Specialized Properties Can Present Lending Challenges

SEBASTOPOL, CA—Loans in secondary markets can be challenging under the best of circumstances, but one that is not only located in a smaller city and for a specialized property can be doubly complex. Despite these obstacles, a property consisting of two full-scale production wineries, two breweries, a distillery, and complementary retail and industrial uses recently received a $37.5 million permanent loan.

Proceeds were used to refinance 17 buildings and 178,000 square feet of space in downtown. The financing was used to buy out an existing equity partner and replace the project’s debt with long-term fixed rate financing.

Landmark Capital completed the transaction for an affiliate of Aldridge Development, a local developer with expertise in retail and multifamily communities throughout the Pacific Northwest. Ethan Schelin, director at Landmark Capital, represented the client. He recently shared some insight about the transaction, the challenges of winery loans and the general lending outlook for the region in this exclusive. A key aspect of completing this transaction was identifying a lender who would understand the Sebastopol market and the unique tenant mix. What did that entail?

Ethan Schelin: The property is located within a small town in a secondary market. This is challenging to most lenders because they perceive the depth of the rental market as being very shallow. For example, if you lose a tenant in a market like this, lenders think it could take a long time to find a replacement, and even though a property is fully leased, it creates questions and doubts about the consistency of the cash flow going forward to support the loan.

In terms of the tenancy, there are several wineries, breweries and other unique tenants at the property producing specialty goods. This can create its own set of challenges to lenders as it’s easy to perceive these specialty tenants as having “specialty buildouts” to their spaces that would be hard and expensive to re-lease to another tenant if they were to vacate. From a lender’s perspective, it is ideal to have a property located in a strong and deep rental market with space that is easy and cost effective to re-lease to another tenant. Landmark Capital Advisors was able to identify a lender that understood the dynamics of the local market, and its true depth for replacement tenancy. winery properties have any unique lending requirements that make them more challenging in general?

Schelin: If it was a standalone winery, it would have been subject to unique requirements. For this particular property, though, the wineries were large tenants within a greater mixed-use retail and industrial park so these requirements did not apply. However, many lenders assume that wineries have very specialized buildouts and it is expensive to modify that space to meet the needs of a replacement tenant if they were to vacate. Although this can be the case, oftentimes I have found that specialty equipment is misconceived as specialty buildout, and when a tenant vacates, the equipment can be removed much easier and much cheaper than originally thought. Also, if a tenant gets into financial trouble, they will likely remove the equipment for you and try to sell it. Will the rate increase have any impact?

Schelin: Not on this particular transaction as we fixed the rate for 10 years and closed prior to the increase. However, higher interest rates in the market going forward will adversely impact a property’s debt coverage ratio which could translate into lower leverage. What is the current market climate for lending in Northern California?

Schelin: In general, it’s pretty bullish but there are certain submarkets and product types that are getting more scrutiny than others. Outside of this particular transaction, I have seen lenders reining in their allocations for hotels and dialing back leverage for multifamily development in certain areas.

One multifamily loan recorded last year was located in the Bennett Valley, also in Sonoma County.