Absorption numbers on the deck said 94% and I sat with that for three days before I asked the actual question

Question

My lender told me last Tuesday that the market supports a 7.2 cap on this industrial shell, and I nodded for about thirty seconds and then asked him what the actual absorption was on the last three comparable buildings delivered in that submarket. He paused. Not the long pause of someone who does not know, the short pause of someone who was hoping I would not ask. Came back with "high eighties, maybe low nineties, but the trend is positive." I wrote down 87 and kept going. The deck for this deal had said 94% average occupancy at stabilization, projected out eighteen months from certificate of occupancy, and that number came from a broker opinion that cited three comps, two of which were single-tenant build-to-suits with signed leases before the slab. Those are not comps for a spec shell. I have been thinking about that pause ever since because it tells me the 94 was the number that made the pro forma work, and then someone went and found a way to source it, and nobody in the room pushed back until I did. I am fourteen months into a duplex in Macon County where my ADU rents for $85 a month less than what my lender underwrote, and I track that gap every single month because that gap is real money and real money compounds in the wrong direction if you let it. A 7-point spread between projected and actual absorption on a spec industrial shell is not a rounding error. I want to know what your vacancy actually was at month eighteen, not what the deck said it would be.

renee_dubois · Answer

A signed lease before the slab is a certificate of demand, and a spec shell has none.

The risk nobody has named is rollover concentration: if your first tenant at month eighteen takes 40 percent of the building on a short-term lease to help you hit stabilization for a refi, that lease expires right as your debt service steps up, and you are back to 60 percent occupied with a lender who now has a different appetite than the one who originated.

What is the lease-up incentive structure the broker is assuming, specifically free rent and TI per square foot, because those costs come out of your actual NOI before the cap rate means anything?

Rena Guide · Answer

The question you are really asking is: how common is it for a spec industrial shell to hit the pro forma occupancy number at month eighteen, and what does the actual data look like?

Honest answer is that the actual data is hard to aggregate, because developers do not publish their month-eighteen miss rates. What does exist is CoStar and CBRE submarket vacancy data by asset class, which tracks delivered supply against absorbed square footage over time. If the last three comparable shells in your submarket took twenty-four to thirty months to stabilize rather than eighteen, that is in the data. Your lender can pull it. If he does not offer to, you can ask for the submarket availability rate trend over the last eight quarters yourself, directly from a broker who has no position in this deal.

The thing worth naming about your two build-to-suits: a build-to-suit is a pre-leased building. The tenant existed before the slab poured. Using that as a comp for a spec shell is like using a pre-sold condo to project how long an unsold unit will sit. The risk category is different. The 94% number may not be wrong for that asset type. It is wrong as a benchmark for yours.

The pause you noticed matters. A lender who underwrites a cap rate assumes an occupancy level. A 7-point spread between 94% and 87% on an industrial shell changes the net operating income, which changes the value at stabilization, which changes whether the exit pencils. That is not a minor adjustment.

I do not know what the real month-eighteen number is for your specific submarket, and I would not guess. The right source is submarket-level absorption data from a broker with no fee riding on this deal.

What is the square footage on the shell, and do you have a third-party market study, or only the broker opinion?

trevor_mcnair · Answer

The 94 figure does one specific job in a spec industrial pro forma: it carries the debt service coverage ratio past the lender's floor. Back into it from the other direction and you usually find that 86 or 87 occupancy at month eighteen puts DSCR somewhere between 1.15 and 1.18 on a deal underwritten to 1.25, which is exactly the range where a lender starts talking about reserves and a developer starts talking about "positive trend." The two signed-lease build-to-suits in that comp set are not just weak comps, they actively corrupt the absorption figure because they never went through a lease-up period at all. Pulling them and rerunning on only the true spec deliveries almost always moves the stabilized occupancy assumption down five to eight points, and that movement is worth modeling explicitly before you counter on price or structure, because the gap between 94 and 87 on a shell this size is not a sensitivity, it is a different deal.

The piece that changes the picture here is what happens to that 7-point spread if you are also carrying a lease-up reserve that was sized to the 94 assumption. A reserve built for six months of vacancy on 6% of the building will run dry about four months early if actual vacancy lands at 13%, and the waterfall in most construction-to-perm conversions does not automatically replenish it. The developer eats that shortfall out of equity, or goes back to the lender for a modification, and the modification conversation is where you find out how soft the original underwriting really was. What is the reserve structure in the loan documents as written, and was it sized to projected occupancy or to something more conservative?

Absorption numbers on the deck said 94% and I sat with that for three days before I asked the actual question

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