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posted: 3/14/2019 1:00 AM

Investors see big opportunity in small industrial

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  • David Bradley

    David Bradley

 

Nine years into the current real estate cycle, the industrial sector remains the darling of the commercial real estate industry -- both in Chicago and across the country.

We're now in the 36th quarter of positive absorption, according to Marcus & Millichap data, continuing a record-setting run that has helped spur new industrial construction throughout metro Chicago. Most recently, megawarehouses with footprints exceeding 1 million feet have grabbed headlines. These include multistory behemoths built for e-commerce giants like Amazon, which is planning a four-story, 2.6-million-square-foot distribution center in Oak Creek, Wis. -- one of several such facilities in the company's pipeline.

But at the other end of the spectrum, we've noticed increasing demand for smaller industrial properties -- most below 5,000 square feet -- creating an exceptional opportunity for investors.

Unlike the largest projects, which are being built from the ground up, many of these smaller properties already exist as older Class B and C buildings in need of renovation.

They are found primarily in the suburbs, especially around O'Hare and Midway airports, but also throughout the city of Chicago, catering to users in search of light manufacturing, warehousing, distribution and flex space.

What's driving demand in the smaller industrial sector? As the economy has improved, more small businesses have started or expanded; with prosperity, they have gone looking for space for storage or other needs, increasing demand, limiting supply and driving up prices. And the potential returns make it an especially bright spot for investors: Cap rates for these stabilized properties are in the 8.5 to 9.5 percent range versus sub-7 cap rates for larger industrial properties. Returns can be even higher -- sometimes reaching double digits -- for smaller assets that are rehabbed or reconfigured, but only if investors are willing to assume the risk of these more labor-intensive projects.

Examples of businesses with smaller footprints range from roofers, contractors and other construction-related companies that need a place to store trucks and equipment to small manufacturers, distributors and other users serving the automotive and health care industries, among others.

As it's often said, small businesses are the backbone and lifeblood of the U.S. economy, making up a significant part of our GDP, and today more than ever, they're also bolstering industrial investment and leasing.

Marcus & Millichap projects 15.5 million square feet of new industrial space will be added to the Chicago market in 2019, below the previous three-year average of 19.8 million square feet but still a strong number. Much of the new supply has been larger properties built with institutional capital. Meanwhile, limited land availability and an abundance of older -- and often well-located -- industrial buildings has kept smaller private investors focused on reconfiguring existing spaces to accommodate the smaller user.

Typical building modifications can range from adding simple internal partitions or new loading docks to building additional floors on top of the existing structure.

While megawarehouses are sure to make headlines in 2019, look for more noninstitutional investors to keep their eye on smaller properties that, if well-located and repositioned the right way, offer attractive returns.

This is an investment strategy being employed not only by firms with existing industrial holdings, but also those trading out of multifamily and other sectors where pricing has leveled off.

With the local industrial vacancy rate at its lowest level in more than a decade, now's the perfect time for investors to start thinking outside the big-box.

• David Bradley is regional manager, Chicago Downtown office, for Marcus & Millichap.