What will happen when investors own all the IOS real estate? - by David Skinner

I read books on founders, CEO’s, and innovators so that I can find out the secrets to their success, like Brad Jacobs (United Rentals), Jack Welch (General Electric), and Alex Hormozi (Acquisition.com). They all basically say that leaders need a vision of the future and need to communicate that vision effectively. They observe patterns, and make bets on what will happen in the future. I know you don’t read my articles for fun. You want a prediction. So here is my best attempt at real estate wizardry. Buckle up. 

I am going to speak about fund managers, investors, owner-users, and tenant. The fund manager is a group of people who raise money to then invest in investment real estate. The Investor is the person who gives the fund manager the money. The owner-user is the company who owns the property and is occupying it for their business, and the tenant is what you think a tenant is.

Both private and institutional fund managers are in a frothy frenzy to buy industrial outdoor storage (IOS) commercial real estate. Properties that have been owner-occupied or family-owned for decades or even generations are selling to operators of funds managed by Blackrock, Blackstone, JP Morgan Chase, and family wealth offices around the country. 

If this trend were not developing at bubble-like speed, there would be no worry. Investors usually do help tenants who want to keep their money in their companies rather than tying it up with large downpayments for real estate, so I will not propose that investors should not own real estate. However, these investment deals are getting funded faster than tenants in the market need to occupy new property.

The fund manager has a real problem if he raises the, for example, $500 million to be invested in the next two years, and then doesn’t deploy it all by the deadline. If this occurs and the committed money from the investor does not get deployed, the fund manager will not be able to raise as much next time.

In order to avoid this, the fund manager may be tempted to stretch the limitations of the fund return metrics that they sold the investors they would achieve at the beginning. For example, take a nice IOS property where the owner shares that he will sell for $10 million which represents a 5.25% return for the investors. Initially, the fund manager passes on the deal because the investment mandate was to only find deals at a 6.5% return or higher. However, the time for the fund is closing soon, and the fund manager needs to get the money out the door, so he tells his investors that the current lease is below market and they can get a lot more when the tenant needs to renew. Then the fund ponies up the $10 million and closes on the property.

In the short-term, not much changes because the tenant will continue paying the rent that they were paying before the closing. When the tenant’s lease comes up for renewal, the fund manager raises the rent just as they promised the fund committee to a lease rate that would justify their purchase price for the property. Of course, the tenant is operating a business that can only bear so much rent, so they make the sad decision to leave the property and move elsewhere.

In this brave new world, tenants considering expanding a current operation or opening a new facility will look at the rents that are growing too quickly and therefore decide to stay put. This slows actual economic growth for the companies that produce the goods and services that made our country the juggernaut that is historically has been.

Now you may say to me, “Hey Dave, I get that you’re trying to tell the future and all that, but what if you’re wrong? What if all the fund managers don’t let that happen because they appropriately estimate the rental value of the property they buy and don’t overspend?” 

While this would be a thoughtful and perhaps “tuned-in” response, I don’t believe it is the case, because there was, according to one estimate, ~$1.7 billion raised from both private and institutional capital to invest in IOS property, with no end in sight to the fundraising. At some point, there will be more money waiting to be invested than there are profitable deals in which one can invest. 

So, what would happen when investors own all of the IOS real estate? Well, I don’t think we are at risk of that happening in the next few months or even couple years. However, if property owners and fund managers do not keep their ears to the ground about what the market is doing and where it is going, they may end up with a vacant property at lease rates that are just too high for a cost-conscious, financially healthy tenant to sign.

Prescott IOS leases and sells industrial outdoor storage (IOS) real estate for companies and property owners everywhere. If you need to find IOS property for your business or have IOS property that you would like to value, email help@prescottios.com or call us at (617) 999-0057.

David Skinner, SIOR, is an advisor, partner of Prescott, Lincoln, Mass.