Column by Martin Siegel and Matt Lebenson, Wool Finance Partners, LLC
There is possibly no hotter market in Chicago real estate today than the Fulton Market District. The recent arrival of Google and pending arrival of McDonald’s has placed this neighborhood in the crosshairs of every major developer in Chicago, New York and beyond. This activity has misplaced many of the traditional meat packing and wholesalers who called Fulton Market home for decades.
The ongoing gentrification of Fulton Market and Goose Island has created tight industrial markets throughout the city proper with vacancy standing at 3.5% in the City North submarket. This has created a dilemma for owner-users who want to capitalize on the increased value of their real estate asset, but believe the task of finding an adequate replacement property for their operation is too difficult. Investment properties encumbered by older leases may not reflect current values because highest and best use has changed. How can owner-users and investors capitalize on the rapidly increasing value of their real estate asset without a disposition?
Placing conventional mortgage financing on the asset is one solution that comes with several benefits to the property owner. In a market experiencing rapid value increases, typically long-standing business owners have accrued a significant amount of equity in their commercial property. A cash-out refinance allows borrower to finance property repairs and improvements, payoff existing business debt or provide working capital at a low fixed interest rate.
In low leverage situations, property owners can borrow additional cash proceeds without any income tax liability. For the owner-user there is the benefit of avoiding disposition fees and costs including brokerage fees, moving costs, and downtime costs while gaining additional interest and closing cost write-offs. In addition, the owner-user avoids the often overlooked cost of paying a premium to find an adequate replacement property in a tight market.
In the case of owners of investment property in the neighborhood, many now have underlying fee simple land values that far exceed the leased fee value of their investment property. Many leases that were signed two to three years ago have a current capitalized value that represent as little as 25% of the market value of the property as a development site.
Many of these leases still have significant lease term remaining which makes a disposition of the asset not an appetizing option due to the buyout expense. Furthermore, many of these property owners would prefer to hold the asset while there is cash flow in place since there is strong belief values in this neighborhood will continue to increase over time. Placing mortgage debt or refinancing an existing mortgage is a viable option to capitalize on the increased value.
In recent months Wool Finance Partners has refinanced two such properties in Fulton Market District. In each case, the borrower was able to refinance net-leased single tenant industrial properties with cash out proceeds, limited recourse and minimal prepayment penalties. Leverage for each financing ended up below 60% due to the consideration of underlying fee simple land value as the reversion value in a discounted cash flow analysis.