Why the Finance Spigot Is Open for New York Metro Spec Industrial Projects

Michael Klein

Industrial real estate in the New York Metro market continues to be extremely desirable to lender types due to strong tenant demand, limited available space and rising rental rates that are increasing at a staggering pace. In the wake of COVID, demand for Class A space has never been higher. With limited options available, investors and lenders have made cold storage and flex space a priority, especially in proximity to dense population centers.

Due to the booming demand, developers are seeking creative and economical means by which to develop speculative industrial space amid rising land costs and a lack of available sites. Some options include converting office and retail properties into industrial facilities and even creating new submarkets. Once considered a high-risk venture, these modern speculative buildings are leasing up quickly—in most cases—prior to construction completion, minimizing the risk factor for lenders.

As such, the market is deep with local, regional and money center banks, life insurance companies and private REITs eager to get in the game. There are a variety of financing options available today for investors; traditional construction loans provide a loan-to-cost ratio of below 65 percent on a non-recourse basis often with completion and interest and carry guarantees. 

It’s not too late to take advantage of the market. Investors requiring financing of up to 70 to 75 percent can still secure non-recourse construction financing through alternative lenders at a slightly higher cost of capital. More traditional bank options are also available but would require partial to full recourse, depending on the location and the developer’s track record. To go even higher, up to 90 percent of cost, lenders can layer on mezzanine financing or preferred equity. While this will increase a borrower’s costs, it can be a better option than having to bring in a joint venture partner, which would dilute the developer’s returns.

For investors concerned about interest rate risk throughout the term of the construction loan, there are construction-perm options with long-term rate locks for as long as 25 to 30 years. In addition, a bridge-to-construction loan can provide time for existing tenants to move out and secure zoning variances and entitlements, as well as time to clean up any environmental issues prior to demolition.

Some of the more notable transactions were:

• Construction financing of $381 million secured for the development of Bronx Logistics Center, a Class A, two-story last-mile distribution facility totaling 1.3 million square feet in the Bronx, N.Y.
• Construction financing of $34 million secured for the development of a new 140,000-square-foot cold storage build-to-suit facility for FreezePak Logistics within the Port Industrial submarket on the border of Elizabeth and Newark, N.J.
• Construction financing of $12.66 million secured for the development of 130 Commerce Center, a Class-A, 171,000-square-foot, state-of-the-art speculative warehouse/distribution center in Hamilton Township, N.J.
• Construction financing for a new Class A, 76,000-square-foot, state-of-the-art speculative warehouse and distribution facility in Wallkill, New York.

New York City Outer Boroughs

The New York City Outer Boroughs Industrial market continues to set record low vacancy and product availability, resulting in an increase in rental rates by 15.6 percent year-over-year. As demand continues to outpace supply, we anticipate new Class A developments could push above the $40 per square foot mark.

Industrial sales activity reached an all-time high last year, totaling $1.21 billion. In addition, construction activity is the highest it has been this market cycle, with more than 3.4 million currently underway throughout the Bronx, Brooklyn and Queens, with an additional 3.6 million planned over the next two years. 

New Jersey

The New Jersey Industrial market recorded an all-time high of 450 transactions in 2021, representing more than 45.3 million square feet and resulting in more than 25 million square feet of absorption. In short supply is the Class A market, which posted a 38.9 percent increase in asking rents. The lack of available space spurred developers to break ground on 6.9 million square feet of new product in the fourth quarter, nearly double the 2020 average of 3.8 million. Another 20 million square feet is anticipated for delivery in 2022, much of which is speculative development. It might not be enough.

Eastern and Central Pennsylvania Activity

Demand significantly outpaced supply last year in Eastern and Central Pennsylvania. Net absorption levels nearly doubled the 19.5 million square feet recorded in 2020 to a record 35.8 million. Class A vacancy rates declined by more than 560 basis points from 2020 to an all-time low of 3.1 percent. At year-end, there were only three Class A vacancies above 500,000 square feet remaining, pushing Class A asking rents up more than 25 percent to $6.95 per square foot—the largest year-over-year increase in market history.

Emboldened by strong tenant activity and rent growth, developers broke ground on a record 38.9 million square feet of new construction in 2021, 80 percent of which was speculative, marking a 63.5 percent year-over-year increase in ground breakings. We anticipate they will need even more to meet the growing demand.

Strong fundamentals demonstrate the need for additional industrial space in the New York City metro, New Jersey and Eastern and Central Pennsylvania markets. My advice to developers: Keep building. There will be ample capital available.

Michael Klein is senior managing director and co-head of JLL‘s New Jersey Capital Markets Office.