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CRE Insights Blog
Last updated on Jun 30, 2023
10 min read
by Jeff Hamann

The Comprehensive Guide to Industrial Property Financing in 2023

Understand how lenders will view your property or project, and learn how to find the best possible financing terms.

In this article:
  1. Let’s Start With the Basics
  2. What Is Industrial Real Estate?
  3. Importance of Industrial Real Estate in Today's Market
  4. How Lenders Underwrite Industrial Real Estate Deals
  5. Importance of Location and Market Conditions
  6. Understanding Market Indicators (Sales Prices, Leases, Vacancy Rates)
  7. Differentiating Between Hot and Cold Markets
  8. The Operational Aspects of Industrial Real Estate
  9. Operational Metrics That Matter to Lenders
  10. Impact of Operations on Financing Terms
  11. Key Underwriting Metrics in Industrial Real Estate
  12. Loan-to-Value Ratio (LTV)
  13. Debt Service Coverage Ratio (DSCR)
  14. Importance of Creditworthiness and Financial Strength
  15. Types of Industrial Real Estate Financing Deals
  16. Acquisitions
  17. The Underwriting Process for Acquisitions
  18. Special Considerations for Acquisition Financing
  19. Refinances
  20. The Underwriting Process for Refinancing
  21. Cash-Out Refis: Benefits and Risks
  22. Construction Loans
  23. The Underwriting Process for Construction Loans
  24. Key Risks Associated with Construction Loans
  25. Renovation and Value-Add Deals
  26. The Underwriting Process for Renovation Loans
  27. Key Considerations for Value-Add Financing
  28. Case Studies
  29. Case Study 1: An Overvalued Asset Acquisition in the Inland Empire
  30. Overview of the Deal
  31. Challenges in Financing
  32. Lessons Learned
  33. Case Study 2: Successful Value-Add Deal in Madison, Wisconsin
  34. Overview of the Deal
  35. Financing and Underwriting Process
  36. Success Factors and Key Takeaways
  37. Conclusion: Navigating Industrial Real Estate Financing
  38. Essential Tips for First-Time Investors
  39. The Importance of Due Diligence
  40. Preparing for a Successful Deal
  41. Get Financing
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Navigating the industrial real estate market can be a complex undertaking, especially when it comes to securing financing. This article is designed to demystify the process, offering clear insights into how lenders evaluate industrial real estate deals and what factors they consider crucial.

Whether you're considering an acquisition, refinance, or construction loan, this guide provides an in-depth look into how lenders underwrite such deals and offers practical advice to help you prepare.

Let’s Start With the Basics

Before we delve into the world of industrial real estate financing, it's essential to build a solid foundation by understanding what constitutes industrial real estate, why it's a pivotal player in today's market, and familiarizing yourself with key financing terms.

What Is Industrial Real Estate?

Industrial real estate refers to properties primarily used for industrial activities. These could range from manufacturing and production plants, distribution centers, warehouses, and even research and development facilities. Each industrial property has its distinct features, making it essential to understand the property's intended use and the implications it may have on financing.

Importance of Industrial Real Estate in Today's Market

As global consumption patterns evolve and e-commerce expands, the demand for industrial real estate has skyrocketed. 

However, while this sector has demonstrated robust returns, it's critical to understand that it's not a "buy it and forget it" type of asset. Keeping abreast of market conditions, understanding operational aspects, and regularly reviewing the property's performance is vital to success in this field.

How Lenders Underwrite Industrial Real Estate Deals

The process of underwriting involves assessing the risk associated with lending money for a real estate transaction. Lenders evaluate a variety of factors, including the property's location, its operational aspects, market conditions, and the borrower's creditworthiness.

Importance of Location and Market Conditions

Location and prevailing market conditions are two crucial factors lenders assess during the underwriting process. Understanding these parameters will help you anticipate and meet lender requirements.

Understanding Market Indicators (Sales Prices, Leases, Vacancy Rates)

Market indicators provide a snapshot of a location's economic health, influencing how lenders view your investment. Important indicators include the average sale price per square foot, average lease rates, and vacancy rates. These numbers help lenders gauge the profitability of a location and its future potential.

Differentiating Between Hot and Cold Markets

While industrial real estate is generally considered a hot investment, not all markets share that same heat. Hot markets are characterized by high demand, low supply, and rising property values and lease rates. Colder markets, by contrast, may be grappling with higher vacancy rates and lower prices. Understanding these dynamics can help shape your investment strategy and anticipate lender perspectives.

The Operational Aspects of Industrial Real Estate

A property's operations, including its use, tenant mix, lease structure, and operational costs, can significantly impact its appeal to lenders.

Operational Metrics That Matter to Lenders

Lenders look at operational aspects to assess potential risks and returns. Single-tenant properties with long-term leases might be seen as less risky than multi-tenant ones with short-term leases. Operational efficiency, reflected in lower maintenance and operational costs, also influences lenders' assessments.

Impact of Operations on Financing Terms

The property's operational efficiency can directly affect its net operating income (NOI), a key metric for lenders. High operational costs can reduce NOI and impact the DSCR, potentially leading to less favorable loan terms or even denial of a loan. Consequently, an efficient operation can enhance your appeal to lenders, improving the likelihood of securing favorable terms.

Key Underwriting Metrics in Industrial Real Estate

During the underwriting process, lenders look at several key metrics to assess the viability and profitability of an industrial property.

Loan-to-Value Ratio (LTV)

LTV is a metric that compares the amount of the loan to the appraised value of the property. Lower LTVs indicate a higher proportion of equity and lower risk for the lender. For industrial real estate, lenders typically prefer an LTV below 75%.

Debt Service Coverage Ratio (DSCR)

DSCR measures the property's ability to cover its debt obligations using its net operating income. A DSCR over 1.25 is typically preferred, implying that the property's income is sufficient to cover its debt payments and provide a safety cushion.

Importance of Creditworthiness and Financial Strength

Lenders examine the borrower's credit history, income stability, and overall financial health. A solid credit score, reliable income, and a healthy balance sheet can increase the chances of loan approval and securing favorable terms.

Types of Industrial Real Estate Financing Deals

Industrial real estate financing deals can take many forms, depending on the specific needs of the borrower.

Acquisitions

Purchasing an industrial property is a significant financial decision that requires thorough understanding of the underwriting process.

The Underwriting Process for Acquisitions

For acquisition loans, lenders review the property's income-producing ability, condition, location, and the borrower's creditworthiness. They'll examine the property's appraisal, environmental reports, existing leases, and market conditions to ascertain its value and potential.

Special Considerations for Acquisition Financing

When financing acquisitions, lenders may be concerned about the property's ability to generate consistent revenue. They'll look at the length and terms of existing leases, creditworthiness of tenants, and vacancy rates.

Refinances

Refinancing involves replacing an existing loan with a new one, often to get better loan terms or extract equity from the property.

The Underwriting Process for Refinancing

During refinancing, lenders assess the property's current market value, the owner's creditworthiness, and the property's income stability. A significant factor they consider is the equity in the property and how much the owner wishes to cash out.

Cash-Out Refis: Benefits and Risks

Cash-out refinancing allows property owners to extract equity from their property by taking a larger loan. This can be a great way to leverage equity for improvements or other investments. However, this increases the loan amount and potentially the risk if the property's income declines.

Construction Loans

Construction loans are used to finance the building of new industrial properties.

The Underwriting Process for Construction Loans

Underwriting for construction loans is a complex process. Lenders review the borrower's creditworthiness, construction budget, timeline, and projected income from the completed property. The future value of the property (upon completion) also plays a key role.

Key Risks Associated with Construction Loans

Construction loans carry inherent risks, including construction delays, budget overruns, and market changes during construction. Lenders will scrutinize the construction plan and the borrower's track record in managing similar projects. Certain types of projects, like build-to-suit industrial developments, are often considered less risky, but it depends on the specifics of the tenant and the lease terms.

Renovation and Value-Add Deals

These deals involve enhancing the value of a property through renovations or improvements.

The Underwriting Process for Renovation Loans

In value-add financing, lenders will review the renovation plans, projected costs, anticipated increase in property value, and the potential for increased income post-renovation. The borrower's experience in managing similar projects will also be considered.

Key Considerations for Value-Add Financing

Renovation loans carry risk, as improvements may not result in the anticipated income increase. Lenders will look at the feasibility of the plans, the reliability of the projected costs, and the borrower's track record with such projects.

Case Studies

Real-world examples can illuminate the complexities of underwriting industrial real estate deals. Here are two case studies showcasing different situations and their outcomes.

Case Study 1: An Overvalued Asset Acquisition in the Inland Empire

This case study explores an investor who committed to acquiring an overvalued industrial asset in the Inland Empire.

Overview of the Deal

The investor entered into a deal to purchase a 100,000 square foot industrial property for $27 million ($270 per sq ft), well above the average sales price of $134 per sq ft in the first half of 2023. The property had an annual net operating income (NOI) of $1 million, implying a cap rate of just 3.7%.

Challenges in Financing

Given the high purchase price, the investor sought 75% LTV financing, resulting in a loan request of $20.25 million. The DSCR at this loan amount was 0.8, well below the preferred minimum of 1.25, indicating that the property's NOI was insufficient to cover the debt service. As a result, lenders were wary of the high leverage and low DSCR. The investor struggled to secure financing and had to renegotiate the purchase price or bring in more equity.

Lessons Learned

This case underscores the importance of careful property evaluation and understanding underwriting metrics before committing to a purchase. The investor failed to assess the property's value accurately relative to its income-generating capacity, resulting in significant financing challenges.

Case Study 2: Successful Value-Add Deal in Madison, Wisconsin

This case explores a successful value-add deal involving the renovation of a small, older warehouse in Madison, Wisconsin.

Overview of the Deal

An investor purchased a well-located but dated 50,000 square foot warehouse in Madison for $3 million ($60 per sq ft). The property was leased at below-market rates, generating an NOI of $150,000 per year. The investor planned renovations costing $500,000 with the aim to increase lease rates and improve the NOI.

Financing and Underwriting Process

The investor sought a loan of $2.35 million for the acquisition and renovation, representing a 70% LTV. The lender analyzed the deal, considering the investor's plans to renovate and the potential to increase rents. They also took into account the investor's solid credit history and experience with similar projects. Given the value-add potential, the lender was comfortable with the initial DSCR of 1.2, with the expectation that it would improve after renovation and rent increases.

Success Factors and Key Takeaways

The deal was successful due to several factors: the investor's clear value-add strategy, the well-located property, and the investor's proven track record. Post-renovation, the property's NOI increased to $250,000, pushing the DSCR to a comfortable 2.0. This case highlights the importance of a clear value-add strategy and the willingness of lenders to consider future income potential in their underwriting process.

Conclusion: Navigating Industrial Real Estate Financing

Financing industrial real estate deals can be a complex process. But with a strong understanding of underwriting fundamentals, keen market insights, and strategic preparation, you can navigate this landscape effectively.

Essential Tips for First-Time Investors

Industrial real estate is a dynamic field that requires a deep understanding of market trends, property operations, and financial metrics. As a first-time investor, it's crucial to familiarize yourself with key underwriting metrics, such as LTV and DSCR, and understand how these factors can influence your financing terms. Always be prepared to illustrate your financial stability and creditworthiness to potential lenders.

The Importance of Due Diligence

Due diligence is not a step to be skipped or rushed. It includes a thorough review of the property's financials, condition, and market position, along with an assessment of potential risks. Whether you're looking to acquire, refinance, or develop, a meticulous due diligence process can save you from costly missteps and ensure that you're making a sound investment.

Preparing for a Successful Deal

Success in industrial real estate investment often boils down to preparation. Understand the market conditions, know your property inside out, have a clear and realistic financial plan, and anticipate potential challenges. If you're pursuing a value-add strategy, ensure that your plans are feasible and that the increased income will justify the investment.

In the world of industrial real estate financing, knowledge is power, and preparation is key. Equip yourself with the right tools and insights, and you'll be well on your way to securing a successful deal.

Keep in mind, however, that the best way to find the most competitive terms is to shop your loan to various lenders. Our platform connects your deal with thousands of lenders — and it just takes a minute to fill in the details in the quick form below.

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