Industrial outdoor storage (IOS) is industrial-zoned land primarily used for the storage of trucks, trailers, vans, large equipment, containers and materials. The land can be improved by installing pavement, perimeter fencing and flood lighting. The defining factor of IOS, as compared with traditional enclosed industrial, is that the primary value is derived from the open, horizontal outdoor space, rather than a vertical building. This is reflected in the way IOS properties are rented on a per acre basis as opposed to per square foot. Any enclosed spaces on an IOS property serve ancillary purposes, such as truck maintenance and repair, loading and unloading, or back-office needs, and typically make up less than 20 percent of the property.
Location is a critical factor for IOS sites and demand is largely driven by proximity to both multiple transportation options as well as dense populations. Site selection is also affected by local zoning regulations and macroeconomic drivers, such as manufacturing and distribution hubs and their continued reliance on ecommerce. The best-performing sites are generally located near major urban centers with population density and at the intersection of primary logistics and infrastructure hubs — such as ports, railways, highways and airports — where there is high demand within the supply chain for a space to store, sort and move goods as well as store the equipment required to move those goods. Places such as Northern California, Miami, Los Angeles/Long Beach, New Jersey and Savannah, Ga., are some of the primary locations that have seen strong demand for these sites.
Emerging niche to growing demand
In the beginning, the lack of available sites, combined with the demand from increasing storage needs along the supply chain, made the opportunity for IOS even more attractive. In addition, one of the main principles of investing in real estate is a comparison with replacement cost, and within the IOS sector, replacement is really difficult given municipalities’ continued effort to remove the use from zoning and a “not in my backyard” mentality.
Numerous municipalities viewed IOS as the lowest and worst possible land use, given that it is not particularly aesthetically appealing to have an open lot with heavy equipment or trucks exposed. As a result, local governments have attempted to put parameters in place to avoid developers using industrial-zoned land for IOS, with many largely halting the zoning of land for industrial use completely. However, as the industrial distribution ecosystem continues to grow, and more trucks and transportation equipment are required to keep up with distribution demand, the need for IOS sites will be imperative. These factors make for compelling supply/demand characteristics and unique investment outcomes.
When IOS was still an emerging and fragmented asset class, there was a lack of readily available data, which made it more difficult to understand and underwrite IOS opportunities.
There are three main factors that made IOS investments particularly attractive in the early stages: existing expertise and relationships in many of the markets in which these sites exist, the lower amount of capital required for initial investment, and the increasing supply/demand imbalance.
To go a layer deeper on each of those, starting with expertise, most existing sites today are mom-and-pop owned, which means sourcing acquisitions takes in-depth knowledge of local markets and hands-on experience with local brokers. Given the scarcity and fragmented ownership of IOS sites, having existing market knowledge and deep relationships in some of the top local markets where IOS sites exist — such as New York City and London — gives an advantage in sourcing because having boots on the ground can canvass site-by-site and develop in-person relationships with individual owners.
Furthermore, the initial capital required to transact is much less than other real estate sectors. After acquiring a property, the owner may install pavement, perimeter fencing and overhead lighting — the installation and upkeep of which pales in comparison with typical renovations undertaken with a multifamily asset.
Building on that, demand for these sites is extremely high given the limited supply, and as a result, tenant turnover is low. Tenants need these sites to operate their businesses and participate in ecommerce and last-mile logistics, which makes these assets mission-critical for business owners. The demand for the sector, as well as other logistics-related assets, is expected to continue to accelerate as a higher percentage of the population continues to rely on the ecommerce ecosystem.
Unlike the office sector, where tenants have tremendous optionality in their space and could pivot to remote work, these sites are required for businesses. The friction costs of disrupting business to move sites and rearrange the supply chain far outweigh rental increases, drastically increasing the stickiness of the tenancy. In some cases, given transportation is one of the largest costs for certain users, a well-located and well-designed IOS property can increase operational efficiency and decrease distribution costs. And tenants do not generally require costly tenant improvements as they might in an office.
Most operators need IOS in some capacity, even if the bulk of their goods require enclosed storage. Take an operator such as Amazon, for example, which requires enclosed warehouses with racks to store and sort its small goods. The vehicles that transport those goods to the warehouse and then, once sorted, transport them to the next location or end destination include trucks, trailers and vans that need space outdoors proximate to the warehouses themselves. Another example is a car rental company that might need to store up to 500 rental cars near its dealership. We’ve found car storage to be a common use for IOS in Newark, N.J., which receives imports from Volkswagen and Mercedes Benz from Europe daily. These car companies require space to store their vehicles between the time the ships carrying them arrive at the New Jersey port, and the time when the vehicles are ultimately ready to be distributed across the country.
Exercising caution today
The early investors and operators in this space have scaled their portfolios to such a large extent that they are attracting more large institutional investment into the asset class. For example, some of these early investors own 20 to 30 sites valued at $100 million in aggregate and are positioned to sell them. And with the performance of these earlier investments starting to play out in a positive way, more investors are becoming interested in IOS. A lot of this performance has been driven by consistent and growing rents. Despite economic headwinds today, rents have grown 20 percent to 40 percent since 2019 and were consistent throughout the COVID-19 pandemic and shutdowns. Indeed, the sector has grown so much that there is now significant data that show IOS investing is not a one-off or niche opportunity. Both new operators and established institutional operators are increasingly adding IOS to their investment portfolios, particularly over the past three to four years.
While there is an uptick, there remain barriers to entry for new entrants. The proven performance of IOS, coupled with demand for the sites, has affected pricing, driven down cap rates and made sites harder to source. When Meadow Partners first began investing in the space, the underwriting was at double-digit cap rates — we have not seen that for some time. Also hindering the market today is limited financing, which is true across all asset classes in a rising-rate environment. Investment activity has certainly slowed, but overall, the sector is expected to continue to institutionalize and become more competitive with new investors entering the space and mom-and-pop owners becoming more sophisticated in understanding the value of their land. However, there will be continued opportunities to invest in smaller-scale deals, in the 10- to 20-acre size range.
While being bullish on IOS to expand footprint in the sector and to go with the strong tailwinds in the medium to long term, proceed with caution today. Many investors have overpaid for assets because they are more focused on building critical mass quickly than ensuring each of their properties has strong value fundamentals and features the right IOS attributes. Try to be thoughtful and measured, carefully evaluating each IOS investment opportunity case-by-case, keeping in mind the specific market and broader macro dynamics.
And wait patiently for pricing to appropriately reflect true underlying value and allocate capital into IOS at the most opportune times. With that in mind, future IOS opportunities should be tremendous.
Tim Yantz is a partner at Meadow Partners.