So I'm looking for answers from other aquisition guys rather than the debt guys (sorry).
This may be a bit too specific, so much so that many or all of you may not have an answer for me.
When underwritting an industrial warehouse aquisition do you take a general vacancy if its only two tenants? I was thinking about this because when we do portfolio's theres always a general vacancy (obviously) but when we do one off buildings its pretty willy nilly on if theres a GV in the model or not.
So what would you guys do? 300k sqft vacant warehouse to be leased up over the course of 15 months to two tenants. Do you / would you take a market general vacancy?
I would use 2% if there are two 150k SF spaces, unless the location justifies more.
To clarify, I would use a 0% general vacancy rate, and 2% stabilized vacancy rate upon resale (grossed up to stabilized market vacancy). Assuming you're using Argus.
So you would use an arbitrary 2% vacancy?
For that type of asset, yes.
Typically I only lease assets up to market occupancy rates in ARGUS. So if market occupancy was 90% I would lease it to 90% but not have any general vacancy. That is not standard though. Obviously there is no right answer.
This is essentially general vacancy, but I consider this "P-VAC" or permanent vacancy. GVAC is more conservative, and is more of a standard for acquisitions. Let me explain the difference.
GVAC - Lease the building to 100% occupancy. When leasing up, the corresponding tenant improvements & leasing commissions hit your cash flow. ARGUS then takes 5% GVAC (usually) off scheduled base revenues (or 10% depending on credit worthiness of tenants).
PVAC – Lease the building to 95% occupancy. The remaining 5% never gets leased up, or is “permanently vacant”. You do not have leasing costs associated with the vacancy that hit your cash flow.
Of course, sure. I've seen a lender require a 15% vacancy factor on a single-tenant deal simply based on the vacancy of the surrounding market. Seems silly, but it was done for the sake of being conservative.
Right, but he's asking about underwriting for acquisitions. If you used 15% vacancy on a dual tenant industrial building, I promise you would never get a deal. And it's not really logical, perhaps in a multi-tenant scenario with 30 10k sqft spaces.
I'm sure that underwriting for the acquisition (vs. underwriting for debt) you would want to walk a fine line between being optimistic yet provide some room for comfort. I have never underwrote an industrial product to hold for industrial (have worked on repositioning industrial to mixed use retail & creative office) but regardless you would want to assume some general vacancy, even in a single tenant building. Obviously there are exceptions: tenant has been there for 30+ years, triple A credit worthy tenant, maybe a logistic hub that is prime for industrial / storage, etc.
A lender is wearing a different hat, and will want more room for comfort. But even for acquisitions, you would run base, optimistic, and conservative scenarios to ensure you can sleep at night if something goes wrong.
I would assume a stabilitzed vacancy of 3 to 5 percent based on the credit of the tenant. So even if the building is 100% occupied, you assume only 95% fo CF is coming in. Change your assumptions in argus assumptions menu, leave the rent roll section as is. Hope that makes sense.
5-10% off the top, depending on credit, and your UW standards, for this scenario. The buyer for that type of property will almost always take this percentage off the top for credit loss (assuming Amazon isn't your tenant), just because. If your value is going to be decreased by a buyer at your exit, you probably should incorporate it into your UW.
I think you are probably fine hitting it with the credit loss, because 1. It's a warehouse (limited TI dollars) 2. Two tenants (limited TI dollars) and 3. Long term leases (limited TI dollars - ***just an assumption if each tenant is occupying 150K SF). In other scenarios, I tend to follow GentlemenandScholar (never leasing a % of the available SF up, assuming the space is statically vacant). If you do decide to "lease" only 95% of the in-place occupancy, I would make sure you double check the actual dollars spent in TI's and the actual dollars collected in rents once the tenants roll.
For large industrial properties with credit tenants I assume a static 3% vacancy upon stabilization
We use 3% for residential, an obviously much safer asset class. How can you use 2% of an industrial warehouse, even if they had a ten year contract. You have to include a high vacancy. I would assume 8-10%. Could be all wrong but just some quick thoughts.
Yeah, you are wrong. These two tenants are each paying let's call it $600k a year in rent. In order to generate income to pay $600k a year in rent, you're a big company, with good credit. I'm overgeneralizing but not so much that it's inaccurate. And residential is not an obviously much safer asset class. Look at cap rates, which reflect risk, for class a institutional product. The gap is approx. 100 bips between the two, and you are not signing 12 month leases, you're singing 3-10 year deals. Not to mention in markets I work in, industrial has lower vacancy rates than multi-family. I think you also forget that we're talking about underwriting in Argus, so there's a downtime probability factored modeled at their LXD - you aren't collecting 100% of the CF less 2% infinitely.
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