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By Noel Liston
Principal – Darwin Realty & Development Corp.

The availability of capital for the acquisition of industrial facilities remains, at best, scarce.  Any party looking to acquire a vacant industrial facility without a tenant or pre-negotiated lease will have an extremely difficult time finding financing for their project.  As is often the case with recession and recovery periods, the pendulum has swung too far to the opposite direction.  For five years or more, the cost of capital was probably too low and barriers to entry almost non-existent.  The current correction taking place is unfortunately probably one of over correction.

As the industrial market tends to lag behind the balance of the economy, underwriters and lending institutions are just now accounting for some of the distressed assets out there as well as the wave of default on commercial mortgage backed securities (CMBS).  Capital was readily available and probably too cheap during the periods of 2002 to 2007.  Non-recourse debt during the period of 2002 to 2007 has caused significant problems for today’s end user, as well as investors seeking capital for industrial acquisitions.

There is no question that debt coverage ratios needed to be adjusted after the financial storm in 2008.  The repercussion of that storm, however, has impacted not only investors but end users.  When end users have difficulty obtaining reasonable financing, the market is negatively impacted with less absorption, which slows down the correction process the market needs to sustain.  Many of the smaller industrial transactions (less than $5 million) that have closed within the last 18 months have been all cash transactions or, at a minimum, 50/50 loan to value ratios.  There is capital available for qualified users seeking to purchase industrial facilities.  The challenge is the timing to receive approval to fund a project (The challenge today is timing).  In the current economic climate, sellers are forced to choose between the certainty of closing with a cash deal and greater value derived from a sale with conventional financing.

Leasing Remains an Attractive Alternative

In years past, it was realistic for a purchaser to conduct due diligence studies (including finance feasibility) within a 30 to 45 day period.  Now it is highly unlikely that a prospective purchaser will receive full approval from a financing institution during the normal 30-day due diligence period.  We have seen the underwriting process take as long as 30 to 45 days with final approval at 60 to 90 days, leading to a close date of 120 days after contract execution.  With this in mind, many prospective purchasers are strongly considering lease alternatives.  This is a good thing as it continues to help absorption, which ultimately leads to a stronger marketplace.  The reality is, with one or two months’ security deposit (assuming minimal tenant improvements) a business owner can execute a lease as quickly as seven to ten days and take occupancy within two weeks from touring a vacant space.  Sophisticated and aggressive landlords are more than eager to help expedite a tenant’s occupancy.  Lease negotiations can be shortened once a prospective tenant finally does commit to a space.  This allows business owners to realize their objectives of moving into a new facility much quicker than had they elected to purchase the facility.

While the market does benefit from absorption through leasing activity, there are certain industrial property owners that need liquidity.  The challenge with today’s leasing market is that it does not allow owners to realize the equity or perceived value in their building due to the extremely competitive lease market in which they must compete.  If an industrial property owner is focused strictly on liquidity, a three or five year lease of the property at today’s market rents would most likely force ownership to hold the property throughout the term of the lease.  In years past there was more liquidity with a leased asset based on a healthy investor market.  While there is plenty of capital on the sidelines and investors seeking fully stabilized assets, the pricing demanded by qualified buyers will typically fall short of a seller’s expectation due to the rental rate the asset will produce over the next three to five years.  The combination of modest user demand, lack of readily available capital for building acquisitions, a depressed rental market, and a rise in cap rates for leased assets has created stagnant waters for end users/owners seeking liquidity in this marketplace.

Are Lenders Waiting for Full Recovery or Higher Loan Yields?

It is not clear whether lenders are waiting for full economic recovery or simply higher loan yields.  Based on current economic indicators, one could argue either side of the inflation/deflation debate.  However, history has shown that some of the greater inflationary periods in the United States have followed significant downturns in the economy.  The question is whether the climb to recovery (potential for inflation) will be slow and steady or quick and dramatic.  In either case, capital markets do need to free up for end users to properly run their business and make capital investments in their company and in real estate.

Liston joined Darwin Realty in 1995. His areas of concentration include tenant and landlord representation, built-to-suits and development of raw land. In addition, Mr. Liston offers thorough investment services by assisting buyers and sellers in the analysis of potential investment sales and acquisitions. He can be reached at nliston@darwinrealty.com

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