NATIONAL CITY, CA—The need to place capital allocated for industrial in strong-credit-tenanted assets is driving demand for this product type in the San Diego market and across the country, Stos Partners principals tell GlobeSt.com. As we recently reported, the privately held commercial real estate investment and management firm recently sold a 91,541-square-foot single-tenant industrial building here to a large institution for $21 million after acquiring the asset in November 2016 for $12.2 million and making improvements to it, reflecting a 210% project level IRR in just 14 months.

Stos says the sale reflects a larger trend of institutional demand in last-mile distribution centers. We spoke with CJ Stos, principal, and Jason Richards, partner, of Stos Partners, to discuss institutional demand for last-mile distribution centers in San Diego and how buyers are gaining an advantage in the competitive industrial marketplace.

Richards: “[Last-mile distribution centers] represent a long-term safety net for institutional investors, along with the credit of the tenants.”GlobeSt.com: What are you noticing in regard to institutional demand for last-mile distribution centers in San Diego?

Stos: Of all product types, there's more demand from institutional investors to buy this type of product than anything I've seen. This is the second last-mile distribution building we've sold in San Diego, and in both cases, it saw more activity than any other product. The demand is extremely strong. Industrial is the darling of all product types right now, and there's a lot of institutional capital chasing those deals. These investors like to do deals of $20 million or larger because they have capital that needs to get out, and clearly, with some of the big names doing last-mile distribution, these tenants have phenomenal credit. This allows the institution to meet its allocation requirements, and because there is a lack of product on the market, they need to get more into industrial than other product types. Having a credit tenant in a deal size that makes sense for institutions is a driving force. It's not just in San Diego—we're seeing this all over the country with credit tenants.

Richards: Essentially, everything is related to the tremendous growth of e-commerce and the distribution infrastructure needed to support it. Industrial product able to service this industry is in tremendous demand and will continue to grow. This continued growth reduces the risk for institutional investors over time in addition to the credit-worthiness of these types of tenants. Proximity to large residential service areas is key to these buildings; thus, these types of buildings can be solid location plays as well.

GlobeSt.com: Does this trend represent a challenge to private buyers interested in this asset type?

Stos: They create a challenge for each other. The institutions are hot and heavy to get into the last-mile arena, but so are the private guys. There are a lot of 1031-exchange guys wanting to get out of deals, so there are a lot of private-exchange buyers bidding up product as much as the institutions are. Both are going after it and driving up the price. They typically go for assets of between 80,000 square feet and 150,000 square feet.

Richards: More competition always creates difficulty for buyers of all types. Adding to this, the demand from institutions is so strong that we have also seen them willing to do slightly smaller deals than they're accustomed to.  But what's a large deal for San Diego can be small for other major markets.

GlobeSt.com: Which strategies are buyers of all stripes using to gain an advantage in this competitive marketplace?

Stos: We're value-add dealers in real estate. We prefer to buy a vacant building, turn it around and sell it to core buyers. There's not really any magic to it; it's just that an institutional buyer gave us the best terms, a quick close and met our price. We had 10 to 20 offers; however, some buyers are more “real” than others, so we weigh that against who's willing to pay the highest price.

GlobeSt.com: What else should our readers know about last-mile distribution centers here?

Stos: We hope to do more sales like this in the future. Being close to rooftops is important to these tenants, along with immediate access to freeway and excess land. Those are the three components that are important for last-mile tenants.

Richards: Industrial buildings of this type that are located in the infill or central markets of San Diego are in high demand due to logistical efficiency requirements to service dense population centers; thus, we're seeing a slight increase in rental rates in those markets. As a result, valuations are approached differently between markets that lend themselves to last-mile versus those that don't.