However, I do sometimes find myself stumped when this question is asked during an introductory conversation with an industrial building investor. “I own an industrial building in Mississauga and I want a mortgage. What is the rate going to be?” is as easy to answer as “I have a blue car. How fast can it go?”
The reason this question is hard to answer is that not all industrial investments are created equal. The effects of tenant mix, building specs, market characteristics and ownership translate into an interest rate that can range from four to seven per cent.
On a million-dollar loan, with a 25-year amortization, this would place monthly payments somewhere between $5,278 and $7,068. From a borrower’s perspective, the interest cost over a five- year term would be 79% higher for a borrower at the top end of that range versus the bottom. As you can see, these generic answers would leave most potential borrowers a little frustrated.
A lender needs to consider the complete profile in order to ascertain their level of interest in a deal. In this environment of tightening regulations, we are required to thoroughly vet our borrowers.
I’ve had borrower’s representatives swear that their client is a “really solid borrower” but closer examination often revels that this claim is based primarily on paying his cell phone bill on time and being employed. The ideal industrial borrower looks more like this:
- extensive experience in owning and managing industrial buildings;
- experience operating in the same market as the property to be mortgaged;
- a portfolio of properties with low to medium leverage;
- strong net worth statement or covenant;
- strong financial statements;
- a strong credit score.
The quality of the rent roll can have a great influence on interest rate. The volume of the income stream partially determines loan amount but the stability and quality determines rate. The key point is the covenant offered by the tenants: e.g. multiple locations, strong financial statements, in business for many years preferably in stable industries with a bright future.
Lenders also consider how long the tenant has been at that particular location. Obviously every tenant can’t be a large, multi-national chain with billions in revenue but the industrial tenant market is full of mid-size, solid performers in most geographies.
Near term lease expiration can be a frightening prospect when underwriting a property. If a large part of the rent roll or an anchor tenant has lease maturities in the first half of the mortgage term, a prudent lender will need to be cautious.
This risk is amplified in buildings with a sole occupant or owner-occupied. Single tenant risk comes into play when the tenant offers a mediocre covenant or if the property is located in a sluggish industrial market. If the average market lease-up time is 11 months, a lender will need to place more value on the borrower’s ability to act as a stop gap in the property’s cash flow.
The research departments of the large brokerages do a great job of tracking sale prices, lease rates, absorption, vacancy rates and number of days on the market. This information should be readily available from your preferred real estate agent.
The closer your property is to market averages, the easier it is to underwrite and provide favourable interest rates. When your property’s lease rates or its value is too high, it becomes harder to justify a matching lending value. When they are too low, we as lenders need an explanation of why the asset is underperforming.
It’s no secret lenders prefer stable and robust markets as they represent the lowest risk for our money. Financing properties in softer markets is achievable but we look for increased strength in the other categories presented here.
Industrial building construction has changed over the decades. Clear heights have continued to rise as racking technology has allowed better use of vertical space. Industrial buildings have also seen improvements in fire suppression equipment, lower ratios of square feet per shipping door and increased value on large yards with outside storage zoning.
Transportation trucks have also grown in length and yesterday’s site plans did not plan for this. A building constructed in the 1970s with a clear height of 18 feet and 50% coverage is going to attract a smaller pool of renters and a correspondingly lower rental rate. It will also attract fewer of the strong covenant tenants as they prefer the amenities offered by newer buildings.
These are the factors we consider when underwriting a loan. Few properties will score an A+ in all categories and lenders recognize this. If you find yourself lacking in one or more of the aspects required, there are strategies and loan structures you can use to improve the picture.
Adam Powadiuk is a Business Development Manager with First National Financial, Canada’s largest non-bank lender. He is active in most markets in the country with a focus on investment real estate. All feedback is welcome and he can be reached at email@example.com.