Enhancing Your Portfolio With Industrial Net Lease

By David Leavitt, partner, general counsel, and head of strategy; ElmTree Funds

As the market continues to evolve, one sector consistently stands out for its blend of stability and distinctive advantages: the industrial net lease real estate sector. With its unique structure offering predictable income streams, tax benefits, and reduced landlord responsibilities, industrial net lease properties present an enticing opportunity for investors seeking both reliability and growth. The sector’s resilience during a time of economic fluctuations and its capacity to attract long-term, creditworthy tenants further enhance its appeal, making it a strategic choice for diversifying investment portfolios.

The Surge in Warehouse Demand
A successful investment begins by ensuring there is a demand for what you are investing in. Industrial properties specifically are experiencing a surge in demand, particularly for warehouses.

In the United States, much of the warehouse inventory from the 1970s and 1980s was not designed to accommodate today’s logistics automation trends. This challenge is amplified by nearshoring trends, notably in Mexico, which surpassed China in 2023 for the first time in 20 years.

Within the United States, supply chain and logistics networks require upgrades as existing facilities often lack the adaptability needed for modern operations. This infrastructure gap is driving the need for newly built industrial facilities across the nation, fueled by increasing e-commerce demands, manufacturing reshoring, and government subsidies in sectors such as semiconductors and EVs.

Why Industrial Assets Stand Out
Diversifying across different investment sectors or “food groups” is essential. Compared to other real estate asset classes, industrial net lease properties typically offer longer lease terms. Multifamily residential leases are often limited to one to two years, while office leases, despite recent changes driven by remote work trends, also tend to be shorter. Retail leases vary widely but generally target different return profiles.

In contrast, industrial investments intersect with demographic trends and geographic necessities. These assets need to be strategically located near intermodal transportation hubs – accessible by water, rail, and truck – and must have access to affordable labor. Once established in these prime locations, industrial properties become mission-critical due to ongoing logistical demands, making them difficult to replace. This distinction highlights the reliability of industrial investments over time.

Industrial net lease investments can range from speculative ventures awaiting tenants to build-to-suit arrangements secured by pre-leased agreements. These assets provide stable, predictable returns by offering both credit and equity exposure.

Given their stable income and enduring market demand, industrial net lease assets align well with long-term investment strategies advocated by many registered investment advisers.

Dynamics and Opportunities
When advising clients, it is crucial to understand the dynamics of modern logistics networks. Warehouses are not just storage spaces. Today’s warehouses integrate robotics, specialized vehicles, and customized facilities to optimize workforce efficiency and operational capabilities. These factors evidence the positive demand outlook in the sector, therefore making it an opportune time for investment from both yield and long-term perspectives.

When considering the existing stock and the ongoing development of built-to-suit assets, there are also evolutions to consider. Generational shifts toward e-commerce, evident within younger demographics and families, coupled with geopolitical uncertainties, have heightened the importance of robust supply chains. Companies now prioritize resilience over cost savings, recognizing the severe disruptions caused by the COVID-19 pandemic and geopolitical shocks.

Tenants in this space also tend to sign longer term leases, as mentioned above, due to strategic foresight. This necessitates ongoing modernization of supply chains to meet consumer demands efficiently.

Optimizing Tax Advantages
Investing in the industrial net lease real estate sector offers potential tax benefits, particularly in terms of long-term asset ownership. These assets provide traditional advantages such as interest and depreciation deductions, which can significantly reduce taxable income derived from these assets, allowing investors to enhance their total returns. In addition, long-term net leases often shield substantial income from taxation, leveraging these deductions against rental earnings.

Assets can also be structured within real estate investment trusts, offering further tax advantages. Income flowing to investors is often classified as return of capital or non-taxable income due to deductible interest and depreciation expenses offsetting rental income. Upon sale after holding for the required period, investors can benefit from advantageous capital gains treatment, combining the benefits of both income generation and capital appreciation.

In specific sectors like single-tenant net leases for industrial, investors can access private credit-like returns in the real estate equity market. These types of properties are typically custom-built to tenant specifications for long-term occupancy, which brings added negotiation leverage for rental yields and escalations. These kinds of leases also typically feature fixed initial yields and built-in annual rent increases, resembling corporate bonds while providing additional equity upside through real estate ownership.

Key Due Diligence Steps for Investors
In any investment, due diligence is essential for RIAs when selecting investment opportunities for their clients. This includes thoroughly assessing the sponsor’s track record for regulatory compliance and fiduciary responsibility.

RIAs must also evaluate whether the sponsor has a longstanding commitment to industrial net lease investments and has developed and maintained relationships within the sector. These relationships can provide access to attractive investment opportunities and the ability to garner favorable pricing across markets, particularly in the built-to-suit single-tenant sector, which is significant in the U.S. industrial market.

Best practices for investors, guided by RIAs, is to also seek sponsors who can manage assets from inception through operation, ensuring that they have the necessary expertise and experience to handle all aspects of the investment.

Lastly, in any real estate property type, and particularly in industrial markets, relationships matter. Investors should aim to engage with knowledgeable sponsors who grasp the nuances faced by both developers and tenants.

The industrial net lease real estate market offers investors a unique investment opportunity, driven by rising demand for warehouses, strategic logistical benefits, and attractive tax advantages. These factors position the industrial net lease sector as a resilient and long-term investment strategy.

David Leavitt is partner, general counsel, and head of strategy at ElmTree Funds. In these roles, he is responsible for overseeing the firm’s legal matters, strategy, and operations. He is also the chief compliance officer for ElmTree. Leavitt has over 15 years of experience in the fund management industry. During this period, he has advised on more than $30 billion of real estate transactions, including the formation of several multibillion dollar open- and closed-end real estate funds, strategic real estate acquisitions by non-U.S. institutional and sovereign entities, and mergers and acquisitions involving nontraditional real estate platforms.

The views and opinions expressed in the preceding article are those of the author and do not necessarily reflect the views of The DI Wire.

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