Not your grandfather’s warehouse

Internet fulfillment centres have boosted the US industrial real estate debt market, experts say, with last year’s asset sales climbing for the sixth year in a row, reports Justin Slaughter.

Chances are the reader has ordered and received an item shipped from an “fulfillment centre” warehouse, the modern-day equivalent of the old industrial distribution building.

The increasing availability and speed of e-commerce distribution networks in the US have fueled the growth of industrial investment sales as fulfillment centres grow and become scattered across the country, both in and outside of major cities.

Industrial real estate sales for 2015 totaled $76.5 billion, compared with $49.9 billion in 2014 and just $10 billion in 2009, according to Real Capital Analytics (RCA).

Gregory West
Gregory West

Accordingly, debt financing of industrial real estate has continued to be a sought after, stable investment, as banks, life insurance companies and institutional balance sheet lenders target large, safe debt investments on individual asset or multi-property portfolio loans.

Gregory West, senior vice president of capital markets at Walker & Dunlop, says there has been a general shift in industrial real estate financing, with companies focusing on internet fulfillment centres as opposed to traditional distribution warehouses.

“The Amazons of the world weren’t around 15 years ago,” he says. “I did a loan with Amazon back when it was a very risky deal, but now they are credit worthy and people are clamoring to build for them.”

Fulfillment centres are the warehouses in which Amazon and others stockpile, package, and ship products at incredibly accelerated speed due to their increased prominence in and out of major cities and the modernised processes which accompany the high-speed of Internet transactions.

Amazon alone leased 69.9 million sq ft of fulfillment or data centres in North America as of the end of last year, according to its 2015 annual report. And according to an independent consultant, Amazon has 161 distribution centres in the US (including fulfillment centres, delivery centres, and prime hubs, and sortation centres) and 20 future facilities in the works as of this month.

Distributors were once located away from cities, but Amazon and a long list of competitors like and Wayfair realised the importance of greater speed and efficiency as they changed logistics. Meanwhile, traditional retailers like Best Buy, WalMart and Sears have emulated the fulfillment centre process in order to compete.

“Typically on these deals – there is not a giant capital stack – but we go out and find long-term life insurance debt,” West says, noting that Walker and Dunlop acts as an intermediary on their deals. The firm’s industrial deal volume for 2015 was $697 million, compared with $166 million for 2014.

The typical 10-year loan on industrial properties in Southern California, where West is based, carries a 70 percent LTV because values are so high, he says.

Top Industrial Deals

CBRE: the top US industrial broker

Valerie Achtemeier, executive vice president of debt & structured finance at CBRE – the top broker in US industrial real estate last year with $23.8 billion in transactions – says that industrial portfolio sales for 2015 and 2014 were basically all fulfillment centre sales.

Valerie Achtemeier
Valerie Achtemeier

Achtemeier helped finance several Amazon fulfillment centres, most recently in Hartford, Connecticut and San Antonio, Texas, which lenders and borrowers consider a long-term, investment-grade deal with top credit ability, she says.

Typically the centres are large – up to and even over 1 million sq ft – buildings on the outskirts of major cities, but likely much smaller when located within a city, if the centres are equipped for ‘same-day’ deliveries.

Achtemeier says industrial real estate loan cap rates are low and a typical 10-year loan carries 60-65 percent leverage with a 3.5-3.75 percent interest rate, while a five-year loan typically carries a 2.95-3.2 percent interest rate.

The industrial real estate market experienced a huge influx of foreign capital last year, with investments coming from the Middle East, Asia, Canada, and South America, she notes.

A January report from RCA shows that foreign buyers were behind $27.4 billion of industrial deals last year, a whopping 1,115 percent increase for the year. Achtemeier adds that foreign investment in this space will likely continue in 2016.

Both life insurance companies and banks pursue both individual asset and portfolio loans on industrial properties, says Achtemeier, but portfolio loans seems to be more sought after.

“Industrial is really in demand for real estate lenders – and in particular portfolio loans because of the larger scale of $50-200 million and above.”

Life Insurance Lenders

Life insurance companies like Prudential, TPM, New York Life, John Hancock, and The Hartford Group are very active in this space, as well as major banks such as Deutsche Bank, Chase, and Bank of America.

“Banks are playing a big role in this space, but you don’t see them lending as much on value-add opportunities,” says Achtemeier.

Tim McGinnis, managing director with New York Life Real Estate Investors, says life insurance companies such as New York Life prefer portfolio loans, not only due to the larger scale but because the diversification of assets and tenants lowers the risk of the debt.

McGinnis says his firm particularly pursues portfolio loans that include 10-20 buildings, with a fair amount of diversification as far as geography and tenant base, which also scales up the loan offering. “We have done smaller size loans ranging from $20-40 million on two or three properties,” says McGinnis. “But our commercial mortgage programme has a $5 billion target, and there are only so many small deals you can do when the manpower is finite.”

The risk profile on industrial real estate debt is comparatively priced with multifamily and other asset markets, cap rates continue to compress for industrial and his platform pursues loans on industrial properties because they are capital intensive.

“In a warehouse, the cost undertaken if you lose a tenant is not as much as tenant loss in an office property,” says McGinnis. “We like that capital structure.”

New York Life’s commercial mortgage arm has a $28 billion loan portfolio, 12 percent of which is industrial, or roughly $3.5 billion. In 2015 the firm originated $1.9 billion in industrial loans.

Industrial-to-office conversion projects

As fulfillment centres rise, some of the older industrial stock is being phased out and converted into office space, particularly in gateway markets like New York City and Los Angeles, and often for tech tenants who admire the open floor plans and warehouse-like appeal.

In one example, the 1920s-era former Macy’s furniture warehouse in Long Island City, Queens, New York is now a sleek tech office and high-end residential property called “The Factory,” on which Blackstone provided a $160 million loan to Atlas Capital Group to refinance the property this spring.

In fact, the largest investment sales deals involving industrial real estate over the last two years have involved conversion projects.

The highest priced industrial deal from the first quarter of this year was a Westbrook Partners and RXR Realty joint venture’s $161 million purchase of an industrial property at 9-47 Hall Street in Brooklyn, New York, reportedly to convert into offices.

And the highest such deal from last year was Facebook’s purchase of a 996,272 sq ft industrial park from Prologis for $395 million to expand the social media juggernaut’s office space in Menlo Park, California.

West says that, in California, functional but obsolete industrial properties are disappearing, ones that developers are tearing down and converting into multifamily or mixed-use properties, “but not as much as in New York City because the age of buildings there are significantly older than we have out here.”