PERE Q&A: Small-bay Industrial's Big Moment

February 1, 2023 –The US light industrial property niche offers robust income and an inflation-hedge at a challenging moment for the national economy, say BKM Capital Partners’ Brian Malliet and Harry Hedison.

Founded in 2013 by CEO Brian Malliet, a 30-year light industrial veteran, BKM Capital Partners is a vertically-integrated industrial operator with 13 offices and over 90 employees. The firm specializes in acquiring and improving multi-tenanted small-bay industrial business parks across the western US and has amassed a $1.85 billion portfolio to date. Malliet and Harry Hedison, Senior Managing Director, Capital Markets and Investor Relations, argue that the niche asset class not only proved itself to be more resilient than big-box warehousing during the last downturn, but also promises to perform even better in the face of current headwinds because of limited supply and growing demand from a new breed of tenant.

Q How do the investment characteristics of small-bay industrial assets differ from those of big box warehousing right now?

Brian Malliet: One thing that sets the asset class apart is the opportunity for immediate value creation due to shorter weighted average lease terms (WALT). The small-bay space averages 1.5-1.7 year WALTs at purchase versus 5-10 year WALTs in big box warehousing. This allows an investor to capitalize on rent growth across the majority of an asset within three years.

That is one reason why Blackstone paid $7.6 billion for light industrial platform PS Business Parks in July last year. They were looking for short WALTs to take advantage of the expected rental growth over the next two to four years to offset inflation.

That deal has really raised awareness of the space. Investors are also looking for yield, which has not been available in the big box space, where cap rates compressed to 2.75 to 3 percent. Because of the more intense management required, light industrial has traded at about 150 to 200 basis points higher than big box properties, even though the risk profiles are not that different.

Harry Hedison: As well as being a good inflation hedge, the sector offers strong tenant diversification, both by number and industry. Typically, each of our assets has four to 10 buildings in one location, with 20 to 200 tenants.

Having a large number of tenants in a range of industries helps mitigate the impact to cash flow of any one of them potentially defaulting in a difficult economy. There is much greater concentration risk in the large-bay warehouse segment because you usually have only one or two tenants. In addition, our portfolio of light industrial properties has historically experienced very high levels of tenant retention and low credit loss.

Another advantage of the light industrial sector is that these assets are in infill locations. That provides real downside protection, because those sites have very strong value even if the current use changes. For example, we have seen multifamily developers looking to acquire light industrial properties as sites for urban residential development.

Read the rest of the Q&A here.