We’ve seen industrial real estate become increasingly prominent over the past decade, driven by the surge in e-commerce and the resulting demand for extensive space to manufacture, store, and distribute products.1 These vast warehouses (also called big boxes) typically are at least 200,000 sq. ft. and above 2 and typically service large manufacturing, storage, and logistics tenants located around the perimeter of major cities. We have observed developers overbuilt these large industrial boxes in roughly the past four years,3 generally due to the hyper-growth in online retail demand for durable goods, following the pandemic.
Although consumer spending is relatively robust,4 we are observing that the oversupply of industrial space has generally increased vacancies and lowered rent growth in some markets. According to CoStar, new supply additions will likely increase vacancy in the near term and cause rent growth to decelerate further, with quarterly net supply additions to fall below the pre-pandemic three-year average in late 2024 and continue declining, hitting a 10-year low by the second half of 2025.5
This trend of oversupply does vary by subtype of industrial assets. As the overall national industrial asset demand catches up to its supply, an interesting trend we are monitoring relates to the institutional neglect of what CrowdStreet refers to as “light” and “middle-market” industrial due to the size of assets, both in total capitalization and square footage. While the “industrial building boom” of the pandemic led to an increase in supply of larger industrial spaces, a shortage of small industrial properties has persisted for more than five years.6 This subset has also maintained healthy occupancy rates and increasing rents and stood out in performance among other categories of commercial real estate (CRE). So where do these smaller industrial facilities fit in the big industrial picture?
As we define them, middle-market or mid-size properties fall in the range of 50,000 sq. ft. to 200,000 sq. ft., with capitalization generally ranging from $10 to $100 million. Middle-market industrial could be seen as an ideal middle ground in the sector by some – assets with a total capitalization of less than $100M may often be considered too small for big institutional investors, but assets larger than $10M may be too large for single high-net-worth investors, leaving a potential opportunity for investors that are able to fill in the gap.
Middle-market industrial properties typically have a mixture of large credit tenants and smaller users, similar to those in large and small industrial categories, and the locations typically range from in-fill urban/suburban to rural.
The word intuitively suggests the “light” use of industrial space. CrowdStreet defines light industrial as an industrial facility typically under 50,000 sq. ft. with generally a total capitalization correlating to under $10 million. These spaces are typically found in smaller urban in-fill locations or can be found in mature industrial nodes, typically within urban and suburban neighborhoods, as opposed to rural industrial areas where you can generally find larger industrial facilities.
Light industrial properties may often initially be owned by small, family-owned or, as they’re typically referred to, mom-and-pop businesses. If an institution acquires them, they are typically then transformed into what most would consider more efficient and functional spaces, usually by enhancing their asset quality, eliminating any existing functional obsolescence, and completing any deferred maintenance as they position the property as a professionally managed building. This way, a potential opportunity is created for tenants seeking these niche spaces for their specialized needs while also retaining in-place tenants.
While the original spaces may be leased by individuals of a mom-and-pop or family-run business, often for personal use, once transformed into light industrial properties, these spaces can potentially attract a diverse range of professional tenants who may be seeking relatively more compact and efficient spaces for their operations. Tenants we’ve seen interested in light industrial spaces can range from construction companies engaged in roofing and materials, businesses requiring storage for HVAC systems for nearby installations, or other small service trades, including auto repair shops and mechanics, among others. These tenants not only value the logistical advantages and proximity to their day-to-day business activities, but the spaces are also generally more affordable for these small-cap tenants.
Observable in Table 1, we can generally divide large, middle, and small industrial spaces based on their size or square footage, although total capitalization can also correlate, depending on the categories. For example, we’ve observed that light industrial spaces are typically under 50,000 sq. ft., which generally correlates with a total capitalization of under $10 million, whereas a mid-size or larger facility above 50,000 sq. ft. would have a larger cap of over $10 million. We’ve observed that mid-size tenants are generally regional firms in need of storage, manufacturing, or shipping space such as stores with large inventory space needs like furniture or car parts, small to midsize manufacturers of components that supply larger companies, or perhaps regional trucking companies. While mega tenants like Amazon, Walmart or FedEx are generally in the “Large” category of industrial real estate, it could still be possible to find them in the “Middle” range for running smaller operations related to logistics. But when it comes to “Small” industrial facilities, we’ve observed that you will typically find tenants that characterize their usage as “last-mile,” close to the point of business for storage and logistics.
It’s also possible that one major company has a mix of large, middle, and small industrial assets that interact with each other downstream in their respective supply chains or distribution channels. For example, a shipping company might occupy a large warehouse near a major airport, distribute to and from a midsize customer center, and store trucks in a small outdoor storage lot. From a location standpoint, institutions will largely target primary gateway markets and a lot of the assets that fall into the middle-market tend to be located in secondary markets although mid cap assets can be found in all types of markets. Light industrial assets are found in secondary and primary markets and, as stated previously, are usually in smaller in-fill locations in the market such as urban areas and mature industrial nodes within suburban neighborhoods.
|
Categories |
Subtypes |
Typical Total Square Footage Range |
Characteristics |
|
Large |
Bulk Distribution / Mega Sites |
200,000 sq. ft. - 400,000 sq. ft. and above |
Large-cap credit tenants, build-to-suits, large logistic users, and high-output manufacturers typically in rural or industrial nodes. Typically used to manufacture products, storage, and distribution. |
|
Middle |
Mid-size Distribution/ Manufacturing |
50,000 sq. ft. - 200,000 sq. ft. |
Mid-cap properties typically have a mixture of large credit tenants and smaller users, similar to those in large and small industrial categories. The locations typically range from in-fill urban/suburban to rural. These are generally referred to as “Middle-Market” assets in the industry. |
|
Small |
Light Industrial / Last-mile Distributors |
5,000 sq. ft. - 50,000 sq. ft. |
Small-cap and typically lower-credit enterprises or family-owned users, typically around in-fill locations close to end-users or businesses. They are typically used for light manufacturing, storage, and/or last-mile distribution. |
Source: CrowdStreet, May 2024.
We’ve noted that a key distinction today for light industrial projects versus their larger counterparts is that developers are not actively building smaller spaces, which typically results in a higher demand for existing products, depending on various factors such as the quality, usefulness of the intended use, but primarily - location. In a February 2024 article on a similar topic, CoStar mentions, “...for example, industrial properties smaller than 25,000 square feet, about half the size of an American football field, comprise 29% of existing U.S. industrial space, but less than 2% of the industrial space under construction in 2024.”
There are many challenges to getting anything built these days which can generally be attributed to higher interest rates, harder to pencil projects, and slowing absorption, but of the product that is getting built, a small percentage is made up of light industrial. In a March 2024 article on the resilience of small or light industrial spaces, CoStar states that “securing land and entitlements for industrial projects near most major cities is challenging, and few developers are willing to invest the time needed to clear these hurdles unless the projects involved and the corresponding payouts for completing them are large. Demand for the larger products has relatively normalized from the abnormally tight vacancies of the past few years, with availability rates for spaces larger than 100,000 SF returning to 2016 levels at just under 10%, while the supply imbalance with a lack of new smaller spaces has pushed availability rates in smaller spaces to 5.2%.” This gap in availability rates is one of the widest CoStar has recorded.13
Users are generally attracted to light industrial spaces because of their functionality and relatively convenient locations. When assessing opportunities, truck access and circulation are generally more important than features like column width and clear heights. For example, many users aren’t racking anything over 12 feet and therefore don’t need 30–40-foot clear heights that are being built in new product simply because they are not storing as much. According to CoStar, the low availability rates should position light industrial properties for stronger rent growth than larger spaces in the next several quarters, as the glut of supply continues to be delivered in that space.
Approaches:
A sponsor familiar to the CrowdStreet Marketplace, Finial Group is a vertically integrated real estate firm that focuses on the aggregation of light industrial assets. In Finial’s experience, fragmentation in the market – likely due to a lack of institutional management or ownership that typically characterizes smaller cap assets and make acquisition opportunities harder to find – is what creates the inefficiencies that may potentially lead to opportunity in this niche of the asset class. According to Finial, many brokers stay away from the space because the capitalizations aren’t big enough to garner commissions that justify working on a particular deal. As a result, they see the transactions at this level are, more often than not, off-market deals with a greater opportunity to dictate price than in an efficient market with several buyers at the table. For Finial, aggregation concepts are their preferred approach when acquiring light industrial. While a large institutional private equity fund or REIT might not be interested in these assets on a one-off basis, building a larger portfolio can become more enticing as capitalization climbs higher; this aggregation can lead to cap rate compression by building a portfolio strategy for light industrial assets. In their experience, cap rate compression from portfolios is generally related to the value created by assembling a diverse basket of properties, with the potential for asset and location diversification and scalable access to these in-demand assets, which, in turn, may make the portfolio more attractive to institutions or large private buyers who wouldn’t otherwise consider individual investments. In Finial’s experience, many sellers of smaller assets are owner-users that tend to stay in the asset as a tenant, but are generally unsophisticated in the commercial real estate market. Not only does this sometimes present opportunities to buy below market pricing, but also may provide a sticky tenant in place when acquiring such buildings.
Another sponsor that focuses the majority of their business in the middle-markets of multifamily and industrial is Walker & Dunlop Investment Partners. In their latest iteration of their Multi-Res and Industrial Fund, the group notes several approaches that middle-market investment presents at the moment. One that has become more viable for them since 2020 is low-basis conversions to industrial that take advantage of the current distressed office and retail market. The idea is that distressed assets are located in the hard-to-find infill locations and many owners will be looking for whatever liquidity they can find. Other approaches that could relate to both light industrial and middle-market assets are sale-leasebacks and mark-to-market opportunities that arise from corporate user owned real estate. These strategies typically occur when non-institutional building owners, generally owner-users, sell their building, but continue to operate the business that they specialize in at the same property. This can help the user, because they can focus on running their business rather than managing a commercial real estate asset and it can help the buyer by having in-place cash flow from a tenant in-place at acquisition.
We believe navigating the complexities of the commercial real estate market, particularly in light and middle-market industrial sectors, generally demands a strategic approach which can include a focus on property aggregation or taking advantage of dislocation.
Light industrial assets often lack institutional management and ownership, making acquisition challenging. However, this fragmentation presents potential opportunities for sponsors adept at aggregating these assets to potentially achieve cap rate compression through portfolio creation. Middle-market properties may offer ideal positioning for some, where they are often overlooked by large institutions and outside the economic reach of high-net-worth individuals and offer possible opportunities for sponsors looking to deploy a range of strategic approaches with less competition.
However, it is important to acknowledge the challenges inherent in both light and middle-market industrial investments. Light industrial properties can require significant capital improvements and maintenance to bring them up to what potential tenants and buyers may consider professional standards. Additionally, finding and acquiring these properties can be challenging due to the fragmented nature of the market and the reluctance of brokers to work on smaller deals. Similarly, middle-market industrial properties face their own set of challenges, including competition from larger institutional investors that are willing to place capital in that space as well as tenancy competition from other mid-size properties that are able to demise space and make room for different square footage needs relatively easily making leasing more difficult.
In conclusion, while the light and middle-market industrial sectors present interesting approaches for entering the industrial space, investors should approach them with careful consideration and risk awareness. With a thoughtful approach to various risk factors, investors may have the potential to find interesting opportunities in these segments of the CRE market.
For more information on industrial and other CRE asset classes, read our full commercial real estate outlook.
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In addition to more general risks such as high vacancy rates, oversupply of product in the market, and credit quality of tenants, some of the factors that can impact the success or failure of industrial investments include declines in manufacturing activity due to reduced demand or trade agreements that outsource manufacturing efforts.