What type of industrial building is Chad Griffiths investing in today? What are the downsides of the industrial asset class? Chad Griffiths, Partner and Commercial Real Estate Agent at NAI Commercial Real Estate shares his knowledge.
You said that there are a couple of different subclasses of industrial that are becoming more popular today, for example, data centers, the rise of AI, and everyone working on that, can you touch on these two separately? Does the location or weather matter? What else are these companies looking at when getting industrial data centers, and electric battery companies that are also growing in popularity?
This might have changed a little bit in the last year because there are now data centers popping up everywhere, but last year, half of the data centers in North America were in Virginia. The reason is there are requirements to locate a data center beyond just being close to a population base, which would make sense intuitively, the closer you are to the population, the more efficient that's going to be, but there are a lot of variables. Beyond that, you need an incredible amount of power, a large data center can require the same amount of power that would give power to several 100,000 homes. It's the equivalent of 800,000 homes, but the data centers also generate a ton of heat, so that heat needs to be mitigated, and that's usually through water and a cooling system. You need access to a lot of power, you need regulatory approvals, you need state buy-in, and you need local buy-in.
There are a lot of people who are opposed to data centers. Anytime a new one gets presented, it seems that there's an opposition group of community people that are trying to fight it and get it blocked. I understand that pushback, but we need these data centers. AI is growing at a crazy pace. We need the data centers on top of it. There's a study that said that by 2030 data centers will take up to 9% of the total US grid, and that's double from what it is today, and that's already coming off of huge growth in the last few years, as these data centers have become more prevalent. They're taking up a lot of power, the forecast is for them to take up even more power, and they also need the water, which is an under appreciated component of data centers. They are going up in different areas now, but companies have to be creative. One example is Amazon, they bought a data center right next to a nuclear power plant in Pennsylvania. At full peak, when they're going to build out a few more data centers on the site, it will take 1/3 of all the power that gets generated by the nuclear power plant, which is a crazy thing to think of. Normally, the power plant would just be going to service houses, commercial buildings, and industrial buildings. Now, this one data center project is going to take up a third of all the power that gets generated.
The news was just last week that Microsoft is looking to do the same thing with another data center not far away, in Three Mile Island. Everyone might remember Three Mile Island and the partial meltdown that they had in 1979. There are two reactors on that site, one had that partial meltdown, and the other one operated until 2019, and then it shut down because it wasn't making any money. Microsoft is looking to bring that backup, they're signing a 20-year lease with the owner of that nuclear plant to get all the power just for a data center there. It's an incredible amount of power. I think we, in North America, aren't fully recognizing how much power demand these facilities are having and how much they're taking off the existing grid, and they also need creative solutions like reactivating an old reactor just to get power from it.
It's fascinating but I also think that it comes with a different set of risks. These buildings are built for data centers. Picture racks and racks of computer servers inside the building, and that's what they're built for. These buildings are very large, they're built with very little internal infrastructure in terms of office space or windows, they're essentially dark buildings where the sole purpose of it is for these racks and racks of servers. At some point down the road, I would have to think that technology will continue advancing to the stage where we'll be able to do it more efficiently. Instead of having 10 racks of servers, we could accomplish the same amount with one rack of servers or a different technology altogether, and at that point, we've built out a considerable amount of infrastructure with these buildings that I don't know how easy they would be to retrofit. They're very expensive, they're not built with overhead doors, and they're concrete bunkers. By definition, they're meant to not have easy access, because otherwise the system can be compromised. But I would have to think that technology continues to change, and how we deal with the demand for AI or things in the cloud, these servers are being used for that, if the technology changes, you have a building without a use. I'm fascinated with the industry, I think that there's still a long runway for it, but I'd be very apprehensive about investing in a data center.
You're not investing in the data centers right now?
No, it's a risk-reward thing. I'm sure that there are companies out there, large and small that will do very well in this industry. That's the reward, but the risk, in my mind, is just too great.
What are you investing in right now?
I like very simple buildings that can be used for multiple purposes, and my favorite is another one we haven't touched on, which is Flex Industrial. It is any industrial building in an industrial park used for other purposes other than manufacturing or warehousing. One building that I have, an industrial building, on a main industrial road, zoned industrial, and it used to look industrial until we did a renovation on it. We have an office tenant in there, a hot tub store, a flower shop, a cabinet store and we just put a bridal dress company in there, all nonindustrial uses. Most people would never think of a bridal shop being in an industrial building, but this building works for so many different types of uses that if we have a vacancy come up, we might have 20 to 30 different ideas that people present to us in terms of what could work in the building.
I love the flex industrial, the rates tend to be a lot more competitive than retail. If someone wants to be in the suburbs as an office user, you're typically going to be paying a lot less than being in a dedicated office building in the suburbs, and you could still have light industrial in there as well. It's versatile and it's somewhat removed from warehousing. The one that I have is more in the inner city limits. It's very difficult to build something next door to us to compete with us, whereas, if you have a warehouse outside of city limits and there's available land, you could go and build another building next door, and have the versatility of the different types of tenants, that's my preference. If I could just buy one thing going forward, that's what I'd focus on.
There are a lot of online businesses now, people have the appetite for this kind of industrial, smaller units. What are the downsides of the industrial asset class? It sounds like a very somewhat easy asset class, so long as you find a good opportunity, are there any downsides?
I've said to a lot of people, don't invest in industrial real estate. The biggest thing is, if you make a mistake, it's magnified much more than any other asset class. To illustrate, imagine if you were to buy a 15-unit apartment building, and you bought it in a good area, in a city, you're always going to have tenants. You just might need to lower the rent a bit. If it's $1,200 and you're thinking, "I just want to make sure my bills are paid, I want some money coming in." and you undercut the market at $800, you'll always have tenants. It's just a matter of what price you need to accept. In industrial, if you buy the wrong building, you might never find a tenant. There are horror stories that I could tell of guys that have bought a property and they've sat vacant for years. And if you do that with a single-tenant building, perhaps for the equivalent price of a multi-tenant apartment building, and it sits vacant, you just lose 100% of your revenue. Whereas if you have that 15-unit apartment building and one tenant leaves, you still have 14 other tenants paying rent. That's the biggest concern, is that the risk-reward equation is bigger in industrial than in residential.
Residential gets very competitive. That same 15-unit apartment building, for the reasons that I mentioned, might have 50 people interested in that building, whereas there's a lot less in industrial. There's a reason for that though, industrial can be confusing, it can be complex, the math on it is also different. In residential, you can typically get a longer amortization period, you can typically get a higher loan-to-value ratio, and interest rates might even be a little bit more competitive, whereas in industrial, everything that I personally own is a 20-year amortization, sometimes you can get a 25-year amortization, with 65 to 70% loan to value, so you're outlaying a lot more money, and the due diligence costs are considerably higher. You might be able to buy a single-family home or a small apartment building with minimal upfront costs, but industrial is not uncommon to have to pay $2,500 for an environmental report, $2,500 for a building condition assessment, and $3,000 for an appraisal. Those numbers will vary across different markets, but you add in legal fees, you've spent $10,000 doing your due diligence on a property, not knowing if you're going to buy it or not. There are a lot more upfront costs, and not as favorable financing in terms of the loan to value and the duration of the mortgage. That complicates it for a lot of people who might just say, "If I can get started and go buy a six-unit apartment building, that might just be easier to do."
I don't think multifamily is better than industrial nor industrial is better than multifamily. It's just where do you want to go, where do you want to place your money, and what gets you excited, that's another reason. I like to invest in industrial real estate. I enjoy reading articles or seeing a trend that's coming up, watching a video about it, listening to a podcast, and I love hearing about industrial real estate. I wouldn't have that same passion in multifamily and it probably goes both ways. You need to find something that you're comfortable investing with, and can also be very passionate and interested in.
Is there anything else that you think is important for our audience to know regarding industrial that we haven't touched on yet?
Industrial real estate is the antithesis of getting rich quickly. If anything, I'd prepare investors to spend a year, or two years learning the market, understanding exactly what industrial real estate is, and some of its limitations, understanding what the local market is, being very patient with it, and looking at it as a 10-20 year horizon. I don't think it's possible, outside of luck or great timing, to make a lot of money in industrial real estate early. It's almost impossible to not make a lot of money over 20 years in it, but it's a slow journey. There's nothing quick about industrial real estate.
I think about real estate in general. It's very tight in the beginning, and then it gets better over time, and maybe industrial is even worse. That's very important for people to know. It's not a get-rich thing.
Chad Griffiths
www.industrialize.com
www.youtube.com/@industrialize