In this episode, we're joined by Kevin McGrath, principal at Cardinal Industrial, a leading buyer, seller, and operator of both warehousing and distribution assets. Kevin is also an official member of the Forbes Real Estate Council. Today we discuss various aspects of investing in industrial real estate for active and passive investors as well as tax strategies for real estate brokers, agents, and professionals.
Types of Industrial Properties
Flex Industrial: Smaller industrial space, essentially multi-tenant industrial buildings. The building would be an industrial building that's divided into several units with different tenants. Each unit generally has office space and warehouse space in the same units. The turnover on these units is relatively high.
Bulk Industrial: Distribution or fulfillment warehouse space that is 100K sq. feet or larger. These facilities are generally 20-25 years or newer, have large ceilings of about 28 feet or taller, and typically are Class A or Class B properties.
Manufacturing: These buildings are difficult to retrofit when a tenant moves, the building is generally highly customized to the occupying company. It's not one-size-fits-all like a bulk warehouse.
There's money to be made in all of these areas, but the most popular type of industrial is the bulk warehouse category, and that's where Kevin and his team focus.
There is a lot more institutional competition in industrial, but there are less syndicates. Not as many people are familiar with this asset class.
Historically, the returns are a bit better with industrial assets, but the space is becoming more competitive. Keith likes to look at secondary and tertiary markets that lease to good credit tenants in smaller areas. Institutional money isn't chasing these deals as much. Kevin looks for 8% cash on cash return at a minimum or there's no deal.
Industrial is historically not necessarily recession-proof. It's more tied to consumer spending. With e-commerce, it has changed the dynamic, because it's not how much consumers are spending, it's how consumers are spending. Even if consumer spending is down, if they spend online, that is growing the industrial tenant base dramatically.
Amazon has leased close to 25MM square feet this year alone even with COVID. The next closest company hasn't even passed 10MM square feet. With more people online shopping, companies are following the Amazon standard now. Our consumer expectations for fulfillment and delivery are very high. If you can think of a city with more than 50,000 people, Amazon probably has a facility within 25 miles.
"For every billion dollar increase in e-commerce sales, the market needs to deliver 1.25MM square feet of industrial space."
In 2018, e-commerce sales were about $423B. This year in 2020, sales are expected to reach $700B.
In 2008-2012, this asset class was overbuilt. We now have more of a balance of assets and demand, this asset class has stabilized. There is still supply available and developers are still building in first-tier markets, and have been spec building these assets since 2013.
As an agent, Kevin was a W2 employee. Now, as a 1099, Kevin is focusing more heavily on tax strategies, and it has been a game changer. It's possible to be a real estate professional as a 1099 and you can reduce your tax bill much easier.
As an agent or 1099 consultant, you'll be subject to the Self-Employment tax of 15.3% on all of your income up to $137,700 in 2020. This is a lot of money. Instead, you have the money flow through an LLC. You elect to have the LLC taxed as an S-Corp. You then pay yourself a reasonable salary through the S-Corp, and only the salary is subject to the Self-Employment tax. The remainder over the salary is not subject to the tax. This strategy would potentially save you $6,000-$10,000 a year.
In addition to this strategy, Kevin is also tracking his hours to determine exactly how he is achieving material participation and can qualify as a real estate professional. You must have direct investments and you must spend 500 hours or more on these investments, at the very least. Be sure to check with your tax advisor.
Kevin also utilizes the home office, he tracks his miles, and uses a Solo 401(k). He originally started a Self-Directed IRA and was able to roll that over into a Solo 401(k) as a 1099 contractor to avoid UBIT, the Unrelated Business Income Tax.