Short-term WALT industrial assets garner more lender, borrower attention

US commercial real estate sponsors and lenders are competing for industrial assets that fit a specific profile – well-located properties with abbreviated weighted average lease terms that present the potential for raising rents in the near-term.

The shift comes as the industrial sector has seen record deal volume in 2022, with $74.6 billion of transactions completed through the middle of the year, according to data from MSCI, a 35 percent increase over the same period in 2021. While there was no specific data on WALTs, MSCI’s Capital Trends report from the end of Q2 shows the average cap rate for industrial assets now rests at 5.1 percent, a 40-basis-point drop from the prior year.

The best industrial deal now

From the lending perspective, deal metrics are now reflecting the favorability shift toward short-term WALT assets. Sadhvi Subramanian, US Bank’s head of commercial real estate for the East region, says the Minneapolis-based bank has seen the trend play out as it has evaluated new loans. The lender is anecdotally seeing industrial properties with longer-term leases trading at lower price points compared with short-term peers.

“Up to this point at the end of August, [industrial] buildings with short WALT tend to be more valuable than long-term leases in industrial,” Subramanian says. “People believe that the rents in industrial will continue to rise.”

This has also led to an increase in deals that are initially all-cash as sponsors look at the metrics of financing a property at today’s rent and after leases roll. As an example, Subramanian cited a hypothetical situation of a sponsor acquiring a property at a 3 percent cap rate. In today’s market, the sponsor likely would be able to secure a loan with an interest rate in the 4.5 percent range though loan pricing is increasing, but it could opt to close the deal for cash and then seek long-term financing after re-leasing the property at higher rental rates.

“It seems to be the strategy for a number of people that are buying all cash and then thinking they’ll refinance once done,” Subramanian says. “[A buyer can buy a property] and then let the leases turn to bring up the NOI and get a higher leverage.”

A specialist’s perspective

Keyvan Ghaytanchi, chief operating officer and president of the lending division at Port Washington, New York-based manager BEB Capital, says rising interest rates, an uptick in exit cap rates and the subsequent impact on valuations have changed underwriting for firms active in the industrial sector.

Ghaytanchi says the firm is now looking more closely at debt service and cashflow from assets for the duration of a loan to guarantee the best terms possible from the lending side. “As a lender, you have to always take the downside scenario,” he says, noting lenders cannot count on rent acceleration to continue solely because they have done so in the last two to three years.

“We look at market dynamics, vacancy rates, where the rents are going,” Ghaytanchi says. “We try to take a little bit of a conservative view as a lender, not so much that we can’t transact. But you have to be a little conservative in this market.”

Local labor markets also factor into BEB’s assessments of the viability of an industrial sector loan or even an equity investment. Credit tenants including Amazon and other top industrial building occupants have notably encountered some headwinds maintaining a full staff depending on the region or city being operated out of.

Industrial deal metrics today have been further complicated because while income streams on assets are fixed, other expenses have been going up, especially for borrowers with variable rate mortgages. With more industrial loans nearing the expiration, questions from borrowers on refinancing have risen and generated greater interest in bridge lending for financiers such as BEB.

Unlike some larger advisories and banks, BEB has seen building management companies within its industrial portfolio prefer term leases spanning a more standard range of five to seven years because tenants do not want to have to move in two or three years’ time.

On a geographical basis, Ghaytanchi says BEB sees more opportunities along the East Coast still in Pennsylvania’s Lehigh Valley and Northern New Jersey, as well as North and South Carolina, Connecticut and parts of Florida such as the Tampa area. “Those are some of the areas that have a lot of tailwind and they seem to still have room to go,” he adds.

While some bank and alternative lenders are active, Jaran Burt, a director of valuations at Kennett Square, Pennsylvania-based risk management firm Chatham Financial, said the firm has found that money center banks are not as active right now regardless of sector. The banks have been focusing on their corporate credit clients in the first couple of quarters this year in lieu of originating new loans, using accordion-type instruments.

“They did that in preparation for shoring up their balance sheets in case we go into a recession or a deeper recession than planned, and so their capital is a little bit constrained,” Burt says.

The result of this focus has taken some money center banks out of the market across several asset classes, Burt says, noting in some cases the transitory withdrawal can span all sectors.

Lay of the land

There is a further nuance in the sector, with Burt noting sponsors and lenders are favoring existing assets.

“Build to suit really just isn’t happening right now,” Burt says, noting developers are less inclined to pre-lease in an inflationary environment because they believe they can get better leasing terms when construction of new industrial assets is completed.

Inflation has also forced leasing agreements to change. Burt says that in some cases, building owners are potentially installing higher rent bumps on a regular basis or linking the bumps to the consumer price index because of the unknowns being encountered in today’s economy.

“Throughout the pandemic, industrial and multifamily had been really the most favored asset classes,” Burt says. “Over the last couple quarters, multifamily has maybe created a bit of a gap there, they’re a little bit more favorable now compared to industrial.”

The lending pace picked up by the multifamily sector traces back to the frequency of rent resets compared with other primary asset groups, according to Burt. “A lot of the tailwinds for industrial are consumer spending, at least in the warehouse side,” he says, noting the industrial sector could be susceptible to recessionary troubles if the economy encounters more headwinds.

“The other thing is that multifamily has agency lending behind it and there’s nothing really like that for industrial, and so the tailwind for the multifamily developers [is that] they’re seeing a little bit more liquidity in the debt markets because of the agency financing,” Burt says.