Investing in commercial real estate (CRE) can be incredibly beneficial. If you are able to find the right investment, you’ll be able to achieve a considerable return on your initial investment, as well as enjoy a wide variety of other financial benefits (tax benefits, access to additional capital, general equity-based leverage, etc.). Billions of dollars are poured into the commercial real estate asset class every year—the investors who are able to find the niches with the highest upside potential can generally expect to receive the highest returns on their investment (ROI).
However, the primary problem that most commercial real estate developers encounter is knowing which specific types of properties can actually help them achieve their long-term goals. A significant portion of the data utilized in the industry is lagging, meaning that by the time it comes across their desk, the prime opportunity for investing will have already passed (this is especially true for location-specific properties).
There are plenty of reasons why an interested investor might choose one category of CRE investments over another. For example, there might be a sudden change in market demand (something we saw with the housing market in 2008), they might be worried about their ongoing exposure to asset-specific risks (such as assets that are connected to an unstable supply chain), and so much more.
Nevertheless, with the right research and sense of market awareness, the CRE marketplace will always present unique opportunities for capitalization, regardless of how the economy is performing as a whole or how interest rates have been changing.
Recently, one of the most desirable classes of CRE development has been industrial flex spaces. These spaces can be readily adapted to a fast-changing economy, and utilized to maximize long-term capital stability. In this guide, we will answer some of the most common questions CRE investors have about industrial flex spaces, including what they are, the pros and cons of investing in them, and how to find an industrial flex space that is compatible with your investor profile.
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Definition of Industrial Flex Space
Let’s start by defining what, exactly, industrial flex space actually is.
There are two key components to this term. The first—industrial—suggests that the space itself will be used for industry, which makes it categorically different from other types of spaces, such as commercial real estate spaces, residential spaces, and many other categories. “Industrial” spaces are where physical materials are either processed, assembled, stored, or otherwise transformed and managed in some distinctive way.
The other important component of an “industrial flex space”, as you might guess, is the flex component. As the term implies, a flex space is a space that can be used for several different purposes—some of which are only loosely related to the underlying industry. Depending on the situation, an industrial flex space can be used as a production center, as an office, as a warehouse, or as a combination space.
The ways in which a particular space can be used will depend on several factors, such as zoning laws. Depending on where the property is located, converting between an office space and a warehouse might not be easy (or even allowed). This is why it is important for anyone investing in an industrial flex space to understand the rules and regulations governing that particular zone.
And—as we will further explain—industrial flex spaces can be utilized in many different ways. This is especially important during times when economic turbulence is relatively high and supply chain issues are abundant (as we have seen over the past three years). While it will be important to do your due diligence and carefully analyze any industrial flex space you are considering investing in, this unique, rapidly expanding asset class presents a wide array of investment opportunities.
Current State of the Industrial Flex Space Industry
As is the case with many commercial real estate classes, industrial flex space has experienced a considerable amount of volatility over the past few years. A significant portion of this volatility can be attributed to widespread changes sparked by the COVID-19 outbreak, which has especially impacted global supply chains and has impacted how particular buildings are used.
In general, these changes have unleashed a new “era of agility”, where it has become clear that enterprises that are able to adapt the use of their real estate will be best positioned to generate stable cash flows and achieve long-term success. Having the capacity to quickly shift between warehousing, office space, and industrial production—something that only industrial flex space can distinctively provide—has helped many enterprises across the country adapt in the face of unprecedented changes.
As a result, many of the industry’s most profitable leaders have begun looking for places that afford this particular degree of flexibility. And many community leaders have also taken note—especially in the post-industrial Midwest, where many abandoned spaces have been repurposed—and have sought to change their zoning laws and other industrial regulations accordingly.
According to CBRE, a real estate development group, the amount of “flexible” space has considerably increased over the past 8 years, though the current state of the market is slightly lower than it was during its peak in 2021 (this is common among many classes of commercial real estate).
While the urban distribution of these sorts of properties has been slightly increasing, the suburban portion of these properties has been steadily rising, up about 300% from where it was in 2015. This is evidence that the market—fundamentally—is rapidly changing. As producers, warehousers, and other relevant parties reevaluate their approach to a supply chain-dependent market, many of these parties have been aggressively seeking undervalued properties that can be easily “flexed” in order to meet their particular needs.
According to the CBRE report, the metro area that has experienced the largest amount of growth has been Los Angeles—the nation’s second-largest metropolitan area, containing about 20 million residents—a place that can be characterized by remarkably high property values (especially regarding price per square foot), organic and inorganic development restrictions, and access to one of the world’s most important ports.
Over the course of the next year, it is clear that millions of square feet will be added to the broader industrial flex space marketplace. In general, the value of these particular investments will likely outpace the growth of the real estate market as a whole. However, just because a particular asset class is performing exceptionally well, that doesn’t necessarily mean that any particular asset within that class can guarantee strong returns.
Keeping that in mind, you might ask yourself, what are the pros and cons of investing in industrial flex space?
Benefits of Investing in Industrial Flex Space
The most obvious reason you might consider investing in industrial flex space is that these particular spaces do an excellent job maintaining their value. Even if a specific building is unable to find an adequate amount of tenants, the value of the property will continue to increase year over year.
Keeping this in mind, it is easy to see why so many people have begun genuinely considering investing in industrial properties (including industrial flex spaces). While the S&P 500 Index has, for example, historically increased in value by about 9% per year, the industrial real estate market has historically increased by about 11%--and that’s before even accounting for the cash flows generated from rents.
With the right investment, industrial flex investors can increase the appraised value of their equity while also generating stable cash flows. If the units can rent at a considerable rate (at least 80% or higher), then the roughly 10% returns provided by pure equity increase can be supplemented by an additional 5% return (give or take), making these properties among the most profitable asset class in the country.
Of course, as is the case with every significant real estate investment, these projections still require quite a bit of speculation. All of the figures mentioned above—proposed equity increase, proposed rental rates, and proposed ROI—can all easily change. Still, it is clear that this is a market that is worth exploring.
Additionally, it is also important to recognize that industrial flex spaces are uniquely resistant to general recessionary pressures. First, the “flex” component of these spaces makes it significantly easier to adjust to sudden economic changes, such as supply chain interruptions, changes in working preferences (for example, working in an office or working from home), and any other industry-wide changes that might occur along the way.
Furthermore, it is important to note that these spaces are always in high demand. Regardless of the state of the general economy, goods will always need to be produced, which is why industrial spaces—as a whole—have experienced relatively less value volatility when compared to their non-industrial counterparts.
As a result, the combination of these interlocking forces—increase in equity value, stable and predictable, long-term cash flows, recession resilience, and more—has helped reinforce the stability of the industrial flex space marketplace.
Potential Drawbacks of Investing in Industrial Flex Space
Every class of commercial real estate investments will, naturally, have its own fair share of drawbacks. While it is evident that industrial flex spaces can be very profitable in the right situations, it is also important to keep in mind how these spaces subject their investors to a considerable amount of risk.
The clearest “risk” that comes with investing is that, in general, these properties have a fairly high investment horizon. Once you commit capital to a specific property, your capital will generally be “locked in” into the foreseeable future—on the low end of the spectrum, this will be a 5-year commitment. On the higher end of the spectrum, this investment will be closer to 10 years, or even more in certain situations.
Of course, it is often possible to withdraw your capital before the investment horizon has been achieved; but doing so will usually require you to pay a considerable penalty and, therefore, substantially alter your final ROI.
This is something that all investors will need to consider before making a final decision. Additionally, it is important to keep in mind that the industrial flex space is particularly subject to changing municipal and county-based regulatory changes. If a space that used to be considered flexible is suddenly considered to be heavily zoned (i.e. it must be an industrial space or it must be zoned as an office), then the so-called “flexibility” will eventually be built out of the underlying value.
Conclusion: Is Investing in an Industrial Flex Space Right for Me?
Ultimately, whether it makes sense to invest in an industrial flex space will depend on several personal variables, including your general investment goals, the state of the market, the status of your existing portfolio, and so much more.
If you are considering becoming an investor, it will be important to carefully do your research and explore the pros and cons associated with every possible location. Naturally, location will be the driving factor behind your ROI, meaning that you will not only need to pay attention to location-specific price per square foot trends, but also look at how demand for warehouse space, industrial space, office space, and more is changing over time within each specific area.
There is no guarantee that any particular industrial flex space will be able to outpace the real estate market, outpace the stock market, or outperform any other conceivable metric. However, with the right approach to investing, a willingness to do your own research, and understanding of what causes industrial flex spaces to continue accumulating value, there will be many benefits that come from allocating your capital in this particular sector.
