Spec Industrial construction - Debt underwriting/sizing

I would be curious to know how other lenders are underwriting/sizing spec industrial construction loans. LTC, DY, DSCR, how they underwrite NOI, etc. Specifically focused on traditional bank/senior balance sheet loans vs. higher-leverage debt funds and/or deals with a mezz component, though that would be interesting to hear about too.

Any input would be appreciated, from all sides of the coin - fellow lenders, brokers, developers, PE/LP folks, etc.

I'm in originations (senior secured balance sheet loans at a top 10 bank) and am constantly losing or passing on spec industrial opportunities because we can't get deals to pencil-out at our target underwriting parameters. Obviously deals are tight across the board with constructions costs and cap rate compression, but I still think our own sizing metrics are too conservative. Even getting to 60% LTC is often a struggle.

Basically, to make a deal work I need it to be 10% DY on developer proforma NOI, because we are going to haircut the NOI down to a 9% and a 9% DY is what the credit guys want (at minimum!) Which is not realistic because 10% DY deals rarely exist at the leverage points being requested in the market (65% LTC +/-)

A typical example:

  • Sponsor sends us a 60% LTC deal and their proforma is showing a 9.0% DY. We hit their NOI with a minimum 5% vacancy (they are showing 0% because why not, realistically the building is going to be either 0% leased or 100%, assuming one tenant) and $0.15 PSF replacement reserves. This usually results in an 8-10% overall haircut to borrower's NOI. This is also assuming we're fine with their proforma rent (sometimes we're not and ding the rents, which further decreases NOI).
  • So now, the original 9% DY is an 8.25%.
  • For many, an 8.25% DY is healthy, but my firm primarily focuses on DSCR. For industrial we're using a 6.81% mortgage constant (5.5%/30-yr). So that 8.25% DY = 1.21x DSCR. For spec industrial construction we want to be at a 1.35x-1.40x DSCR (9.2-9.5% DY). The only way to get there is to cut proceeds from 60% to 55% LTC.

Note - I'm specifically talking non-recourse financing. Generally working with top/institutional developers & equity players in the market, loans from $30-$80MM.

I know getting deals to pencil is a constant challenge for everyone, but it's frustrating when I'm constantly 5% lower on leverage than the competition.

Any other lenders in the same boat? How far off-market is targeting 9-10% DY on new spec industrial construction?

Comments (5)

Jan 7, 2022 - 9:00pm

Basically your lending standards are not at market.  I am at a bank balance sheet lender and we are able to get to 8.25 to 8.50 DY on spec construction assuming all fundamentals like quality sponsorship, good markets, etc. checkout.  Industrial is too hot right now to win deals at 9 DY.

Jan 10, 2022 - 11:17pm

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