Financing trends for 1997

Real Estate Weekly, Jan 22, 1997 by Jack Houlihan

Even though apartment buildings and single-tenant, credit-tenanted properties are still most highly sought after by most lending institutions, industrial properties and, to a lesser extent, office buildings are becoming not only acceptable but, in many cases, desired. This is due to a variety of factors including but not limited to a lender's ability to achieve higher spreads over treasuries than in the overheated apartment and credit sectors, the view that multi-tenanted properties enable a lender to spread the transaction's leasing risk among many different tenants, the strengthening markets in both the industrial and office sectors, and the diversification of risk in a lender's overall loan portfolio.

With respect to spreads and interest rates, lenders are able to achieve interest rates of .25 -.75 percent more than would be applicable on comparable quality and loan-to-value situations in the apartment and credit sector. Whereas we are financing apartments and credit deals at spreads of as low as 1.25-1.35 percent over comparable treasuries, better quality industrial and office buildings are being financed at spreads of 1.75-2.25 percent over the same indexes, in addition to industrial and office loans being made with shorter amortization schedules. Likewise, B and C grade industrial properties, including older and partially metal buildings with lower ceiling heights (e.g. 14 to 16 feet) are being financed at spreads of as high as 2.5-2.75 percent over treasuries, while we just closed a first mortgage on a C grade apartment property at 1.9 percent over the 10-year treasury at 75 percent LTV.

The psychology in lending has also changed dramatically as many lenders prefer the heavily, multi-tenanted property versus the single-tenanted property as leasing risk is spread across a wide range of tenants, even if they are not of a credit nature. For example, we recently financed two industrial buildings in Morris County, NJ with 50,583 square feet and 69,950 square feet, respectively, where the average tenant occupies only 2,500 square feet. Due to the smaller nature of the tenants, the average rents per square foot were higher than usual and the loans per square foot were concurrently higher, equaling $46 and $39 p.s.f., respectively. In these cases, the lender was able to achieve a spread of 2.25 percent over the five-year treasury with a 20-year amortization schedule and a 1 percent fee.

Similarly, we are now financing an industrial building in Bergen County where two tenants occupy the entire 67,500 square feet of rentable space, with both leases expiring in late 1998. Despite the short-term leases, a lender is willing to issue a loan at the requested level of $25 per square foot, since the tenants are paying an average rent of $1 per square foot below market in space with a 20-foot ceiling height and a small office buildout. The lender is taking a $50,000 annual reserve for the next two years in order to have enough funds to be able to pay for tenant improvements and leasing commissions if either or both tenants vacate. This loan is being priced at 2.5 percent over the 10-year treasury.

We are still finding it easier to finance single-tenant and/or owner-occupied properties where the tenants are strong financially, even if not of a credit nature, and the pricing being offered by lenders in these cases is much more competitive. In fact, we just closed a loan of $2.2 million on a 58,500 square-foot industrial building in Bergen County where the purchasers occupy the entire building, having signed a 10-year lease at a market rent of $5.25 per square foot. These owner occupants are in the clothing manufacturing business and use 15 percent of the 18-foot ceiling height space as offices. The lender priced this loan at 1.6 percent over the 10-year treasury versus a 20-year amortization schedule and the borrower purchased the property for $3.2 million.

As previously indicated, both the industrial and office markets have either stabilized or improved greatly in the past few years, giving most lenders with whom we deal the confidence to aggressively move back into these markets. Whereas most, if not all, lenders would have required the unamortized loan balance at the end of a single tenant's lease term to equal no more than land value, they are now willing to take additional risk based on their belief that the unamortized loan balance at lease maturity will be easily serviced by the market rent at that time.

For example, we just closed a loan in Mahwah, NJ where this same situation was involved. A strong but non-credit tenant had 4 years left on its lease term and our lender funded a first mortgage on this 50 percent built-out, 85,000 square-foot office warehouse building at over $60 per square foot. The lender's exposure, however, amortizes down to $32 per square foot by the time the lease expires in the year 2000. Once again, the lender received a slight premium for taking some leasing risk (2 percent over the 10-year treasury) but this six-year old building is m a very successful industrial park where there is little or no vacancy.