Small-Bay Industrial: Why the Overlooked Middle of the Market Deserves Your Attention

When most investors think about industrial real estate, they picture Amazon fulfillment centers or massive warehouses and distribution facilities serving national supply chains. While those assets dominate media headlines, there’s a different conversation happening among more sophisticated operators who’ve spent time in secondary markets and infill neighborhoods. It’s about a segment that doesn’t make the news, rarely gets analyzed by the big banks, and until recently traded at a discount because it seemed too difficult to scale: multi-tenant industrial properties with unit sizes between 2,000 and 10,000 square feet.

These aren’t the buildings you see from the highway. They’re the ones tucked into the heart of local city centers—home to local contractors, small distributors, repair shops, and the kinds of businesses that keep a metro area functioning. Call them small-bay industrial properties, service-industrial, or shallow-bay real estate. Whatever the label, they’ve quietly become one of the most compelling plays in PERE.

The Fundamentals Tell a Clear Story

Here’s what caught our attention: while big-box warehouse vacancy rates have climbed into the 10% range—driven by a construction boom that overshot demand—small-bay properties are running at a much more modest 3% to 4%, and it’s not a fluke.

The gap exists because the supply and demand dynamics in this segment are fundamentally different. On the supply side, almost nothing new is being built due to developable infill land being nearly nonexistent, expensive, and hard to entitle.  Developers who can secure these prime pieces of land would rather build apartments or retail because the per-unit or per-square-foot returns are higher (which helps justify paying the higher land prices). Even when industrial zoning exists, most developers chase larger single-tenant opportunities that are easier to finance, manage, and ultimately sell to institutional buyers. These supply constraints are producing negligible new small-bay construction nationwide.

On the demand side, the tenant base is anchored by businesses that need to be close to their customers. Unlike the logistics companies and national retailers who lease big-box space in secondary and tertiary areas, small-bay industrial tenants, like your local plumbing company, can’t operate profitably out of a warehouse 40 miles from its service area. These businesses need space within minutes of their job sites, which creates demand that’s both persistent and geographically constrained.

Lease rates reflect this supply and demand imbalance. Small-bay industrial lease rates per square foot frequently exceed those of larger warehouses, sometimes by 30% or more. Tenants aren’t just paying for space—they’re paying for location. And because most of these businesses generate revenue by serving the local economy, their willingness to pay holds up across market cycles.

Resilience Comes from Diversification and Necessity

One of the underappreciated strengths of small-bay industrial is found in the tenant diversification associated with these opportunities. A typical small-bay industrial property might have 20 or 30 tenants, each occupying 3,000 to 8,000 square feet, with no single tenant accounting for more than 5% of revenue. If one of these tenants leaves, the impact is minimal, and, in most markets, the vacancy is absorbed quickly due to the demand factors discussed before.

The tenant mix is another strength of small-bay industrial. Tenants at these properties aren’t speculative startups or businesses riding macro trends. They’re everyday HVAC contractors, cabinet manufacturers, wholesale distributors, electrical contractors, and similar businesses that provide essential services that don’t go away when the economy softens. Their revenue is tied primarily to local population and business activity, which means as long as people live and work in the area, demand for their services (and the space they operate from) remains stable.

We’ve seen this play out in real time. During the pandemic, when e-commerce demand surged, small-bay properties filled up almost overnight as delivery services and small-scale fulfillment operations scrambled for space. When that wave receded and some of those tenants downsized, the units were quickly backfilled by trade contractors and local distributors who’d been priced out during the boom. The underlying demand didn’t disappear—it just shifted, which is exactly what diversification is supposed to protect against.

Tenant retention in this segment of industrial real estate tends to be very high because of how disruptive relocation is for these types of tenants.  For most of these tenants, relocating means downtime, lost customer access, and the risk of losing employees who can’t commute to a new location. That level of disruption leads tenants to renew, often at the new and higher market rents, because the alternative is cost prohibitive.

Fragmentation Creates Opportunity for Disciplined Capital

For all its strengths, small-bay industrial has historically been inefficient. Ownership tends to be fragmented across local operators, family offices, and individual investors. Many properties were built in the 1970s or 80s and have been held for decades with minimal reinvestment or capital improvements. The lack of reinvestment leads to peeling paint, outdated spaces, tenants on month-to-month leases paying below-market rents, and property management that’s reactive at best.

That inefficiency is an opportunity. For savvy, experienced investors, the playbook is straightforward: acquire at a basis that’s well below replacement cost, invest in eliminating deferred maintenance and performing exterior upgrades, professionalize the leasing and management, and drive NOI through a combination of rent growth and occupancy gains.

The strategy isn’t speculative and comes down to executing simple blocking and tackling for experienced investors. Repaint the building, upgrade the landscaping, add LED lighting, and renovate a few office suites. Convert gross leases to triple-net where possible. Renew existing tenants while right-sizing their rental rates to align with the market. Bring in a property manager who actually responds quickly to tenant requests. These simple moves bring the properties up to a standard that attracts institutional buyers.

Why We’re Focused Here

At Hanson Capital, our interest in small-bay industrial investments grew out of observing firsthand what actually performs across market cycles. When we looked at assets that maintained occupancy, delivered consistent cash flow, and appreciated steadily without relying on market timing or leverage, small-bay kept showing up.

The segment aligns with how we think about risk. We’d rather own an asset with 25 tenants in a supply-constrained market and where demand is eager to absorb any unanticipated vacancy than a single-tenant warehouse where one lease expiration or credit event can become catastrophic. We’d rather compete in markets where new construction is structurally limited than in ones where another million square feet can break ground on a moment’s notice.

Our approach is to target infill properties in metros with strong population and employment growth, where land is scarce, zoning is restrictive, and demand from small businesses is durable. We look for assets that are fundamentally well located but operationally underperforming, where a defined capital plan and hands-on management can unlock value. The goal isn’t to flip properties.  It’s to reposition them into stabilized, income-producing assets that justify institutional pricing when the time comes to exit.

Small-bay industrial won’t be the highest-returning sector in every vintage. But for investors seeking a combination of downside protection, income stability, and appreciation driven by fundamentals rather than speculation, it’s worth serious consideration. The opportunity is real, the market is inefficient, and the tailwinds of undersupply, tenant diversity, and infill scarcity are not going away.

Sources include third-party data from CBRE, Green Street, NAIOP, MSCI, and Preqin.

If you’re curious about how our approach could fit into your portfolio, visit our website or schedule a call to connect with our team. We’d love to talk through what we’re seeing and where we’re going next.