The Rising Promise of Industrial Outdoor Storage

Once overlooked as little more than open-air spaces for trailer parking, industrial outdoor storage (IOS) sites are emerging as a promising niche for their increasingly significant role in the e-commerce and logistics sectors and their potential to earn strong returns for investors.

“The pandemic brought shifts in demographic trends, changes in consumption, and repositioning of procurement strategies,” says Jessica Harrison, head of transactions and capital markets, real estate equity, U.S., for Manulife Investment Management. “As a result, industrial supply increased, and new submarkets became prevalent to help manage fast-growing populations, dispersion of population from urban to suburban markets, and surging e-commerce growth across the Sun Belt…creating extensions of industrial hubs.”

A prime industrial outdoor storage site is strategically located in infill areas with excellent freeway access, proximity to major trucking and shipping infrastructure, including ports and intermodal rail terminals with multiple points of ingress/egress, according to Pryse Elam, chief investment officer for Foundry Commercial. “Certain constraints make traditional warehouse use unfeasible [even though the site is zoned for industrial use], and thus industrial outdoor storage becomes the highest-and-best use for the site,” he says.

Foundry Commercial

The Opportunities of IOS

Investors in IOS gain “early entry into an asset class with all the drivers of industrial [sites] but a fraction of the capital costs,” Elam says. Typically, ownership is more scattered, he adds, because fewer institutional investors operate in this space. “And [there is] minimal supply growth, because cities generally oppose new development due to a desire for job creation and lower truck trip generation.”

John Huguenard, senior managing director and industrial group leader for JLL Capital Markets, concurs: “With trends such as the growth of e-commerce and onshoring of manufacturing continuing, entering the sector at this stage provides an excellent opportunity to capitalize on these same demand-drivers at a yield premium and benefit from an environment where the sector is growing more accepted by capital each day.”

Existing well-located IOS sites are often redeveloped into other product types. “This serves to decrease existing supply, while it remains difficult to zone new IOS product,” Huguenard says. At the same time, “billions of dollars in institutional capital have been earmarked for IOS. Demand for the product type from institutional capital is driving competition and pricing and will provide more data points to provide ‘proof of concept’ in the months and years to come.” In early March, the Employees Retirement System of Texas announced plans to enter into more niche product types globally, specifically noting IOS as a sector to explore.

Another advantage that IOS holds over traditional warehouse sites is that there are relatively limited capital expenditures required compared to cash outflows, Huguenard points out: “If there’s no building on site, there’s no roof replacement concern, and many sites are graveled, which saves on parking lot maintenance and repairs. When coupled with the favorable lease structures, IOS portfolios are relatively simple to manage.”

Stockbridge

Challenges of the new niche

Typically, IOS deals are small, which renders the asset class less efficient from a capital deployment perspective, and especially from a development/operational perspective, according to Austin Maddux, executive managing director, investment management, for Foundry Commercial. “To be successful, IOS investments require local sourcing, development, and operations that will likely result in aggregation strategies,” he says. “As with any new sector, there are many lessons to be learned about optimal site location, site layout, sizing, improvements, access points, inclusion of maintenance buildings, etc.”

Because of the wide variety of property formats that fall under the sector, data is also difficult to track. “This creates a variance in rents depending on factors such as site shape, usage, the existence of a building, security, and finish level, such as paved or graveled, lit, fenced or gated, etc.,” Huguenard says. “Tracking rents and rental rate growth is more of an art than a science. Traditional data aggregators—such as CoStar—do not have specific analytics reports for IOS.”

Zoning can be a challenge as well, according to Huguenard, as permitted uses may not align with the current use of a site. “Furthermore, municipalities are reluctant to change zoning to permit IOS uses or zone new IOS sites,” he says. The reasons for this include “a [smaller] tax base, given the unimproved nature of the sites; a perception that IOS sites will not drive job creation for the community; and a general ‘not in my backyard’ sentiment when it comes to trailer or laydown yards.”

Industrial investors new to the asset class may need to acquire additional expertise to succeed with IOS, Maddux says. “For example, many traditional multifamily investors believed they could seamlessly move into the build-to-rent, single-family rental space over the last few years, when in reality, build-to-rent land sellers typically have different profiles than multifamily sellers, with unique contract provisions, site design, and operational differences,” he says. In the same way, investors accustomed to investing in industrial warehouse sites may need to study carefully the tenant profiles specific to IOS. Maddux also advises investors to take advantage of the favorable lease structures possible with IOS, which include triple net leases, limited tenant improvements, and restoration clauses.

Common misperceptions about IOS as an investment type

Given the relative newness of IOS as a property type, misperceptions about investing in IOS remain. “There is a belief that the only user profile for IOS is an e-commerce van or semi-truck parker,” Maddux says. “But there are also e-commerce-related users, as well as any company that transports products and needs a location to keep trucks, chassis, equipment, raw materials, or finished product that can be stored outside while not in use. Two-thirds of the demand for IOS comes from non-trailer parking users.”

Another common misperception is that industrial outdoor storage users do not have strong credit profiles, says Huguenard, but that is not the case given the diversity of tenant demand. “In some large portfolios that JLL has been hired to advise on, credit-worthy entities back 35 to 50 percent of the income stream, demonstrating that it is possible to build a rent roll backed by strong credit,” he says. In addition, the perception that it is difficult to achieve longer lease terms is inaccurate. “While there are smaller tenants that may prefer flexible month-to-month terms that allow them to scale up and down with demand, many credit tenants are willing to execute long-term leases—five to 10 years—for strategic sites.”

Maddux says that Foundry Commercial’s typical IOS investments are located in growth markets within Texas and the Southeastern U.S. and have eight percent or more untrended stabilized yields [return on cost] and 20 percent or more internal rate of return profiles. An example is Foundry’s Centennial Yards IOS investment in Nashville, which consists of 24 leasable acres with two existing buildings totaling 30,000 square feet (2,800 sq m) with two points of ingress/egress, located within 15 minutes from downtown Nashville.

The Potential of IOS

Although IOS has been growing rapidly, it is still highly fragmented in terms of institutional ownership and exhibits outsized growth potential given the barriers to entry. “Municipalities have constrained supply by limiting the by-right zoning for IOS as a result of the lower tax revenue generated from this use and increased traffic considerations, which creates a favorable supply/demand dynamic,” Harrison says. “Not all IOS sites are equal, and our primary strategy in this sector targets infill locations with access to major population hubs and a combination of primary distribution routes and port and intermodal access to address the supply chain needs of facilitating an additional point of transfer between the warehouse and households, which we believe will generate an attractive yield premium to industrial.”

The demand and supply drivers of IOS are only indirectly related to those of the industrial market. “One of the challenges we are facing at the infancy of this niche sector is the limited market data, both historical and present, which show a wide divergence of outcomes when it comes to triangulating rental rates and growth,” says Harrison. “We are tracking this closely, and as U.S. industrial vacancy increased to 5.7 percent at the end of [the fourth quarter of 2023] from 3.9 percent a year earlier, with asking rents growing 6.4 percent annually, down from the mid-year 2022 peak of 11.2 percent. At the same time, across many markets, IOS rental growth appears to be outperforming overall industrial rent growth by approximately two times, on average.”

Maddux expects more investors to become interested in IOS, anticipating increased leasing activity in the first quarter of 2024 compared to 2023, and a continued push towards institutionalization of the space, as happened with the self-storage asset class, but 15 years earlier in the life cycle. “Through our early entry and experience owning and developing industrial outdoor storage properties, we have refined and focused our strategy, leading to superior investment performance and positioning Foundry for continued success in the sector,” Maddux says.

From a capital markets perspective, Huguenard says, large portfolio sales comparables are coming and will be key in helping investors understand the benefits that aggregating IOS provides. “Industrial outdoor storage sites have long played a critical role in the transportation, logistics, construction, and manufacturing sectors, among others, but their importance is finally being recognized.”