More than $700 million worth of industrial properties fell intotrouble in February, upping the total outstanding distress to $6.8billion by the end of March, according to Real Capital Analytics'latest figures. Workout activity of just $58 million did little tooffset the second largest monthly increase this cycle in theinventory of distressed industrial properties.

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But the sector is still faring considerably better than otherasset classes-with office, retail, apartments and hotels postingdistress figures between $25 billion and $33 billion. What's more,industrial accounts for only around 5% of outstanding CMBSbalances. The sector's strength is due largely to a lack of hotmoney in the market during real estate's mid-2000s heyday and awillingness to work through troubled loans. But it's also leftinvestors cooling their heels with few purchasing prospects.

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Even February's jump in troubled assets is partially due to theaddition of two $100-million portfolios to the distressedinventory-a 12-property pool in the Midwest, which is owned by theMirvac Group and James Fielding Funds Management, and a secondsix-property, Kirkman Kennedy Edgewater-controlled bundle inOrlando and Memphis.

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"Most of the trouble in industrial is connected to economicfactors such as lost tenants rather than actual debt," says NewYork City-based RCA's senior market analyst, Ben Thypin, whobelieves industrial will continue to stay on the low end in termsof distress. The fundamentals are better for industrial, agreesConrad Andersen, EVP and managing director of financial servicesassets management at Grubb & Ellis Co. in Newport Beach, CA."Although the port business has been impacted, most industrialproduct is located in key submarkets that weren't oversupplied," hesays, adding that the vacancy factor, pre-downturn, was in thesingle digits.

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Unlike office, industrial investors were not accumulating trophyproperties and then flipping them into a large portfolio."Industrial buildings are often more prosaic," says Thomas A. Fink,managing director of New York City-based commercial mortgageresearch provider Trepp. "These properties do not tend to be trophybuildings. There are only so many people in the world who getexcited about 30-foot versus 35-foot clear heights."

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But that is not to say there is no stress in the market Most ofthe nearly $2 billion worth of distressed industrial assets areconcentrated in Michigan, Illinois, Florida, California and NewJersey. But these figures can be misleading. In California, forinstance, only 2% of the state's almost $7 billion worth ofoutstanding CMBS is delinquent Meanwhile, nearly one- third ofRhode Island's comparatively puny $70 million in outstanding loansis delinquent According to Fink, the industry is being hit thehardest in the upper Midwest, where properties were predominatelyowner/user-owned assets such as heavy manufacturing facilities.

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"In Chicago, there are a number of extra boxes ranging from300,000 square feet to over one million square feet," adds locallybased John Huguenard, managing director and co-head of Jones LangLaSalle's national industrial investment sales practice. "Thelarger assets are having problems, but most of the institutionalowners have been able to hold onto them because they are investingrescue capital," he says.

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This focus on fixes is not unusual in to day's market and, infact, as lenders gain both perspective on their holdings andguidance from federal regulators on handling workouts, the pace ofresolutions, and especially restructurings, has picked up.Confronted with piles of bad loans, lenders nationwide havedemonstrated a reluctance to file foreclosure suits, which can becostly and time-consuming, notes Thypin. Of the nearly $30 billionworth of restructurings since the beginning of 2009, a fulltwo-thirds have occurred in the past two quarters. "We're seeingeverything from a principal reduction to deals requiring borrowersto inject fresh equity or find an external capital partner," hesays.

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Industrial loans are even more likely to be worked out thanother asset classes, relates Huguenard, because "the banks believein the product." He predicts industrial loans will continue to bemodified and pushed out until the market improves to the pointwhere a foreclosure does not make sense. Part of what is bolsteringthese loans is the low interest rate environment, where the debt isfloating rate and puts less pressure on borrowers to make mandatorypayments. "We'll see how long that lasts," says Paul Griesmer,senior managing director in the Real Estate Advisory Group ofFTISchonbraun McCann Group in New York City. He adds that there havebeen some recent indications interest rates could start to tick upin the near future.

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Reduced rates aside, the sheer complexity of the $3.2 trillionworth of commercial real estate debt-one-third of which issecuritized-has also been dragging out the process. "Participatingdebt and mezz debt have been around for years, but there's so muchmore of it this time around," says Griesmer. What's more, thesecuritized loans are bound to Real Estate Mortgage InvestmentConduits underwriting requirements, which means "once youforeclose, you cannot provide a facilitating loan," says Andersen.Add to this a lack of liquidity in the capital markets forcommercial real estate, and most conduit servicers have been slowto foreclose, opting instead to reposition or sell industrialproperties, or sell the note once it's defaulted, usually under theauspices of receivership. But this lack of velocity is not tiedsolely to securitization. RCA also found that lenders' strategiesvary based on the size of the property, with lenders more likely tosell off small properties and hold onto large ones until realestate market conditions recover. Almost half of the troubled realestate worth less than $10 million has been sold or is on themarket, while 75% of the properties valued above $25 million arebeing kept on the balance sheet, the firm says. This could also bedue to the fact that nearly every loan north of $30 million-and insome cases, $20 million-has been syndicated. "We are seeingsyndications with six to 10 participants and nobody can agree onanything," Andersen relates. What this means, of course, is thatconsensus on a disposition strategy is challenging, at best. "Wereally only see a mark to market with the portfolio loans south of$20 million," he adds. And a majority of these are held withfederally chartered institutions, as many savings banks cannot somuch as utter the words "mark to market" without going out ofbusiness. "Their process has been very incremental," says Andersen.This is bad news for buyers, who have lined up looking for product."Investors are always willing to buy industrial buildings," saysFink. "They create a good, steady cash flow. And they are generalpurpose enough to be repositioned and repurposed for the next userbecause an empty space is an empty space." But since REOopportunities are hard to come by, most of the offers are throughnote sales, and even these are on the low end. "There is atremendous amount of buyers for industrial and they are frustratedthat there hasn't been more distressed asset sales," saysHuguenard. "Investors created funds to buy these assets, but ithasn't panned out at all."


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