Talking Property | Funding the Fit Out of Your I&L Asset

KB 
Hello, and welcome to Talking Property with CBRE. A podcast in which our team of experts, our clients and industry specialists share insights into the way we live, work and invest through the lens of commercial real estate. My name is Kate Bailey, Director of Research in the Pacific and I'm your host for today's episode. The rise of eCommerce over the last few years, combined with consumer demand for fast delivery has placed increased pressure on landlords and occupiers to future proof their assets. One way occupiers and landlords are looking to do this is investment in fit-out and automation, but it's a pretty expensive exercise. So what opportunities exist when it comes to funding the fit-out of your industrial logistics asaset and ensuring your supply chain is set for the future? To help me unpack this topic, I'm joined by two of CBRE's experts who specialise in just this, Jason Burgess Senior Director from our Debt and Structured Finance team and Christine Miller, CBRE's Head of Supply Chain in the Pacific. Christine and Jason, thanks so much for joining me today. 

JB 
You're welcome, Kate. Thank you. 

CM 
Thanks for having me Kate. 

KB  
Well, Jason, maybe before we dive into this conversation, could you please give our listeners, a bit of a two minute tour of your role at CBRE and of the Debt & Structured Finance business? 

JB 
Sure can, so I head up the Victorian Debt and Structured Finance business for CBRE. For those, who are familiar with the CBRE brand, I would assume that the debt business is not the first, second or third or fourth line of business that immediately comes to mind, but to put some meat on the bones, this is a well established business overseas, we are a significant contributor to CBRE's global profit. We came to Australia five or six years ago. We're currently managing worldwide, north of $5 billion worth of funds, through some direct relationships with some offshore lenders and that's growing at roughly the three quarters to a billion dollars a year is our business line. So it's not something that jumps straight into people's head when they think of CBRE but within the walls of CBRE, it is a big, big part of our business. 

KB 
Yeah, it's surprisingly large actually and so you are obviously working with landlords and occupiers, but is funding, supply chain networks and fit out something that the team would look at? 

JB 
Yeah, certainly, we have a number of funds, that...We look at at all types of funding, Kate to answer the question probably more broadly, not just traditional mortgages. We look at equipment finance. We look at, fit outs and business to business lending as well. So whilst majority of our day to day work is doing property lending. We do also do other types of lending as and when our clients need it. We look at proposals anywhere from sort of 5 million to 300 million is, is probably where we do a lot of our work. That could be a pure investment asset where someone buys a Seven-Eleven for example, right through to someone buying a property in Collins Street to a development of several hundred apartments. So there's a wide variety of things that come through our pipeline. Not just investment debt, not just property debt, but as Kate said in the start of the conversation, we do also equipment finance that might be planes, trains, automobiles, fit, outs, computers, anything else that the business needs to operate properly. So there's a wide variety of things that come across our desk, not just traditional property assets. 

KB 
Yeah. Right. That's super interesting. Christine, you're obviously at the forefront of, you know, our supply chain advisory business in Australia and New Zealand, maybe you can provide our listeners with a quick overview of some of the services you provide. 

CM  
Oh, sure. I'd love to. We are a team within CBRE of supply chain practitioners. So what we do is work with clients in order to define their requirements. So the team does everything from design distribution networks. So determining how many facilities, what size they are, where should they be located? What role should they play in the distribution of their products? We also design the warehouses as well as the internal operating solutions, which can include manual or automated solutions. So we work alongside the occupiers in providing those services and then the experience that we have from that helps us advise investors on what type of products are most aligned to the occupier requirements in the market. 

KB 
Yeah. Great. One stop shop. Love it. <laugh> Jason, maybe shifting gears a little bit and starting to think about where we're at at the moment, it's obviously a little bit of uncertainty in the market at the moment, rising interest rates and a lot of the costs associated with debt. Can you talk to the current lending landscape and some of the challenges that clients are facing when it comes to sourcing debt? 

JB  
Sure. So where we've come out of the last two years through the pandemic was interest rates were at all time lows. So when people started talking about interest rates going up and up and creating sort of negative sentiment, almost, I said it almost a positive we're moving back to business as usual. So we're not...Interest rates, they're more coming from a base that we've never seen before. So pre-pandemic we're at the same rates. Now, whilst inflation is sort of a little bit of control. The main lever that the RBA has is increasing interest rates, but that'll tail off over time. So we are in a bit of a high inflation environment. So that's, what's causing interest rates increases. There's still plenty of funds out there. So for people listening to this call, don't, uh, it's not all doom and gloom. Both the banks, the non-bank, the property trusts, they're all keen to right business. And when you do property finance and I'll just concentrate on property finance for a second, you have two interest rate components. One is the, what called the Wholesale Rate or the BBSY rate and then is the margin. What is increasing is the BBSY rate, the margins aren't overly increasing in some respects, they're actually coming back a bit. So the banks fund of a certain interest rate above the BBSY rate. So that that interest rate is gone from 0.06% at the height of the pandemic to now somewhere around the 185-190 mark. So there has been an increase and I'd love to say that that's where it's going to stop, but there is a fair bit of evidence that those interest rates will keep going for other few more increases, uh, so that they were, we're going to increase a bit more over time, but that's not to say that, as I said, that there is a lot of appetite in the market. 

Australia's relatively safe haven for debt finances. So whilst you've got the big four and the associated sort of second tier banks in Australia still actively lending, you've also got a lot of other funds that are coming more and more prevalent in the market that we're seeing every day and the amount of money that's being brought into those funds. You just have to pick up the financial review most days, and you see a billion dollars here, or 500 million being here, being invested into the local property market. So there is, there is a strong, willingness from the lenders to provide finance, but there is a little bit of caution with interest rates going up and what that does to the covenants. And when I say covenants that, uh, for example, on, an investment deal there's this thing called interest coverage ratio with interest rates increasing that some of the covenants been put on a little bit pressure, but it's not to say that the banks and the non-bank aren't there ready to lend, they are, it's just, they are ticking a few more boxes then they perhaps would've been six to 12 months ago. 

KB  
Christine, how are you seeing that play out with your clients and their projects? 

CM 
Funding is often the last and most difficult hurdle is, you know, the uncertainty in the market has really translated to disruption in supply chain, and that's really been a constant for the past 18 to 24 months. So we've seen everything from uncertainty in terms of supplier performance and the availability of product coming through the supply chain. We've seen disruption through the transport, whether that's ocean, whether that's air, whether that's road transport, and now we've seen shifts in consumer behavior as we've gone from COVID where everything was online to now, consumers are quite interested in returning back to shopping in person and having that in store experience. So what we're seeing now is businesses really having to reassess post COVID. What does their growth look like? How does that normalize over the coming months, you know, to years? And if you add in that disruption with things like low vacancy that we're seeing in the industrial and logistics in particular, that increases the need to increase throughput through an existing footprint and that means getting more out of those operational sites and that oftentimes requires investment in improved fit out. So that's improved process handling equipment, and often times where those decisions are made at board level, there might not always be a direct line of sight between those operational investments and the direct link to top line growth. So I think often times at that final stage of getting that final sign off, it can be quite a hurdle to provide the visibility on how that's directly related to the growth of the business. 

KB  
Yeah, absolutely. Just expanding on some of those challenges, what are some of the other challenges that, um, your clients are seeing when building their supply chain networks at the moment? 

CM  
You know, it's probably something that doesn't get a lot of visibility, but the challenges with confidentiality is for a lot of business, most in fact, service delivery would be their competitive advantage. So that means there's not a lot of open sharing of best practices in terms of distribution, order handling, whether that's online, whether that's store replenishment, because it's seen as that competitive advantage on doing things better in the market, which means everyone's trying to solve it on their own and if we couple that with, you know, Australia has traditionally lagged behind some of those other mature geographies in terms of distribution, multi-story warehousing would be, you know, just one example and often times if that's envisioned to be part of the future solution, again, that can be a challenge getting support behind being a first or an early mover in kind of adopting some of those things that you don't see as necessarily mainstream. So I think those are some of the challenges that don't necessarily get a lot of visibility. 

KB  
That's, really interesting. Now probably a question for both of you, but Jason, I'll get you to go first with average lease terms, we know that they're shrinking at the moment with landlords, really trying to capitalize on some of that rent growth. What are the ways that landlords can support their occupiers and really create those relationships to ensure stickier tenants? 

JB  
When I first started banking many moons ago, the loan term of the debt was very much closely aligned to the lease term. So in a four year lease, you do a three year loan term and it was very much, that was the golden rule in lending 101. As we've got more intelligent, we've looked into it and we've looked a little bit deeper things like fit-outs, if you're lending to a property where it's just had a recent fit-out, well, tenant's are unlikely to leave it if there's a short term loan. If you're lending to a property, that's got multiple tenants that are all three to five year leases, then it's not as big concern a as you've got one. So there is ways to look around this. It's not just all about the lease term anymore. The banks are probably a little bit late to adopt that. Certainly the non-banks look behind the scenes and say, well, what's the true motive of the tenant. If they've just signed a brand new lease for three or four years, but they've just spent 5 million on a fit out, it's unlikely you're going to leave quickly. So it's about understanding what the tenants, how long they've been there. We've had properties recently where, you know, we had had a collective weighted average lease expiry of just over two years, but the property portfolio we are doing at a hundred tenants. So we're able to procure loan terms in the seven years. Uh, we've also seen tenant properties where they're all short term leases, but the customer's been on these 15th three year lease. They've been there for 50 years. So you look behind the scenes and understand it better. So it's not just all about how long the lease is these days versus where it was five, 10 years ago, where you were certainly very structured by just looking at very macro data and not looking behind the scenes. So to get tenants in longer, there's, there's many ways tying their fit outs to, to leases and a number of other ways that we as finances, we, we can now look under the covers, but we've still got to, uh, be concerned about that if it's a short, really short term lease, you got to understand the motives of the tenant. 

KB  
Yeah. And Christine, what are your thoughts, especially around, you know, investing so much into automation, if it's going to be a shorter lease that obviously throws up some challenges. 

CM 
Oh, it definitely does and I completely agree with Jason's point about understanding what the process is and what that fit out means to that particular occupier. I think that's the opportunity to provide a mutually beneficial relationship between that occupier and the landlord. Clearly from an investment side, there's an, an interest in driving up the rents and for an occupier who puts his facility in the right location to service his customers, there would be an ability to absorb those rental increases. If the facility allowed for them to increase their throughput and their product. So if they can grow their top line and just maximise the utilisation that they get from that site, that actually gives them an interest in staying there longer. So naturally if they've invested in the fit out, or if that is part of the relationship with the landlord, gives them a bit of stickiness. And again, being in the right location allows them to save on transport and service delivery. Maybe absorb a bit of that rental increase that's happening now. But I think the other way of doing that is also to align the physical characteristics of the site with the operational requirement of the occupier. So in order for that building to really perform to those occupier requirements, it needs to have the right number and the right type of dock doors. It needs to have the right type of hard stand and amount of hard stand to have a really efficient operation that just allows them to increase sales, increase their throughput, and really maximise the utilisation of their site. So I think there's an opportunity, even though lease terms are changing to just find a way for that relationship to be quite mutually beneficial. But I think it needs to align both the sites with those operational requirements of the occupier. 

JB  
I I'd agree with that. Just if I sort of jump in for a second that, uh, we also look at these days, you know, what's, especially in environment, where the employment rate is so low. What's the amenities for the, the people that occupy the buildings, the actual employees. And if there's no, no amenities, it's far away from train stations. It's not easy to get by car. All those things come into when we're considering the finance. When you look around the area and say, well, these five properties here are fully tenanted. We've got one here that's a little bit vacant. Okay, we'll take a punch on that one that's a little bit vacant because we know it's got the amenities that the tenants want and also the employees of the tenants. So it's about looking under the scenes and saying, well, why is the property vacant? If it is that way, why has it got a short term lease and what's the long term view on the property and those things weren't considered probably 10, 15 years ago, but now they are, you know, the end of trip, that's something that, that I probably, would've never seen me saying, or, or talking about 10 years ago, but now it's something that I, I regularly have conversations with our funds about. 

KB  
mmm, interesting. 

CM  
Kate, Jason is spot on. I just came from a client this morning and there was a whole five minute discussion around how much use the basketball court gets. <laugh> that's, that's there on site. So it provides great amenities. Often times employees are staying behind to have a bit of a team game type of thing, but it's also just engagement having that environment and that, that's definitely not something that historically you would've seen as is part of a warehouse footprint. 

KB  
No, they're remembering that people work in warehouses and you've got cater to them. So that's absolutely right, Jason, to finish things up today. You know, funding obviously plays such a big role in building those really efficient supply chains and so I guess my question is for those occupiers and landlords who, who don't want to be left on the side lines due to a lack of funding, what opportunities are available to them? 

JB  
Sure. One thing that's probably come out of that I didn't realise, and I'm not sure I can't speak for Christine, but it's something that we tend to ask the same questions, except my question is...Christine might say, well, how are we doing this? And I'll be saying, well, how are we going to fund that? So very much, pretty much any question that Christine has, I can put, how are you going to fund that at the end of it? So our businesses on the surface may appear world's apart, but when you break it down, actually pretty close. But to answer your question, there is a number of ways we can fund fit outs. The first and most obvious is just to increase the debt on the property, through their finance chain, but that's not always available. So our fall back then is to do equipment finance and how it works is we essentially get a hundred cents in the dollar funding. So if you buy something for 5 million, we get 5 million worth of funding and how it's paid for is a small increase or the leases increase to dramatise that extra finance cost over the term. Otherwise the tenant starts putting all sorts of equipment into a property, which they don't own. One there's, there's all sort of legal clauses about something was to go wrong. Who owns that equipment? The landlord might not want people drilling and boring holes into his property without their 'okay'. So the easiest way to do it is, is to get an increase equipment, find that facility against whatever the, whether it be forklifts, racking, you name it, any sort of equipment that you want to put into an industrial property and that's essentially paid for by, you know, a small increase over the loan term. Obviously that's better. If the loan term's longer that the caveat I'll put on it, if the loan term's short, then no, uh, landlord wants money owing at the end of that lease. So if it's a five year loan term, the rent will be a lot higher whether it's a 10 year, lease term rather. 

KB  
Fantastic. Well, thank you so much for your time today, Christine and Jason, it has been a really interesting discussion and I have just learnt so much about the breadth of both of your business lines. So really appreciate your time. Thank you for listening to talking property with CBRE if you like the show and want to check out more, visit cbre.com.au/talking-property or subscribe through Spotify and Apple Podcasts. You can also read CBRE's Q3 Credit Intentions Survey by clicking the link in the show notes.
Until next time.