. Over the course of the past couple of years, national players like Brookfield Properties and JPMorgan Asset Management have come around to IOS as an asset class that costs very little to maintain but has a reliable cash flow and a favorable ratio of supply to demand.

The most common IOS sites range from 3 to 20 acres, with less than 25% of land occupied by buildings (a small office for site management, in most cases). The property type is far from new, but has been the exclusive province of either owner-occupiers or local and regional property owners until very recently, multiple sources told Bisnow.

Unlike distribution centers, which have strong demand but also steadily expanding supply, there is little reason to believe that the pool of available properties will grow significantly anytime soon. Any property that would be well-located for IOS is also suited for higher, better uses of land, from warehouses up to multifamily developments. Even those who extol the virtues of IOS as an investment recognize how low it ranks on the scale of acceptable uses of real estate for municipalities.

“The entitlements just aren’t there,” said Devin Barnwell, Brookfield Properties’ U.S. head of real estate management and logistics. “I haven’t seen truck terminals being developed anywhere in the country.”

For many users, IOS is mission-critical real estate, meaning it is an irreplaceable part of a company’s business model, multiple sources told Bisnow. Logistics companies, including shipping giants FedEx and UPS, use outdoor truck terminals to quickly move goods from one truck to another without clogging up the traffic at a distribution center. Construction companies that use IOS to store building materials have few, if any, alternatives for where to keep them near a construction site but not on it.

Because IOS sites are only useful insofar as they service a core business located somewhere else, they are generally only viable within metropolitan areas and very close to roadways that can handle truck volume. For truck terminals or storage of shipping containers, proximity to a port is also important.

“In the supply chain, transportation is about 50% of costs, and when you think about the last mile being the most expensive, the critical nature of these properties really is location,” Barnwell said.

The most common lease structure at industrial outdoor storage properties is a “true triple-net” lease, wherein the tenant is responsible for nearly all site upkeep and costs, Barnwell said. The biggest capital expenditure a landlord might be responsible for is pavement replacement in lots where the weight of what is stored exceeds a surface’s capacity.

Add up the above factors, and IOS reads like an investor’s dream: simple to manage, easy to lease, reliable as a source of revenue and with higher average cap rates than distribution centers. No wonder that the pool of buyers has rapidly become more crowded.

Brookfield has only been active in IOS — specifically truck terminals — since mid-2019, but the product already accounts for 10% of its logistics portfolio in terms of dollar value. The private equity giant wants to own from $300M to $500M worth of IOS property, a number it is “quite a ways away from at this point,” Barnwell said.

Alterra Property Group, known in its hometown of Philadelphia as a developer of mixed-use and multifamily projects, began investing in industrial outdoor storage sites in 2017, not long after a Chicago-based company named Industrial Outdoor Ventures was formed specifically to acquire and manage such properties.

At that time, IOS resembled single-family rental properties and self-storage in terms of its ownership and treatment by the national investment market, Alterra partner Matt Pfeiffer said. When Alterra entered the sector, it estimated that about $15B of IOS deals had transacted in the previous year or so, with an average deal size of $5M.

There is already more demand for IOS than there is supply, and the disparity looks like it can only grow. While that creates an appealingly high barrier to entry for investors, it means that the only way an investor can build scale is through acquisitions. Institutional investors have little time to source such small deals with local owners and, potentially, local brokers.

“We saw an opportunity to institutionalize the asset class, and to bring in programmatic debt and capital at a national scale,” Pfeiffer said.

Alterra now has an ownership stake in more than 40 properties across 12 states, with a handful of them acquired as part of a $300M joint venture it formed with JPMorgan Chase in December. JPMorgan had already been involved in the asset class for “many years,” JPMorgan Asset Management Acquisitions Vice President Dan Schuchinsky told Bisnow in an email, but entered the JV with Alterra as part of a new commitment to growing scale in IOS. In June, Alterra announced that the JV had obtained a $100M credit facility from Morgan Stanley.

Though deal sourcing has been the primary challenge for investors looking to scale up in IOS, more portfolio deals are becoming available this year, Pfeiffer and Barnwell agreed. Brookfield purchased a $27M IOS portfolio in May.

“We’ve been talking about small deal aggregation, but there are middle-market private equity funds and users that see the value in doing a sale-leaseback with outdoor storage space,” Pfeiffer said. “So there are portfolio deals out there.”

Once owners reach a certain scale, they can begin to leverage that scale to make portfolio-sized lease deals with regional and national tenants. Both Alterra and Brookfield have sourced IOS properties for tenants at distribution centers they also own, and Alterra recently executed a sale-leaseback deal with one occupier that had a portfolio of 20 properties.

“Amazon, FedEx, UPS — those are all tenants of ours in warehouses in addition to truck terminals,” Barnwell said. “And there are a lot of third-party logistics that use them as well, so we see a large demand from our tenants.”

A market with fundamentals as strong as IOS can expect to see prices rise as it becomes more competitive, but Barnwell said that so far, values haven’t shifted much since Brookfield entered the market over a year ago. Considering the state of the economy, that is a minor miracle that may not hold true for long.

Much like with distribution centers, outdoor storage has not suffered any significant headwinds as a result of the coronavirus pandemic. The increased demand for e-commerce benefits IOS as a link in the supply chain, and outdoor sites are inherently less dangerous in terms of contagion.

“When we got into this business, the one thing we couldn’t answer for capital partners is how this would perform in a downturn,” Pfeiffer said. “But we’ve had 100% on-time rental payments, so that has performed well. We’re selling a few pre-COVID assets in the venture already to harvest the portfolio at good multiples, and we’ve done leasing transactions at substantially higher rates than in-place rents.

“So the data is proving to be strong that this is resilient in a downturn.”

Source Article by Bisnow

A year later, Alterra-JPMorgan venture bulks up on $300M property play

A year after establishing a venture with JPMorgan Chase & Co., Alterra Property Group has deployed $250 million of $300 million to buy industrial outdoor storage properties across the country and is seeking another round of funding from the financial institution.

The Philadelphia company has so far closed on buying 50 of these properties in Oregon, Arizona, Texas, Alabama, West Virginia among other states and is in the process of making other acquisitions, said Leo Addimando, managing partner at Alterra.

Last January, Alterra teamed up with JPMorgan to launch a joint venture to spend an initial $300 million to buy industrial outside storage sites. It is targeting 30 markets across the country where there’s job growth and commercial activity. The sites Alterra buys are typically near airports, ports, highways or intermodal transportation centers and between five and 30 acres with less than 25% of the surface covered by structures. Most often these properties have been used on a long-term basis by the companies that own them.

Frank Roddy of Roddy Inc., a commercial real estate brokerage, sold Alterra one of those properties last fall that fit the profile. Alterra paid $9.5 million to buy a single-story, 17,280-square-foot building on 4.43 acres at120 Minue St. in Carteret in Middlesex County, N.J. The property is leased on a long-term basis to Maxim Crane Co., which has been the sole occupant of the building for years.

“Apart from the Amazon effect, there are lots of willing sellers. Some with reasonable pricing expectations,” Addimando said.

Alterra wants to try to institutionalize this oft ignored industrial property. Though these properties are overlooked, they are ubiquitous in every community. These gritty industrial parcels are used to park cranes, tractor trailers, earth moving equipment, building materials and other products.

Alterra intends to seek a fresh round of funding from its venture partner, JPMorgan, Addimando said. The goal is to eventually cultivate a $1 billion portfolio of these industrial outdoor parcels by mid-2022.

“One of the really nice things about this real estate is it will well during unforeseen economic events,” he said, noting that they have so far had 100% rent collection during the pandemic.

While Alterra builds up its portfolio, it’s looking to the future and where it sees this effort headed. “There are several different ways this could end,” Addimando said.

One is to keep accumulating properties and use it to generate revenue to re-deploy into more acquisitions or grow to a certain point, sell and start all over again.

“To be honest, all of that is putting the cart before the horse,” Addimando said. “We want to continue to build the portfolio, go into good markets with good opportunities and get to $1 billion as expeditiously and prudently as we can.”

Alterra has brought in Bill Hankowsky, former CEO of Liberty Property Trust, an industrial real estate investment trust that was sold last year to Prologis Inc., as a senior advisor.

In a statement, Hankowsky described Alterra’s platform as “a really thoughtful real estate concept.” Hankowsy said that industrial outdoor sites “is a national opportunity that has the characteristics of the net lease sector – low capex, long lease term with strong cash flow. And at the same time has characteristics of the industrial sector – locational and geographic scarcity while seeing an increase in the long term demand for the product. I see it as an asset class which will have strong investor interest.”

Natalie Kostelni
Reporter, Philadelphia Business Journal

Source Article by The Business Journals