Mastering the puzzle of a successful commercial real estate loan requires more than due diligence on the borrower. To execute a solid loan transaction, shrewd originators make sure all of the existing pieces fit together — and consider how future pieces might fit into the equation.
Beyond the Borrower
While the history and financial health of a borrower are top concern for originators, there are many more factors at play.
“Having a strong borrower is important, but it’s also critical to research the current tenants, the leasibility of the property, the desirability of the location and the long-term activity of the market,” says Peter Margolin, commercial loan originator with Chicago-based Alliant Credit Union.
He describes a recently closed loan to show how lenders analyze some of the underlying factors that drive financing packages.
In April of this year, Alliant provided a $6.4 million loan to refinance a 64,637-square-foot industrial building located on Statesville Road in Charlotte, North Carolina. The borrower was a REIT that focuses on single-tenant R&D and industrial properties throughout the Southeast. Husqvarna North America, a producer of outdoor power equipment, utilizes the property as a research and development facility. Terms of the 10-year loan include five years of interest-only payments and a 30-year amortization schedule.
Husqvarna North America — the sole tenant at the property — did not have a long-term lease in place. However, the facility’s proximity to the company’s corporate headquarters in Charlotte, makes a long-term commitment to the property highly likely.
Additionally, Husqvarna has made a significant investment in build-out and infrastructure at the Charlotte property. This type of investment generally increases a tenant’s commitment to the property.
Tenant-Driven Investment
Tenant-driven investment in a facility and its infrastructure is a reliable signal of long-term commitment by the tenant, Margolin notes.
Originators should evaluate whether a tenant has designed a space that works specifically for their needs, and how expensive or time-consuming would it be to build-out another property. This helps originators understand a tenant’s commitment to a facility and the likelihood that a tenant will fulfill its lease terms.
Single- or Multi-Tenant Properties
While multiple tenants diversify risk, Alliant actively looks at both single-tenant and multi-tenant assets with a lending range of $5 million to $35 million. Instead of focusing on the tenant split, the due diligence team vets each tenant’s financial security, business success and potential future growth and opportunities.
The quality and business aptitude of the tenants can be more of a driving factor regarding the longevity of a loan than the borrower’s history, Margolin says. “The success of a property — its ability to generate revenue through quality leases and tenants — is what supports the loan.”
Reducing Risk
Properties that have tenants with longer lease terms (5 years or more) and multi-tenant facilities with staggered lease roll-over reduce risk for lenders. “There’s always lease roll-over risk, but some markets carry higher risks than others, especially when it comes to re-tenanting,” says Margolin.
Originators study markets and submarkets to understand an area’s desirability and potential for re-tenanting should occupancy drop prior to a loan’s maturation.
It’s important to consider the future leasibility of a property, particularly if current leases will expire during the loan’s terms.
Geography is a key factor. Multi-use or flexible-use properties in logistically central locations for delivery offer greater leasing stability than facilities that are isolated or designed for specific uses.
Future Drivers
Older industrial facilities, which were primarily designed for manufacturing, do not offer the large blocks of space and cubic square footage of warehousing and distribution space that e-commerce sales demands. Constructing new facilities is typically less expensive than retrofitting functionally obsolete product.
Margolin notes that there has been in uptick in speculative development in the industrial sector, particularly in the Chicago area. Alliant Credit Union does not offer construction financing, but the company studies the impact of the new construction in different markets.
“Metro Chicago is seeing an increase in speculative development due to aging product, which is becoming obsolete, and the increasing demand for more distribution- and warehouse-focused industrial product to accommodate the growing e-commerce needs of retailers,” says Margolin.
This is a trend that does not show signs of stopping as online sales continue to grow year after year. The estimate of U.S. retail e-commerce sales for the second quarter of 2018 was $127.3 billion, an increase of 3.9 percent from the first quarter of 2018 and a 15.2 percent increase from second-quarter 2017, according to the Census Bureau of the Department of Commerce.
These factors point to a strong industrial market, which will remain that way for the near-term, and a healthy lending environment for borrowers and lenders who are focused on crafting smart financing packages that work for borrower and lender alike.
“We try to structure transactions to fit a borrower’s needs,” says Margolin. “When seeking industrial financing, look for a lender who is willing to offer flexibility and consider financing with terms that match a facility’s lease terms.”
— By Amy Bigley Works, staff writer. This article was written in conjunction with Alliant Credit Union, a content partner of REBusinessOnline.