Best practices for Midwest industrial borrowers as a downturn looms – REJournals

Best practices for Midwest industrial borrowers as a downturn looms – REJournals

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Throughout the recent turbulence in the commercial real estate market, the industrial segment has served as one of the few bright spots for Midwestern borrowers and investors. Rents have continued to grow at a moderate but steady pace. Deals have continued to get done, with borrowers and investors having better access to capital in the segment despite the pullback of regional banks from CRE lending.

For those of us who have seen a few economic cycles, however, it’s clear that warning signs are beginning to flash, even in the industrial space.

According to Lee & Associates’ Q3 2023 North American Market Report, vacancy rates in key Midwestern markets including Chicago, the Twin Cities, Cincinnati, Columbus and Kansas City, Kansas, all increased in the third quarter on both a year-over-year and quarter-over-quarter basis. Absorption in key Midwestern markets is down year-over-year, as is new space coming online.

For borrowers in the Midwestern industrial segment, then, it will be critical over the next several months to take stock of their various investments and business plans, and to think proactively about working with their lenders to ensure that their loans remain in good standing.

Brian Good, managing partner, iBorrow

Following are some key best practices that can help these borrowers prepare to weather a potential downturn:

  1. Be aware of your options.

Lenders are often willing to work with borrowers with whom they have good relationships. They can give borrowers more time to pay back their loans, adjust their interest rates or other terms and even upsize their loans (within reason).

Newer borrowers sometimes think that loan terms are set in stone once a transaction closes, and that complying with those terms is a binary proposition, especially during tough times.

In fact, the borrower/lender dynamic frequently offers more options than they realize, as long as they work to keep the relationship strong. Being aware of this – and working with lenders that have exhibited flexibility in the past – can make all the difference when a borrower encounters turbulence in the market.

  1. Maintain consistent dialogue with your lenders.

Maintaining strong lender relationships during a rough stretch is all about communication. At iBorrow, we continually remind borrowers to tell us early and often if a problem emerges.

If a borrower suddenly stops responding to a lender’s emails, or worse, stops providing required information like quarterly financial reports or bank statements, the lender relationship can turn south very quickly.

On the other hand, those that proactively and consistently stay in touch often find that their lenders become their most valuable partners when challenges appear.

As an example, one iBorrow client recently found that the costs of improving and leasing up a vacant industrial property that it had just purchased in a Midwestern MSA were going to come in $600,000 higher than expected.

The borrower was willing to pay the extra cost directly to make the lease work, but the loan documents dictated that those excess funds needed to be funneled through the lender to avoid mechanics’ liens. That would have involved putting the funds in escrow – an outcome the borrower wanted to avoid.

Without strong communication from the borrower, our team might not have felt comfortable working with it to find a mutual solution to this problem. In this case, however, the borrower went out of its way to keep us in the loop. The borrower let us know about the issue right away and did not try to obfuscate the situation to avoid the escrow.

As a result, we agreed to allow the borrower to pay the extra costs without iBorrow’s involvement. This solution streamlined the situation for the borrower, helped to avoid the escrow restrictions and resulted in an even stronger borrower/lender relationship.

  1. Don’t assume your lender relationship has to be adversarial – and don’t play games.

Borrowers who have not encountered difficult conditions before often think of their relationships with lenders in ‘us vs. them’ terms. If they can’t adhere to the exact terms of a loan agreement, they assume that the lender will immediately take the most extreme position and consider them to be in default.

This mentality leads some borrowers to use hardball tactics when conditions get challenging, like threatening to hand over the keys to a property as a test of the lender’s resolve. They unfortunately take the short-sighted route to try to force the lender into more favorable terms, when they could have found a win-win solution simply by maintaining a better rapport.

The fact is that hardball tactics most often result in a kind of self-fulfilling prophecy, turning a solvable problem into a standoff in which neither side wins.

  1. If necessary, investigate refinancing options before a downturn hits.

Most industrial leases are structured with three- to five-year terms, meaning that borrowers can sometimes ride out a short-term downturn, even if they have a shaky relationship with their lender. It’s also possible to repair some damaged lender relationships by increasing communication or taking steps to proactively make payments early.

In some scenarios, however, borrowers may want to take stock of their existing lender relationships and ask whether it would be beneficial to switch to another lender before conditions worsen in the industrial segment.

For borrowers whose lender relationships have frayed significantly – and who have access to other sources of capital – it may be wise to explore a fresh start elsewhere, rather than risking further strain on the relationship should a downturn hit.

Conclusion

Midwestern industrial borrowers who have become accustomed to relatively smooth sailing in that CRE segment may soon find themselves in unfamiliar waters as industrial conditions worsen. Although industrial continues to look significantly better than other segments today, warning signs are emerging for sharp-eyed market watchers.

However, by taking a proactive approach to maintaining strong communication with lenders, being aware of their options and avoiding the temptation to ‘go silent’ or play hardball, Midwestern borrowers and investors in the industrial segment can put themselves on firm footing to come through the looming challenges, keep their loans in good standing and fulfill their business plans.

Brian Good is managing partner of iBorrow, a nationwide direct lender that provides short-term bridge financing to commercial and multifamily property owners.

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