5 Reasons Why IOS Should Trade at a PREMIUM to Class A Industrial :

High Demand with Limited Supply:

IOS sites are critical for last-mile logistics and other essential services. Since these sites are often in limited supply due to zoning restrictions and fewer large-scale IOS developments, the high demand versus low supply can justify a lower cap rate. This low supply also increases the value of existing sites and potentially lowers cap rates as these sites become more coveted for their scarcity.

Growth Potential in the IOS Sector:

The fragmented nature of IOS ownership presents aggregation opportunities, which can increase asset value. There is greater perceived rent growth potential in the IOS sites versus Class A industrial sites, which allows investors to get comfortable with lower cap rates in exchange for anticipated high demand and rental growth. As large institutional investors demand greater portfolio allocation to IOS assets, they may drive down cap rates due to the perceived growth potential in the sector.

Stable, Recession-Resistant Tenant Base:

Tenants in industries like logistics, construction, and waste management often exhibit stable, counter-cyclical demand, meaning these tenants are less impacted by economic downturns. Freight recessions do occur and the asset class is impacted by macroeconomic trends, but in general this relative stability attracts investors desiring predictability of income. 

Simple(r) Operations: 

Unlike Class A industrial buildings, which often require substantial spending on roof, HVAC, interior finishes, etc, IOS sites are typically simpler to maintain. Since IOS properties primarily consist of open yards with limited building structures, CapEx needs are usually minimal, reducing operational costs. Most leases also feature a NNN structure, so the landlord can pass through all of the costs to the tenant. This means there is a lower cost of entry into the IOS asset class than the Class A Industrial space, and in turn should drive cap rates down comparatively. 

Onshoring and E-Commerce Tailwinds: 

E-commerce demands, coupled with “just-in-case” inventory strategies, have spurred rapid rental growth in the IOS sector, with companies seeking to secure extra space for inventory and overflow. In many markets, IOS rental rates have grown alongside warehouse rental rates but started at a much lower rate, positioning IOS as a key alternative for operators with stringent cost and location requirements. Given its function as a lower-cost, strategically located option for inventory storage, IOS has gained a demand premium, leading to a cap rate compression as investors anticipate opportunity for robust rental growth.

5 Reasons Why IOS Should Trade at a DISCOUNT to Class A Industrial :

Perceived Higher Risk Profile:

IOS sites generally lack the aesthetic appeal of Class A industrial properties, which are typically newer, more modern, and historically accepted as an asset class that institutions like. The idea that tenants will pay (and pay well) for improved yards with small buildings can be difficult for some groups to imagine, which makes it hard to justify high valuations. As such, some investors may demand higher cap rates to compensate for the perceived risks.

Less Standardized Asset Class:

IOS properties have existed for a long time, but did not have a widely used acronym or name classification until this decade. Sites can vary significantly in size, use, quality, functionality, and location, making valuation challenging and potentially leading to more market volatility. This variation may make investors less willing to accept lower cap rates compared to standardized, Class A properties.

Environmental Concerns:

IOS tenants include groups that are sometimes considered “dirty” uses and could involve operations with fuel tanks on-site, oil leaks and staining from vehicles and machinery, amongst other hazards. Depending on the site history and tenant uses, there are potential liability issues and environmental risk associated with IOS sites, which causes some investors to attribute a discount to IOS properties. 

Zoning and Community Challenges:

IOS sites are sometimes met with community opposition due to noise, traffic, and aesthetics. Changing zoning laws or regulatory challenges can also impact these sites, making them less attractive than Class A properties that typically have more predictable zoning outcomes since they were developed recently. 

Lower Perceived Upside in Property Appreciation:

Class A industrial properties often see more significant appreciation over time, particularly in fast-growing logistics hubs and in areas where replacement costs are increasing rapidly. Investors may view Class A properties as having a higher long-term value increase, thus accepting lower cap rates, while IOS sites may need to offer higher returns due to perceived lower appreciation potential considering the majority of the value of the site is in the land.

In Summary

While the demand-driven fundamentals of IOS could justify lower cap rates, the risks and challenges unique to this asset class could drive some investors to require higher cap rates than they would for Class A industrial properties.

There are strong arguments for and against the idea that IOS assets should trade at a premium to Class A Industrial assets and at the end of the day, like with most investments, it’s a case-by-case evaluation. 

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Disclaimer: The authors of IOS Yard Dogs are not finance or tax experts. We love big yards, small buildings. This email is for educational uses and is not financial / investment advice. Please conduct independent research and consult with industry professionals before making financial or investment decisions. Our content, which may contain affiliate links, is subjective and not to be used as the only basis for such decisions. We are not responsible for any losses from relying on this information.