Investing in warehouses has become increasingly popular in recent years, especially with the boom in e-commerce and the need for more fulfillment centers. However, like any real estate investment, buying a warehouse has its own unique considerations in terms of risks, rewards, and strategies. In this article, we will explore the key factors to weigh when assessing a warehouse property as an investment opportunity. Topics will include warehouse demand drivers, valuation methods, lease structures, location analysis, risk management, and expected returns. Proper due diligence and financial modeling are essential to determine if a warehouse acquisition will meet your investing objectives.
Warehouse demand is driven by economic and e-commerce growth
The need for warehouse space is heavily dependent on the health of the overall economy. As manufacturing, trade, and consumer spending grow, so does the need to store and distribute goods. E-commerce in particular has exploded in the past decade, leading to major expansions by Amazon, Walmart, and other retailers into fulfillment center networks. The rise of same-day delivery has also pushed inventory closer to end consumers. Understanding demand drivers in the target metropolitan area can highlight potential tenant industries to focus on during leasing.
Net operating income valuation models apply with some adjustments
Warehouse properties are commonly valued using the income capitalization approach, similar to other commercial real estate asset classes. This involves estimating market value based on the property’s expected net operating income (NOI), which accounts for rental revenue less expenses like maintenance, insurance, and property taxes. However, warehouses may have specialized features like heavy power access, cooling systems, and loading docks that affect construction costs. Cross-dock facilities designed for truck flow-through require customized layouts. Make sure to factor in functional obsolescence when using the cost approach as a secondary valuation method.
Triple net leases with longer terms are typical
Warehouse tenants often sign triple net leases, meaning they pay property taxes, insurance, and maintenance in addition to base rent. Investors can charge lower base rents in exchange for passing on these variable operating expenses. Longer lease terms of 10+ years enable tenants to lock in space for their distribution needs. However, the tradeoff is having less flexibility to adjust rents to market conditions over time. Make sure to model out multiple lease renewal scenarios, as an expired lease for 50% of a property can severely impact NOI.
Proximity to major highways and ports is ideal
Connectivity is king when it comes to warehouse location. Look for sites close to interstate highway access so trucks can efficiently move inventory in and out. For distribution hubs serving ports, evaluate the surrounding road and rail infrastructure. Warehouses should accommodate high volumes of large trailer traffic. Congested urban areas can be challenging for truck access and parking. Understand any local traffic limitations that could deter prospective tenants even if the base building features meet their needs.
Have a plan to manage vacancy and capital needs
Warehouse properties tend to have large blocks of space, so even a single tenant departure could impact over 50% of cash flows. Model out different scenarios with periods of vacancy, lower renewal rents, and re-leasing costs. Also budget for big-ticket maintenance items like roof and parking lot repairs that may coincide with turnovers. Maintaining adequate reserves and securing longer lease terms for creditworthy tenants can help manage risk, along with portfolio diversification across multiple properties and geographies.
Warehouses can generate stable income streams, but the properties themselves have unique operational and valuation considerations compared to other real estate. Conduct thorough due diligence on demand drivers, construction specifications, and lease rollover risks. With proper underwriting and active management, warehouses can play a valuable role in a well-diversified commercial real estate portfolio.