By Brian Malliet. CEO and Co-Founder.
BKM Capital Partners | download the pdf +
Two WREB experts believe the West’s industrial sector points to the next big value play.
The West’s multi-tenant industrial market is poised for recovery, presenting a great opportunity for sawy investors.
Multi-tenant industrial might not be the sexiest product type out there, but it is the next important institutional asset class, as these properties present tremendously lucrative opportunities for yields over the next two to three years.
We will see increasing institutional interest in multi-tenant industrial assets as 2016 approaches that will be based on three primary factors, outlined below:
Multi-tenant industrial has lagged behind the rest of the industrial sector. This is extremely good news for investors.
While big box industrial product bottomed out years ago and has now made more than a full recovery, rents in multi-tenant industrial didn’t hit bottom until about a year and a half ago.
Since then, we’ve seen occupancy rise and rents increase. This translates into a tremendous opportunity to deliver yields.
BKM is sourcing and buying multitenant industrial assets that are 50 percent below peak pricing. These assets are also about 50 percent below replacement cost.
Malliet From there, the firm utilizes its operator model to tum the asset around, stabilize it and achieve strong profit from stabilization.
This opportunistic, or value-add, play is meant to take advantage of a lagging market. In this scenario, the firm can recognize the opportunity to come in and restructure the capital stack with proper capital to perform the execution, something any institutional-quality product operator understands.
2. Returns and Cash Flow
Multi-tenant industrial is much more attractive than big box industrial for institutional investors in the current market.
Large credit tenants sign seven- to 10-year leases in big box spaces, making this investment type similar to buying a bond. If a big box asset has a 10-year, locked-in income stream with a very high-credit tenant, pricing for that asset becomes extremely aggressive. In contrast, multi-tenant industrial rents roll every one to three years, providing a much faster opportunity for increased cash flow.
Coming out of the recession, BKM sought an industrial product type that could deliver 20-plus levered IRRs (internal rate of return) and double-digit cash-on-cash returns. Multi-tenant industrial emerged as the product type of choice for this objective.
Essentially, when we buy an asset at today’s pricing, we lease it at today’s rents. The majority of our profit is broken down into a 50-50 ratio, where half comes from cash flow once we stabilize, and the other half comes from fixing the asset with capital improvements and essentially taking the asset from a C-level rent to an A-level rent.
The returns are there if you can do it.
One caveat-that is important to note is that anyone investing in this product type needs to have, or be working with someone who has, an operator platform. The strategy outlined above must be executed in a specific way, within a certain timeframe. With this in mind, an investor must have hands-on construction management, asset management and property management all in one place to succeed. Having people on the ground at each asset who can execute is a key to making this strategy work.
3. Current Ownership
The multi-tenant industrial market is exactly where student housing and self-storage were a decade ago: poised for institutionalization. Much of this is based on ownership.
There is a bifurcation of owners within the multi-tenant industrial product type. Some are institutional owners that are just beginning to get into this space. The majority, though, are mom-and-pop or high-net-worth owners who have invested in these properties simply because they are located in a market where the investor has lived and done business, not because they know real estate. The mini storage and student housing spaces were the same 10 years ago – most of these assets were owned by local, small operators spread throughout the U.S.
At that time, a few major mini-storage institutions came in, built their execution team, put processes and procedures in place, and ultimately institutionalized the asset class from an execution standpoint and from an ownership standpoint.
The same thing has happened more recently in the student housing space. Three major institutional-size student housing operators have revolutionized this segment of the industry in terms of bringing processes, procedures and professional execution into it in just the past five to seven years.
Multi-tenant industrial will be next, and we’ll see this institutionalization occur in 2016 and beyond.
Looking ahead, multi-tenant industrial product will be a huge opportunity for institutional investment over the next two to three years until pricing in this sector catches up.
Once that occurs, BKM will likely move to a core or core-plus fund focus. That said, after acquiring multi-tenant assets, putting a good operator model in place – which includes proven policies and procedures and deployment of appropriate capital – BKM believes it can still achieve 8 percent to 10 percent cash-on-cash returns.