Which Industrial Property Owners Have the Highest Risk During a Recession?

Given the market we are in today, it is hard to find any fault in owning industrial property. Vacancy rates are hovering around 5% county-wide and there is not nearly enough construction to keep pace with growing demand. But, if things do go sideways, some owners are at higher risk than others.

Over-leveraged Owners

We saw many owners get hurt in the Great Recession by having a high loan-to-value ratio on their properties. Many investors in the early to mid-2000’s bought leased properties with high leverage, but were still able to cover their debt service at market lease rates. Then 2008 happened. Tenant defaults went through the roof, leaving property owners with overleveraged empty buildings that were declining in value every month. In some cases properties values fell by 40% and many owners found themselves under water. While few in the industry anticipate such a severe correction, highly leveraged owners are at greater risk.

Owners of Functionally Obsolete Properties

When the market is strong and spaces are limited, properties with elements of functional obsolescence like no yard area, low ceiling heights and lack of sufficient parking get a boost in value because of the lack of supply of more functional properties.  In a tight market, tenants are forced into less functional buildings and must often pay a premium for it. When the market corrects, the supply of higher quality buildings increases as lease rates fall, causing functionally obsolete space to sit empty longer. That forces landlords to cut rates further and offer more concessions like free rent and interior improvements to attract tenants.

Properties with Deferred Maintenance Issues

Under current market conditions Landlords are able to get away with deferring some of the maintenance because of the high tenant demand. Landlords have the upper hand in lease negotiations and are more able to insist on tenants taking their space as-is where-is. But, in a correcting market, tenants gain negotiating power and can insist on having the building brought into good condition along with insisting on higher levels of tenant finish. This forces owners to come out of pocket at a time when their cash flow has been disrupted by a higher incidence of vacancy. Tenants will pursue the highest quality buildings first, which increases time on market for properties in sub-par condition.

It is important for every owner to know where his or her property stands relative to the competitive set. If your property has one or a combination of the foregoing risk factors, now is the time to take action. Better to make the necessary capital investment while market conditions are still favorable to property owners. If you would like to discuss how you can reduce your risk of a market correction, please contact me via email me at ajize@voitco.com or call me directly 858-458-3361.