It’s starting to become old news to say it, but industrial properties continue to be the most desired product type among investors and lenders. As logistics, technology, e-commerce and construction services companies continue to be such important parts of our economy, the industrial real estate markets continue to flourish. We have worked on a wide range of industrial property financings this year, and we would like to share some frequently asked questions and key financing themes that have come up on recent deals.
recently completed a Class A industrial development and already are 75% leased
within six months of delivery. Is it too early to explore the permanent capital
markets and consider refinancing our construction debt?
No, it is not too early to explore a refinance. In fact, stabilized property lenders are getting more aggressive on pre-stabilized assets in order to increase their overall exposure to the asset class. Most of the balance sheet lenders – life insurance companies and banks included – are underweight in an industrial property exposure, and creativity is a recurring theme to win good business.
While demand certainly is high, there are sizing constraints and parameters being used to consider funding pre-stabilized deals. Lenders have been requiring a minimum 1.0x debt service coverage ratio at closing and are solving to a minimum 7% debt yield upon stabilization. Typically, these pre-stabilized loans have minimal structure with holdbacks only for unfunded tenant improvement/leasing commission dollars on signed leases (no interest reserves or recourse required, so long as there is a 1.0x debt coverage ratio in place). Furthermore, there is so much liquidity in the debt markets for industrial product right now that pre-stabilized loans do not come with pricing premiums. We are seeing fixed rates range from 125-150 basis points over the corresponding United States Treasuries, which puts all-in 10-year fixed rates around 2.75%-3.25%. We also are seeing floating rates between 150 and 175 basis points over Libor. Elevated demand and strong liquidity in the industrial space continues to make it a borrower’s market with various financing options available.
Question: What types of construction loans are available for speculative industrial development in today’s market?
More and more lenders are actively seeking speculative industrial construction loans for several reasons – speculative construction loans give lenders more exposure to the asset class, and speculative construction loans generate marginal additional yield compared with existing, stabilized industrial loans. Depending on a borrower’s objectives, there are several options for speculative construction loans. For lower-leverage financing with minimal guarantees, life insurance companies are a great option and will fund up to 60% of cost. Current pricing is in the L+325-350 basis points range with a 25 basis points Libor floor. Local and regional banks, which have long been a dependable source for construction lending, also can execute in the 60% loan-to-cost range with completion guarantees only. Banks can push leverage up to 70% LTC with partial or full recourse, but with pricing that is very attractive in the L+250 range. Lastly, debt funds are continuing to make a push in the construction lending environment and have been winning deals by providing higher leverage options up to 75% LTC, with pricing around L+400. We have been seeing several spec industrial construction loan requests and there are various options available in the marketplace. Borrowers can be confident that they will find attractive terms for spec projects with a great location in thriving markets like Denver.
Question: How should I finance a vacant industrial building acquisition?
Financing execution on vacant, value-add properties really depends on the borrower’s objectives – recourse, business plan, absorption timeline, etc. Several lenders are actively financing vacant industrial assets in well-located markets with an executable business plan sponsored by a seasoned borrower. The general financing terms for vacant properties are in the 60%-65% LTC range with pricing at, or better than, the construction terms outlined in the previous paragraph. These deals typically fall under the debt fund category, but certain banks and life insurance companies with strong value-add lending platforms will consider this profile as well, leading to a broader pool of capital, more competition and better economic terms.
Question: Are lenders interested in higher-finish “flex” industrial assets?
Historically, lenders have shied away from high-office-finish industrial assets (40%+). In the current environment, lenders are actively pursuing this product type and are comfortable with higher exposure to higher office finish. Why are lenders interested in this product type now? It mostly stems from the fact that these assets typically have smaller tenant sizes, which leads to better rent roll diversification. A lot of these properties tend to be located in infill areas and benefit from a higher demand for last-mile functions, service-oriented businesses and proximity to densely populated areas. Lenders will want to drill into replacement rents, reusability of second-generation space upon lease expiration, location and surrounding like-kind product, and historical performance before making a loan investment, but this asset class certainly has gained attraction from the capital markets community. Pricing on both long-term fixed-rate and short-term floaters has been very competitive.
Question: I am acquiring an older, infill industrial property that is well occupied, but the rents are way below market and the entire rent roll expires within the first 30 months. How much can I push the leverage to reposition the asset?
We recently financed several of these types of deals and have seen a variety of structures based upon borrower preferences. For borrowers looking for maximum leverage and short-term floating-rate options, up to 80% loan to cost is available. Pricing is very attractive in the 4.5% to 4.75% range, and the lender will fund 100% of the future capital expenditures, tenant improvements and leasing commissions. The traditional structure is a three-year interest-only term with two one-year extensions.
Debt funds have been very competitive in this space. Most debt funds have a minimum loan size of $15 million, but there are several national groups that now are competing in the $5 million to $15 million space. Borrowers also can benefit from a short-term exit with minimal prepayment penalties. With debt funds, these penalties range from 12-18 months’ minimum interest.
Question: Are lenders comfortable with large cash-out refinances in this environment?
This topic historically has been a sensitive one that can vary lender by lender but also is driven by the general dynamics of the capital markets, as well as product type. For high-quality industrial assets with stable, predictable cash flow, lenders are very comfortable with large cash-out refinances, subject to strong debt yield and debt coverage metrics. Lenders will ask about the borrower’s basis, how much capital has been invested into the property, the age of the buildings and years of ownership. All these factors play into the ability to provide a borrower with proceeds to return equity, and the general rule of thumb is that lenders like to be less than 85% to 90% of total cost. There are exceptions to every rule, however, and we have seen 100% LTC loans in this environment. Given the pending impacts of new tax reform, we expect this question to become more important and more frequently asked as the return of equity from loan proceeds are non-taxable dollars.
The overall theme here is that lenders want more industrial assets on their balance sheets and are willing to go outside the box in order to win deals and increase their exposure. Just as equity investors are getting aggressive to purchase these types of assets in large quantities, lenders are just as aggressive and have the same intentions.