Two bulk warehouses at a 4.6 cap in 2022, distributions stopped 14 months in

This is the one I got wrong, and I did the due diligence, which is the annoying part.

Two 1990s vintage bulk buildings, roughly 310,000 square feet combined, 24 foot clear, in a southern distribution market that was on everyone's list. Bought in mid-2022 at a 4.6 percent cap on in-place income. Floating rate debt with a rate cap that ran two years. My check was $100,000 of a raise I won't name.

What I read before I wired: rent roll, the tenant financials they'd share, the third party report on roofs and paving, the market study. All of it was fine as far as it went.

What I didn't push on hard enough was one line in the model. Renewal rents grew at 8 percent a year for five years. In 2022 that looked like a description of the recent past. Then the market took in a lot of new construction, the 260,000 foot tenant in the larger building didn't renew, and the space came back into a submarket where three brand new buildings with 36 foot clear were also empty and cutting deals. Our building leases against those on price, because that's the only lever a 24 foot box has.

Costs: distributions suspended at month 14. The rate cap expired and debt service went up. A capital call last year of 12 percent of original capital, which I funded, partly because not funding it was worse under the docs. Current basis: $112,000 in, no cash out since month 14. Sponsor says stabilization in 2027.

What I'd do differently: I'd have re-run the model with renewal rents flat and asked the sponsor what breaks. If the answer is the debt service coverage, the deal was a bet on rent growth, and I'd rather know that before wiring than after.

5 replies

2laurenkim53Passive

The 8 percent renewal growth line is what gets me. Five years of it compounds to almost 50 percent above where you started. Did anyone on the investor call ask where that number came from, or did it just sit in the model looking normal because the last two years had been like that?

3nicole_adeyemiPassivePRO5

I'd argue the clear height was the deal, more than the growth assumption. 24 feet was a fine building in 1998. A modern distribution tenant racks to 36 and up, and once new supply lands in the same submarket your only pitch is cheaper rent per foot. You bought a commodity box at a price that assumed it was a scarce box. The rent line just made that visible faster.

1diane_kowalskiPassivePRO9

@parcel, I half agree. Plenty of 24 foot buildings lease fine when they're infill and there's no land left nearby to build the 36 foot version. What did the site look like, @canton? Was this in a corridor with a lot of raw dirt and by-right industrial zoning around it? That's the part I look at first now, because a market study will tell you absorption and never tell you how many acres are sitting entitled two exits away.

1paulgrant17PassivePRO5

Reading this before my first rental closes and taking one thing from it: ask what happens if the good number stays flat.

1karen_whitfieldPG4APRO7

Floating debt with a two year cap on a building whose lease had rollover inside that window is the piece I'd underline. The rent growth assumption is a forecast, and forecasts miss. The cap expiration was a date on a calendar that everyone could see in 2022. If the plan needed a refinance or a re-lease before that date and both slipped, there was no slack anywhere. I've held land through two full cycles on the theory that time only helps you if your debt lets you wait.

Two bulk warehouses at a 4.6 cap in 2022, distributions stopped 14 months in

5 replies