The Rise of Shallow-Bay Multi-Tenant Industrial Properties
A Noticeable Shift
A few years ago, single-tenant industrial properties made a lot of sense to buyers. Interest rates were low, and single-tenant leases signed in the five years or so before—with 2% to 3% annual rent increases—had kept pace with the market. Then, market rents started rising alongside interest rates, and single-tenant properties with long-term leases fell behind the market despite their annual rental increases. Sellers in the new interest rate environment wanted cap rates from years prior but found themselves unable to immediately increase their rents, now below market. Many single-tenant industrial leases had fixed rents and built-in option periods, making the property a difficult buy for investors who typically seek to add value. Plus, since transaction volume was down across all asset classes, and there were fewer 1031 exchange buyers, investors were more opportunistic.
One of the main ways investors add value is “mark to market” opportunities, where they increase a property’s rent to match the market rent. Looking to add value, industrial buyers soon shifted their attention from large, single-tenant buildings to smaller properties with multiple tenants.
Industrial buildings with short-term leases and multiple tenants offered investors the opportunity to add value fast—typically 12 to 24 months. Single-tenant industrial properties simply didn’t offer the same value-add mechanics that investors sought in a tighter market. Additionally, investors face lower risk from vacancies with more than one tenant. As the real estate market dug deeper toward a bottom, owning a near-insulated asset—one that can adjust rents often—became increasingly attractive to investors.
Shallow-bay multi-tenant industrial properties have maintained strong occupancy rates and rising rents for several years. Because of how the properties have historically been operated—typically by one owner over a long time—investors find they can add more value than other product types since the multi-tenant model keeps pace with market rental rates.
High asset demand and rising construction costs have led to a shortage of multi-tenant space for small industrial businesses, even as industrial inventory grows at the fastest pace in over 30 years.
What Is a Shallow-Bay Multi-Tenant Property?
Industrial facilities with multiple tenants can take many forms. Shallow-bay multi-tenant properties—also referred to as flex properties—range from 10,000 to 200,000 square feet or more and may comprise one or several buildings. Tenants occupy bays ranging from 800 to 1,000 square feet on the small end to 5,000 or even 7,500 square feet on the large end. Most buildings have grade-level doors, employee bathrooms, and office space for all tenants, many of which are local businesses that benefit from operating in a centralized hub.
Legacy Ownership
Traditionally, multi-tenant industrial buildings have been owned and operated by one landlord for many years. Multi-tenant industrial leases, averaging 12 to 24 months, are shorter than single-tenant ones that typically span five to 10 years. Some multi-tenant leases are even month-to-month and offer owners the most flexibility. By leasing on shorter terms, owners can keep up with market rental rates as they happen. If inflation is high and a tenant is on a 12-month versus a five-year lease, an owner can mark to market much sooner.
Appeal to Tenants & Owners
Shallow-bay multi-tenant facilities appeal to a wide range of users, whose occupancy is usually quite strong. Many industrial tenants have occupied space in a multi-tenant property for several years since moving would be more expensive. The bays, essentially warehouses with some office space, are suitable for most industrial tenants who don’t need 100,000 square feet or more. As a result, tenant improvements tend to be low compared to other product types.
Owning smaller multi-tenant industrial properties remains a wise investment for many reasons. Tenants are relatively sticky with strong occupancy, and owners gain the flexibility to adjust rents as needed. The threat of loss to lease—the amount an owner loses out on by not asking current market rents—is relatively low. Since multi-tenant leases are shorter, owners buy on basis at a better price per square foot than single-tenant buyers. Whether or not supply will meet demand from investors and tenants is a more speculative matter.
High Demand for a Limited Product
Construction costs are high across all commercial real estate, and shallow-bay industrial buildings are no exception. If new development is built, it’s more often a big-box industrial building—over 100,000 square feet—designed for long-term leases from reputable businesses. Development is also cheaper at scale. As a large chunk of industrial square footage under construction is pre-leased or build-to-suit, it appears that developers are simply building fewer small industrial buildings. For instance, buildings smaller than 25,000 square feet make up 29% of existing U.S. industrial space but less than 2% of the industrial under-construction pipeline in 2024.
The U.S. has seen an overbuilding of larger industrial developments. The number of properties bigger than 100,000 square feet has grown by 16% in the last five years, eight times more than buildings under that threshold. At the same time, the demand for such large buildings has not kept pace with supply, and few developers are willing to subdivide their space and lease to tenants around 25,000 to 50,000 square feet. As a result, prices for shallow-bay facilities are increasingly high while vacancies near an all-time low.
Still, buyers of shallow-bay multi-tenant assets remain persistent and willing to accept lower returns at closing. They know they can add value fast and increase their returns within a couple of years of ownership. In other words, shallow-bay industrial investors are more mindful of their going-in basis than their going-in cap rate. A going-in cap rate as low as 4% may make sense to an investor if they can prove their business plan adds value in the first year or two. Because of this, many shallow-bay industrial investors increase their returns after an acquisition. Markets where small industrial space is the hottest include Atlanta, Nashville, and South Florida markets like Tampa, Miami, and Fort Lauderdale.
Big Bets on Shallow-Bay
Investors have been widely unable to avoid speculation this year regarding interest rate cuts, construction costs, and the availability of capital. While more news develops, buyers who want to add value fast are expected to prefer smaller multi-tenant industrial properties to traditional single-tenant ones. Shallow-bay assets simply make more sense: They provide owners with insulation from market rental rate changes, impressive tenant occupancy, and a long list of tenants willing to pay premium prices.
By contrast, developers are expected to build or deliver more big-box industrial properties this year. Buying and entitling a few acres of land large enough for a small industrial property is often almost as time-consuming as preparing a 40-acre parcel for a large industrial development. Areas where small industrial space is needed most also face land constraints. For example, South Florida’s growing local housing stock demands business from HVAC contractors, plumbers, and electricians—key occupiers of shallow-bay industrial buildings. Demolitions pose another threat to the supply of shallow-bay buildings, which are being repurposed as residential development in some places.
This year presents a mix of challenges and opportunities for the industrial sector. On one hand, several major retailers have closed distribution centers. HomeGoods closed 1.2 million square feet of industrial space recently, while Home Depot closed two large distribution centers at the start of 2024. On the other hand, consumers’ purchasing power continues to improve as inflation backs down and wages gradually climb. Inflation-adjusted income rose 4.3% from 2023 to 2024, while incomes rose just 2.7% annually during the five years before 2020. Industrial facilities that support retail operations will only benefit from more activity.
As a result, shallow-bay multi-tenant industrial properties will continue to stand out to investors as one of the highest-performing, most attractive assets in commercial real estate. Near-record low availability rates will position small industrial properties for strong rent growth while falling interest rates and improved consumer spending will stimulate growth in industries like construction and manufacturing. In many cases, these are conditions that investors have been hoping for.
