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.
Question: We
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.