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How to Finance a Build-to-Suit Industrial Development
As the industrial real estate sector continues to perform, new development is essential. Find out how to finance a build-to-suit property.
Image by Guilherme Cunha from Unsplash.
More and more investors and developers are seeking to get in on the hot industrial real estate sector. It’s hardly surprising — steady rent increases of 5.5% over the past year and historically low availability mean that those with distribution and manufacturing facilities in their portfolios have been positioned to win big.
Of course, due to low availability, the costs of acquiring industrial assets have skyrocketed, with sticker shock keeping many would-be investors away. While construction costs also have risen a staggering amount, there can be significantly more upside to building a brand-new, modern development than buying a slightly dated existing asset.
Build Spec or To Suit?
Financing a build-to-suit industrial property can be daunting — and expensive — but there can be less risk for a developer than building speculatively. Having a tenant signed to a development is a critical indicator of a property’s economic viability. While it’s true that many lenders may not balk at funding the construction of a spec distribution facility in a tight market like the Inland Empire or Northern New Jersey, having a tenant in place is likely to put many doubts to rest. That is, provided the property is delivered on time and on budget.
How a Lender Assesses a BTS Project
Lenders will certainly scrutinize a build-to-suit property’s future tenants. If the tenant for your development is financially sound, this will be a major aid in sourcing a loan with beneficial terms. The level of importance a lender places on the tenant, however, depends on both the location of the property and its type or specialization.
When underwriting such a loan, a lender will examine a development from several important angles, including:
If the development is delayed several months, would the tenant select another property?
Does the tenant have strong credit?
Would a different tenant be able to operate in the building should the lease fall through?
Could the property be repurposed for other types of industrial users?
How experienced is the development team?
What are the most common financing options for build-to-suit industrial developments?
The most common financing options for build-to-suit industrial developments are commercial construction loans from more traditional sources, like a bank, life insurance company, or credit union. Specialized lenders may also offer financing packages that include a construction component followed by a longer-term, permanent loan upon completion. It is essential to keep debt service costs as low as possible for as long as possible, as rental income won't begin until after the building is done.
For more information, please see this article.
What are the advantages and disadvantages of using debt financing for a build-to-suit industrial development?
The advantages of using debt financing for a build-to-suit industrial development include the ability to leverage the tenant's creditworthiness to secure a loan, the ability to spread out the cost of the development over a longer period of time, and the ability to access more capital than would be available through equity financing. The main disadvantage of debt financing is that it can be more expensive than equity financing, as the borrower must pay interest on the loan.
For more information, see Debt vs. Equity Financing for Commercial Real Estate.
What are the key considerations when selecting a lender for a build-to-suit industrial development?
When selecting a lender for a build-to-suit industrial development, there are several key considerations to keep in mind. These include the tenant's financial soundness, the location of the property, the type or specialization of the property, the tenant's credit, the ability to repurpose the property for other types of industrial users, and the experience of the development team.
Most developers tend to finance build-to-suit projects with commercial construction loans from more traditional sources, like a bank, life insurance company, or credit union. However, depending on the strength of the borrower and the tenant, better financing options may be available. Some specialized lenders offer financing packages that include a construction component followed by a longer-term, permanent loan upon completion.
It is important to keep debt service costs as low as possible for as long as possible, as rental income won't begin until after the building is completed. Depending on the leasing contract, it might not be considered “done” until after a tenant completes all necessary tenant improvement, or TI, work.
What are the tax implications of financing a build-to-suit industrial development?
The tax implications of financing a build-to-suit industrial development depend on the type of loan you take out. Traditional loans from banks, life insurance companies, or credit unions may have different tax implications than specialized loans from other lenders. It is important to consult with a tax professional to understand the tax implications of the loan you are taking out.
For more information on the tax implications of financing a build-to-suit industrial development, you can check out the following resources:
What are the most important factors to consider when structuring a financing package for a build-to-suit industrial development?
When structuring a financing package for a build-to-suit industrial development, the most important factors to consider are the strength of the tenant, the location of the property, the type or specialization of the property, the tenant's credit, the ability to repurpose the property for other types of industrial users, and the experience of the development team.
Most developers tend to finance build-to-suit projects with commercial construction loans from more traditional sources, like a bank, life insurance company, or credit union. However, depending on the strength of the borrower and the tenant, better financing options may be available. Some specialized lenders offer financing packages that include a construction component followed by a longer-term, permanent loan upon completion.
It is essential to keep debt service costs as low as possible for as long as possible, as a developer won’t begin collecting rental income until after the building is done. Depending on the leasing contract, it might not be considered “done” until after a tenant completes all necessary tenant improvement, or TI, work.
Based on these questions and the strength of the industrial real estate market, a lender can get a more complete and accurate picture of a loan’s risk. This directly impacts the type of loan terms a borrower can receive, with varying terms, amortization periods, and interest rates.
As an example, consider a development preleased to a paint manufacturer. Such a tenant would likely have some very specific building requirements, and that would impact the project’s design, cost, and ability to be repurposed for a different tenant in the future. Compare that project with a distribution center leased to a shipping company. Shipping facilities may have different functionality, but most are similar and adaptable.
Traditional or Specialized Lenders?
Even given these additional considerations, most developers tend to finance build-to-suit projects with commercial construction loans from more traditional sources, like a bank, life insurance company, or credit union. However, depending on the strength of the borrower and the tenant, better financing options may be available.
Some specialized lenders offer financing packages that include a construction component followed by a longer-term, permanent loan upon completion. With build-to-suit developments, it is essential to keep your debt service costs as low as you can, for as long as you can. After all, a developer won’t begin collecting rental income until after the building is done. Depending on the leasing contract, it might not be considered “done” until after a tenant completes all necessary tenant improvement, or TI, work.
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