The Highlights of Industrial Real Estate with Zack Streit | StreetBeats Ep. 107

- Hello, and welcome to another edition of "CrowdStreet Street Beats", my name's Ryan Strub I am the Head of Commercial Investments here at CrowdStreet. And today I'm joined by one of our regular guests named Zack Streit, Senior Vice President over at George Smith Partners, Zack, how are you doing today?

- Hey, doing really well, Ryan, great to be back.

- Absolutely, always good to have you. And Zack, we'll dive right in, really wanna start with one of the highlights and kind of peak points here in the commercial real estate industry today, and really over the past 18 months here, since COVID hit, which has been the industrial sector, really every kind of avenue that you look at this from net absorption, from liquidity in the capital markets, from the availability of debt, all point to just how flourishing this asset type has been, I know on CrowdStreet's side, we've had a lot of success in this. We've been doing some development deals really that have had kind of term sheets in terms of leasing activity, but also on the buy side, kinda future purchase options. And this was before construction has even been complete. I know Zack, you've been doing a lot in the industrial side, recently close the deal on that as well, maybe kinda walk us through where capital markets are both on the debt and equity side for industrial today as you're seeing it.

- Yeah, absolutely, so super-strong, arguably multifamily and industrial are the two strongest sort of asset classes within commercial real estate. And there's seemingly insatiable demand for both. The biggest challenge is probably industrial today is just finding land in close proximity to urban areas that you can build on, that is zoned, and then sellers don't have crazy expectations on pricing 'cause I think most of them have woken up and realized the land bankers, the gold that they're sitting on and what something's worse if you could sign an Amazon lease or a Costco lease or something like that, we close the deal though, that's maybe pretty representative of what's going on out there to sign a strict confi on it, but let's just say it was about a $36 million loan, it was kinda in the Austin, San Antonio sort of corridor. It was for 130,000 square feet manufacturing and research facility, a hundred percent leased to a non-credit tenant. And it was a huge site, it's a hundred acre site. Also 93 of the acres were undeveloped on it, and you could end up with, you know, more than a million square feet of light industrial. So it's a little bit complicated and that you weren't just valuing the building and the lease, but you were also valuing all this ancillary land, but not unusual in the case of big industrial deals. And you know, probably no surprise. You know, we had a bunch of different bids on it, you know, all shapes and sizes, lower leverage, higher leverage the sponsor opted on where I'd call moderate leverage execution that priced in the low threes. And that was of a five-year fixed transaction that they opted for kinda, for their own internal reasons to provide them some flexibility if they ultimately decide to sell afterwards, we were able to take out very high leverage construction financing, right? And this is what's so interesting, at the time they took out very high leverage construction financing on a non-credit single tenant situation into a non-recourse bank execution five-year fixed. That was probably capped at say, I don't know, 65% loan to value. It's not easy to do that in other asset classes, but you can do that in the industrial world and in the multifamily world today, you know, for stuff coming off, construction loans that might've had, 80, 85% loan to cost financing because you're creating that much value, cap rates have compressed that much. And you know, a lot of it on the backs of cheap debt and low interest rate. So that's kind of like one recent industrial execution that we did, that's kinda cool because it's not credit. We get inquiries from equity guys pretty much daily, you know, and we'd love to do one with you guys too, in their seemingly insatiable demand for spec industrial. If it's well located stuff, you know, to capitalize deals. And, you know you're seeing construction financing's from bank sources, go off at, depending on what you're looking for, recourse, non-recourse, partial recourse probably anywhere from like, you know, mid twos and up, but probably in all cases with moderate leverage, I'd say mid twos to 4% non-recourse today, called it a 65% loan to cost for stuff like that. So that's pretty incredible pricing, you know, can make deals accretive offset, of course, by high land costs and construction costs that have moderated some, but are still pretty high. But I would say for well located kinda, you know, either infill or secondary market location, industrial stuff, like almost insatiable demand and be interested to hear what you guys are seeing on the CrowdStreet side too, if it is similar or maybe different?

- No, it really has been similar. And especially for the well located assets moving, we've seen is you really have to move quickly to be competitive. So you know, there's a lot of term sheets coming out from the equity side that really wanna be competitive in those projects, and so for us, it's really how do you move quick enough to participate in those, that you really get like fast feedback from the lenders in terms of, where they're gonna be at, in terms of proceeds and future funding, where they're gonna be at in terms of timing. And then from our side, they're also a little bit easier to underwrite because you really have a good story in terms of tenants in the market, how much demand there is, construction pipeline, net absorption, all that makes it pretty easy to underwrite. And so from our side, we are moving very quickly. We're seeing, not a lot of deals, but you know, enough to kinda keep us hungry in that space. Our investors have been participating in those assets, you know, kind of throughout the past 18 months. So from our side, that has definitely been the same story. It makes it a little bit easier to underwrite, like I said, and then Zack, kind of taking the opposite approach, something that might be a little bit more difficult to underwrite right now within the office sector, right? So you know, and that's kinda all across the board in terms of where it is, workforce utilization net, obviously from every geographic region, that's going to change a little bit in terms of who's coming back to the office, how fast they're coming back, and from our side, you know, on the office perspective, we're always looking at credits, weighted average lease terms, is there story from this tenant in terms of why they need to be here? And it really is difficult to kinda come to that base case scenario, especially when you're looking at a tenant where if they leave, you know, it's gonna cost you X number of dollars per square foot to backfill that space, how long is it gonna be down for, if they do stay, you know, what's that rate going to be? So there's a lot of variables on the office side that has been making it a little bit more difficult instead, there's still a lot of opportunities out there that we like that we participated in, kinda curious to get your take on that both from the equity side, but also from the debt side, like how are lenders looking at that in terms of reserves, future funding, so loaded question there, but I'll kinda up pass up to you to see how you've been doing.

- A lot to unpack. So we're working on two office deals right now and they're, well, we closed one are working on another and they're remarkably similar in their profile, but big picture, I think it's kind of a tale of two markets. I think, you know, trophy office, if it's leased and it's got a lot of wall, like you said, it can go off at exceptionally great rates on the debt side. And you're seeing the sales like up in the bay area, the north of a thousand bucks, a square foot, if there's a lot of vacancy, however, the key question is how do you fill it? And then, what kinda debt is available for it? Certainly it's not gonna be perm debt, it's gonna be some sort of bridge debt and you need to make a convincing case. That's tougher. So we haven't really done much in the way of kind of trophy high-rise with a lot of vacancy, or a lot of near-term role, but I can talk to the one deal that we just closed. And the two we're doing, both are two stories, suburban office product that used to be a real bad word. It seems like, maybe it's not anymore. Largely, I would say neighborhood office, so stuff that's between a hundred and 200,000 square feet and gross leases with long rent rolls that have generally been pretty COVID safe and that they aren't carrying big delinquencies or big collection issues. In the case of the deal we just closed, I think the debt, I'm not being self-congratulatory here, I can dealt was nothing short of remarkable. We closed the deal here in Southern California is in the San Fernando Valley was about a hundred thousand square foot office building. We closed 70% loan to cost non-recourse financing at 375 over one month LIBOR with a 15 basis point floor. So that means we've financed an office building for a sponsor at a 3.9% interest rate at 70% loan to cost leverage with what I would call an a paper non-recourse debt fund lender. The load included future funding for CapEx, both some immediate improvements and deferred maintenance the sponsor wanted to address and some sprucing up and also contain, you know, I would say a pretty modest budget for TILC on the theory that there were a lot of kinda small footprint gross leases that office building almost operated like an apartment building in that sense and had pretty sticky tenants that had been there for sort of a long time, so you figure a lot of renewals and you also figure that if folks leave, it's not gonna cost you that much per unit, you know, to re-carpet and paint, which is really all they thought they do for these roughly 800 to thousand square foot units. We're doing a very similar deal up in Ventura County now, remarkably similar, suburban office product, but, you know, walkable to some amenities, sort of a light value add rehab folks thinking they're sponsors thing, they're picking it up for a good basis below replacement costs. Occupancy is a little bit weaker on that deal. It's probably in the caught 75% range up in Ventura versus it was over 90% range when on the deal we did in the San Fernando Valley. So you figure 5,100 BYPS of spread premium to compensate for location and also vacancy. But what's really interesting is that, you know, both have been in both, but one was, and the other is being really warmly received and guys are thinking like, you'll be able to lease up that vacancy. This type of office is not going to go out of style, it's somewhat COVID friendly and that, you know, there tend to be like, outdoor interior courtyards on both, great sitting areas outside and small units, so you're not really often sharing the space with a lot of other people. Now contrast that to big open floor plans, and, you know, that creates more COVID issues of, are you gonna kinda put up plexiglass where people wearing masks in the office and kinda how does all that, all that work, but for this one particular product, I don't know yet if it's an aberration that we're working on two deals back to back with very similar profiles, or if you're gonna start seeing a lot of sponsors pick off these types of office products on the basis, Hey, I think I can get a pretty good deal on a pretty good going on cap rate. And then I think both probably also have long-term entitlement potential if you want to turn them into something else, they're both pretty large parcels of land. So if from a covered land standpoint, you can generate a pretty good income off of sprucing up the office, and you're still signing relatively short-term leases, like, you know, two, three or type leases with staggered roll. And you're not locking yourself in for 10 years, who knows. And I know a secondary business plans on both strategies, the sponsors are thinking about that, but it isn't the primary means for execution here. If they can just do their CapEx, run it now, lease up at higher rates, they easily have an exit through a sale or a refi just on the basis of kinda having turned around the office. So I think it's pretty interesting that you're starting to see that. What about on the CrowdStreet side?

- No, I was just saying like very, very similar. So, you know, in terms of suburban office, we have seen a lot of demand for that, and also when you look at those, you always wanna try to find that tenant story. So like, is there a specific reason this tenants here, how long have they've been there, have they given back space in COVID, have they signed an extension, you know, especially during a downtime where a lot of tenants who knew they're gonna be there for awhile have kinda reached out to the landlord saying, you know, now's a good time for me to sign a new rate 'cause I've probably got a 10% discount or 5% discount. So that's always interesting to follow. And yeah, also from like the one to two story products, so if you want COVID friendly, you don't wanna be cramped in an elevator, you know, so some of those like four to six stories, suburban assets, maybe not as desirable from a leasing perspective as those one to two story assets can be, so we've seen that as well. And then you've mentioned, from a future funding perspective from lenders, so if you do have vacancy, like, what does it cost you to get those TI dollars, those leasing commissions, you mentioned, I think it was 3.9%, which included, I think a floor of 115 on like where you said. So from that perspective, you almost had a fixed floating rate, right? So you know where LIBOR is today? You know, the one that LIBOR I believe is like 85 basis points, 84 basis points today, something like that. You're gonna see some expansion there, but not like it was three, four, five years ago, we're LIBOR was moving on a daily basis. So is it fixed rate? No, but is there room for that growth between where LIBOR is today in that floor? Absolutely. So from that perspective, again, going back to the underwriting side of it makes it a little bit easier for us to kinda look at that and feel good about what our cost of capital is going to be in two to three years, which again, five years ago was definitely not the case. So we have seen demand on that side, and again, it comes back to tenants in the market, do you feel good about leasing that vacancy are there tenants leasing space there? And I think that goes back to that, workforce utilization rate, if you're downtown in some metros, you're still not seeing people come back to the office, you know, as you can see I'm at my house today, so I'm not in the office myself, but you know, in the Southeast, in certain pockets in the Northeast and definitely throughout the West, you see that as well down in Texas, for example, we have a lot of good stats in terms of what that's looking like. So every product on that side is kind of unique and it's important to make sure that you're looking at it in that manner and not just looking at it holistically as office, but it's more, what's the micro market, what's going on with the tenants and what kind of debt you can get, so that's what seeing on our side.

- Very interesting. Yeah, look, you know, Delta's throwing a little monkey wrench in the wheel. I think a lot of people thought that by August or certainly after labor day folks would be back. Now to October, maybe it's January 1st in some cases. So it a little bit of kind of wait and see, but we were all so close to it. And my own view is I do think most folks come back, I don't know, maybe I'm a dinosaur in thinking that maybe there are shorter work weeks, but I still think, you know, most folks wanna be together, that the outlook for office is generally positive. And certainly if you're suburban, you're COVID friendly, also, if you're doing anything in kinda the media technology space that caters to tech or like soundstage and production, I mean, you're seeing trades go off at phenomenal levels, a deal we worked on, it was kinda a spec creative, industrial to office conversion for a really institutional sponsor, just signed a big lease, a big credit lease 'cause they were in the soundstage space. And so seeing that was pretty amazing 'cause when we did the financing, it was completely spec. So in more niche players, I would say there's a lot of strength to life sciences also, you're seeing a ton of strength and gosh, the basis on the entry point is high on those deals because of the type of build out that you need to attract that type of tenant. It's not stopping a ton of capital markets demand and chasing that. So like you say, it's nuanced, you can't paint it with a broad brush and it depends what you're doing. And I think we'll have better visibility on, you know, some of the more urban core stuff later this year. I'll tell you what, man, traffic's back everywhere.

- That's true.

- You can't get anywhere anymore, so I'm not quite sure where people are going. And interestingly, you're starting to hear in a rebound in rents on the multi-family side, in the urban locations. And the thesis is that people are coming back in advance of thinking they're going to be called into the office. So you know, we've got to see sort of how the rest of the third and fourth quarter plays out, but it's preliminarily positive.

- That's great news and you know, I like the, on the life science component of that, we've been doing a bunch of deals there. We don't have time to cover that today, so that's a teaser for our next episode, but really good to see you Zack, really had a good time. Always good to chat and I'm sure we'll be discussing this again here soon.