Identifying Core and Emerging Industrial Markets

With asking industrial rents surpassing $10 per square foot in markets like Albuquerque, New Mexico and Stamford, Connecticut and $15 per square foot in locations like Miami and Los Angeles, interest in this asset class among investors continues to boom. As a point of comparison, CoStar data indicates that asking rents in these small and mid-size industrial markets have risen by more than 15% and 20%, respectively, between 2019 and 2022.

“We are witnessing a truly unique time for industrial real estate that has an extreme level of competition for a finite amount of available space. Even with new supply in various stages of development, this environment will continue to produce increasing lease rates and a corresponding lift on value — each seemingly without any foreseeable limits in terms of how high they might go,” noted Robert Thornburgh, CEO of the Society of Industrial and Office Realtors.

Adhering to CRE investment fundamentals is typically a sound practice. However, when an asset class heats up, conducting a careful assessment of key risks may be even more important so there is clarity about the challenges a new owner might face. To explore this, LoopNet spoke with Gabriel Silverstein, the national chair for institutional capital markets at SVN Commercial Realty. Based in Austin, Texas, he has completed industrial real estate transactions in 45 U.S. states and 17 foreign countries. He spoke with LoopNet about the fundamental characteristics that make up a core institutional-grade industrial asset. They include:

• Location in a top-tier industrial market.
• Stable income from good credit tenants.
• Leases that exceed five years.
• A recently completed, modern Class A industrial building.

In addition to discussing these indicators, that are similar to those used to assess core, value-add and opportunistic investing in office buildings, Silverstein also expanded on several of the lesser-known characteristics of core industrial markets and submarkets focusing on:

• Road, highway and rail infrastructure.
• Industrial-friendly communities.
• Access to labor.
• Location between the origination and destination points of cargo.
• Inland ports.

It's almost as much art as science. If you ask four people, you’ll probably get four slightly different answers. But in theory, to me, to be a core investment, two to four elements must be there.

First, in my view, from a national and institutional perspective, the asset must be in a primary top-tier market, and there are roughly a dozen to two dozen markets around the country that fall into this category. Again, this is my definition, and you'll probably get a little different one from somebody else.

There needs to be stable income in place, with good credit tenancy. That doesn't have to mean investment-grade credit from a user like Walmart or Home Depot, but it does mean there need to be larger, more profitable companies as tenants.

Leases should go longer than five years, preferably even seven to 10-plus years. It could be a multi-tenant building, or it could be a single-tenant building, but either way it needs to be cashflow that is stable over the long term, meaning it’s guaranteed contractually, ideally with rent escalations, and without a whole lot of uncertainty, like leases coming due inside of five years.

It also needs to be a high-quality asset. Let's call it a modern, Class A building that today means 32-foot or greater clear heights. [Clear height is space that is unimpeded by building features such as joists, lights or sprinklers, which enables users to operate tall pieces of equipment, multi-tier racking systems and/or conveyor systems with vertical components without obstruction.] It probably has a good ratio of docks to square footage and a decent amount of trailer parking on the site for users, if it's a distribution building. I think all those elements must be there, at the same time, to be what I would consider a core asset or investment.

A core-plus investment means that one or two of those elements is missing and must be addressed by the new owner. Maybe it’s 85% leased or has only three years left on a lease. I would say core-plus even applies to being in a second- to third-tier market. So, it might be a really good market, like Nashville, Tennesee, or Greenville-Spartanburg, South Carolina, but to me, it’s pretty borderline to say something is truly core in a market of those sizes compared to markets such as Chicago, Dallas, the Inland Empire [outside Los Angeles], New Jersey, etc.

I don’t know if it needs to be in one of the oldest, most robust submarkets, but it probably should be in, what I would call, an established submarket. So, if the submarket in question is 20 miles past the majority of industrial development, it's probably too far out. If it's on the other side of town from the most industrial neighborhoods, but has some critical mass of similar buildings where more and more new companies want to locate, then that area can be considered something of an established submarket.

Infrastructure is probably number one. That means there needs to be access to highways and roads and maybe even rail, depending on the situation.

An industrial-friendly municipality is also important. What I mean is that there are situations where you might have one really good pocket of warehouses and distribution facilities with good road and highway access, but then next door, you've got a city that is anti-industrial, so you can't grow anymore. You're landlocked and nobody wants to give you industrial zoning.

Access to labor is really important and part of that involves infrastructure, meaning people need to be able to get to and from work, either through commuter buses, rail lines or just roads. Remember, in most industrial uses, the labor pool earns hourly wages, so workers are very sensitive to driving distances, especially if gas prices rise.

If somebody opens a facility five minutes closer to their homes, they can simply switch jobs and go to another warehouse or fulfillment center. Whether companies need skilled or unskilled labor, having access to that labor pool is a really critical piece of a great market.

This is a component that we in the industrial world didn't spend much time thinking about until the last few years. The office world, for example, has been thinking about its labor pool and employee demographics for 20 or 30 years. On the industrial side, I think we took it for granted a bit that people go wherever they need to for a job. But I think as we got into much tighter labor pools over the last decade, we learned how critical proximity and access to labor are for strong industrial markets.

For distribution-related uses — that are by far the biggest piece of the commercial real estate industrial market — a strong submarket should be situated at the intersection of origination and destination points for the type of cargo flowing through.

You could have great access, great labor and a really developed and friendly place in say Peoria, Illinois. But if Peoria isn't close to where goods are coming from or going to, it doesn't help. Proximity to both the origination and destination points of whatever goods are passing through an industrial area is very important because transportation costs are a huge expense, rivaling even labor as one of the top costs to industrial operations, particularly distribution operations.

Interestingly, those ideally situated submarkets ebb and flow over time. Take the conversations about port cities and port access and delays. Look at Long Beach, for example, and the delays in getting shipping containers onshore to process and unload goods versus sending them through the Panama Canal and over to Mobile, Houston or Charleston.

Things ebb and flow over time as to how much is being shipped by rail, versus truck, versus air. Another consideration is whether it's arriving originally somewhere via seaborne transportation, or whether we're onshoring components to be manufactured somewhere in the U.S., making the origination status of the product domestic versus foreign. This change in origination status can mean avoiding customs, or entry ports entirely, which then potentially removes one step in the process of moving things from where they are made to where they are used.

Those elements shift over time, so what might be a great spot now, might not be the best place 10 years from now. Prime locations for inbound and outbound cargo is a dynamic that people don't really have control over, but it still becomes relevant to location and development decisions carried out by industrial users and developers.

One of the things that might move a market toward core or draw interest from institutional investors is the creation of an inland port. There is an inland port 200 miles up state from Charleston, near Greenville-Spartanburg called the Inland Port Greer. The facility has been a catalyst for strengthening the industrial market in Greenville-Spartanburg because the goods that come off ships in Charleston get zoomed up on rail upstate to Greer before they get unpacked and moved outbound from there.

To move those goods into distribution warehouses in Charleston and back out from there, can be challenging because Charleston’s market is landlocked by the ocean and it faces some other geographic constraints. Instead, they put containers on a train, move them three hours upstate to Greer, and you've got lots of space and plenty of good labor to do that with, relatively unimpeded in the ability to expand in every direction, and to be quickly on a highway headed north, south east or west.

So, the inland port is, in some ways, a catalyst that is changing the complexion of the Greenville-Spartanburg market, moving it toward more of a core market for many investors.

Recently, approval was announced for a similar inland port on the west side of Montgomery, Alabama to bring goods up from the Port of Mobile. That might dramatically change the way the industrial sector in Montgomery, Alabama is viewed in the future. Today, it is considered a third-tier market with little institutional ownership. Right now, it would not qualify, in my mind, for a core holding, but 10 years from now that might actually change.

As transportation and warehousing costs rise, and as consumers want shorter and shorter delivery windows for goods, industrial booms are occurring in cities not previously thought of as being larger industrial markets. Boise, Idaho is a good example of a mid-size city experiencing that. The same is true in places like Nashville, Knoxville and Chattanooga in Tennessee; Huntsville, Alabama; and Raleigh-Durham and Asheville in North Carolina. That’s why you see industrial rents so high in Albuquerque, New Mexico, as mentioned earlier.

Austin, Texas is a big city with the same explosion of industrial growth, as it is a location not previously known for its industrial market. In 2021, Austin delivered more industrial space to its inventory than ever in history — so much so, that it was almost double the second highest year on record.

I think you will continue to see that same thing happen, in a very pronounced way, in mid-size “lifestyle” cities, especially in the sunbelt, because it’s no longer feasible to service those communities from a larger city that’s a half-day drive away; they need the products on hand locally to be able to meet one- and two-hour delivery windows that companies like Walmart and Amazon now promise.

This interview has been edited for clarity and brevity.