Page 20 —
COLORADO REAL ESTATE JOURNAL
— November 19-December 2, 2014
Finance
T
he Denver industrial
real estate market is
forecasted to remain
strong in the foreseeable future,
with continued positive trends
in vacancy, absorption and
rental rates. The overall market
has shown dramatic improve-
ment coming out of the down-
turn, and demand for industri-
al space remains robust with an
average vacancy rate of 5.1 per-
cent*, down from 5.4 percent in
the previous quarter and from
5.9 percent at the end of 2013.
Low vacancy, combined with
nearly 3.8 million square feet
of net absorption year to date
and rising rental rates, tells us
the greater Denver industrial
real estate market is poised to
continue to perform well in the
coming year.
Like all real estate, Denver’s
industrial market is one of sub-
markets and various product
types, from state-of-the-art,
high-bay distribution facilities,
to the much smaller, owner-
occupied flex office/warehouse
space. As of the end of the
third quarter, Denver’s total
industrial inventory consisted
of 10,231 buildings totaling
approximate-
ly 287 mil-
lion sf. This
i n v e n t o r y
can be fur-
ther broken
into flex and
wa r e h o u s e
c a t e go r i e s ,
with approxi-
mately 238
million sf of
wa r e h o u s e
and 49 mil-
lion sf of flex
space. Den-
ver’s industrial market consists
of approximately 22 submar-
kets, the largest of which is
the East I-70/Montbello mar-
ket, consisting of more than 73
million rentable sf. The above
referenced 5.1 percent vacancy
rate reflects an average ware-
house vacancy of 3.7 percent
and a flex vacancy of 11.5 per-
cent.
Through the second quarter
of 2014, demand for industrial
space was greater than Denver
had seen in years and was clos-
ing in on the historic peaks in
demand of 2006, according to
CoStar. As a result, develop-
ers are scrambling to meet this
demand, with approximately
2.5million sf of newspace deliv-
ered to the market YTD and
another 2.5 million sf currently
under construction. Deliveries
of new space are well above the
levels seen over the past five
years, but continue to lag the
prerecession high of 4.7 mil-
lion sf and the 25-year historic
average of approximately 4.1
million sf. For the near future,
demand is projected to outpace
deliveries, keeping the strong
market fundamentals intact.
That uptick will not last indefi-
nitely. As deliveries continue to
grow, rent increases will slow
with vacancy reverting toward
its historic average of approxi-
mately 7 percent.
Denver’s impressive indus-
trial market performance is
being fueled by a state and
local economy that continues to
be one of the strongest nation-
ally, adding jobs and increases
in population at a rate well in
excess of the national average.
As a result, Denver, once con-
sidered only of regional interest
Frederick Trask
Senior vice president,
corporate real
estate, Vectra Bank
Colorado, Denver
Q
uick, name the three
most commonly used
metrics by commercial
real estate lenders to assess the
inherent risk in making a real
estate loan. If you got stuck after
quickly rattling off loan to value
and debt-service coverage ratio,
you are not alone. If you’ve been
in the market lately for a com-
mercial real estate loan, you may
have heard the term debt yield.
Debt yield is the newest metric
used in assessing risk and consid-
ered by most securitized lenders
to be the most important. But
what is debt yield and why do
lenders care about it?
Loan to value is probably the
most well-known risk ratio used
by lenders. In today’s lending
environment, maximum LTV
varies across asset and lender
types; life insurance companies
tend to lend between 60 percent
to 65 percent of a property’s
value, while commercial mort-
gage-backed securities lenders
are more aggressive, lending
up to 75 percent of a property’s
value. Acknowledging market
volatility and the subjectivity of
capitalization rates, many lend-
ers have become skeptical of
the accuracy of LTV. Was a cap
rate derived from in-place net
operating income or Year 1 NOI?
What type of rental growth was a
buyer assuming? Is there a large
amount of rollover risk in the
near term that the buyer is tak-
ing into consideration with the
purchase price? Because selecting
a cap rate for lenders’ internal
underwriting purposes can be
subjective, lenders have become
more apprehensive toward LTV
as the most important risk assess-
ment metric.
The other most well-known
metric, debt-service cover-
age ratio, measures the extent
to which a
p r o p e r t y ’ s
NOI covers
debt service.
Tr a d i t i o n -
ally, lenders
want a prop-
erty’s NOI to
cover annual
debt service
1.25 times at
a minimum.
DSCR, how-
ever, can be
manipulated
and
influ-
enced by outside factors. In a vol-
atile interest rate environment,
swings in Treasury rates and
credit spreads can have a large
effect on DSCR. In addition, one
can engineer DSCR by lengthen-
ing a loan’s amortization.
The main differences between
debt yield and other risk ratios is
that debt yield does not take into
consideration cap rates, interest
rate or amortization. Debt yield
is simply a property’s NOI as
a percentage of the total loan
amount (debt yield = property
NOI/loan amount). For example,
a commercial real estate property
with a $100,000 NOI collateral-
izing a $1 million loan generates
a 10 percent debt yield. Concep-
tually, debt yield is the return a
lender would receive if it were to
foreclose on the property on Day
One. Debt yield can be thought
of as a lender’s perspective of the
cap rate, the cash flow a prop-
erty generates relative to a loan
amount or lender’s basis. Using
a debt-yield ratio helps balance a
value that may be inflated by low
cap rates, low interest rates and
high leverage.
Debt yield gives a lender
insight into how wrong things
can go before the lender won’t be
made whole on its investment.
A lender would rather invest in
a 4.5 percent coupon rate loan
on an asset with a 12 percent
debt yield than on one with a 7
percent debt yield. In its simple
context, the property with a 12
percent debt yield has more cash
flow and the chance of default is
less likely. It’s an apples-to-apples
way for lenders and buyers of
securitized loans to compare
each individual loan. Everything
else equal, a $1 million loan on a
property generating an NOI of
$120,000 is less risky than on a
property generating an NOI of
$70,000.
Debt yieldhas become the ratio
of greatest importance to conduit
lenders securitizing fixed-income
loans and is arguably becoming
more and more important to life
insurance company lenders. In
today’s commercial real estate
lending environment, the rule
of thumb for a minimum debt
yield is 10 percent. That said,
minimum debt yields can vary
by market and product type. In
Denver right now, the minimum
debt yield required for down-
town office and Class A apart-
ments are 8.5 percent and 7.5 per-
cent, respectively. The less risky
an asset type or more primary the
market, the lower the acceptable
debt yield. Over the past couple
of years, competition to place
debt has forced lenders to reduce
these minimum thresholds.
Debt yield provides lenders
with a tool that removes sub-
jectivity and helps lenders navi-
gate an inflated market. Lenders
will continue to utilize LTV and
DSCR; however, in today’s low
interest rate and compressed cap
rate environment, lenders will
continue to gravitate toward and
put more importance on debt
yield to assess their risk and rela-
tive basis.
s
Dan Konecny
Associate, Essex
Financial Group,
Denver
For Company Profiles, Contact
Information & Links, Please Visit
Commercial Real Estate
Lenders
Directory
COMMERCIAL REAL ESTATE LENDERS DIRECTORY
If you would like to include your firm in this directory,
please contact Jon Stern at 303-623-1148
@
Academy Bank
Acre Capital LLC
Bank of Colorado
Bank of the West
Berkadia Commercial
Mortgage, LLC
Capital Source
CBRE|Capital Markets
Chase Commercial Term Lending
Colorado Business Bank
Colorado Lending Source
Commerce Bank
Commercial Federal Bank
Essex Financial Group
Fairview Commercial Lending
FirstBank Holding Company
Front Range Bank
Grandbridge Real Estate Capital LLC
Heartland Bank
JCR Capital
Johnson Capital
KeyBank N.A., Key Commercial
Mortgage Inc.
Merchants Mortgage and Trust Corp.
Montegra Capital Resources,
Private Lender
Mutual of Omaha Bank
NorthMarq Capital, Inc.
Principal Partners Lending
TCF Bank
Terrix Financial Corporation
Trans Lending Corporation
U.S. Bank – Commercial Real Estate
U.S. Bank SBA Division
Vectra Bank Colorado, N.A.
Wells Fargo SBA Lending
Wells Fargo N.A. – Commercial
Real Estate Group
West Charter Capital Corp.
