The credit crunch has certainly slowed things down for the retail real estate industry as evidenced by a drop in deal flow and the scaling back of some announced developments. But in December the situation transformed from an inconvenience to a major threat. One of the largest owners of shopping centers in the United States, Australia-based Centro Properties Group, is on the verge of collapse unless it can pay down or refinance $3.4 billion by February 15.

The big question now is whether any other publicly traded real estate companies will follow suit. Investors, unsurprisingly, panicked, selling off REIT stocks en masse following the announcement. And ratings agencies are taking a fresh look at REIT debt.

Many observers, however, argue that Centro, an Australian listed property trust or A-REIT, is largely a victim of bad timing. It bought New Plan and ramped up short-term debt and its overall leverage levels just before the markets took a turn — a situation no other REIT faces. On December 7, about $1.1 billion came due in connection with its acquisition of New York City-based New Plan. It got an extension from its lenders until February 15. But it also has another $2.3 billion in debt coming due by then. Overall, the company had a leverage ratio between 72 percent and 82 percent before its market capitalization crashed. In contrast, the highest debt ratio for any major U.S. retail REIT belongs to General Growth Properties (62.7 percent), according to Deutsche Bank Securities (see p. 6).

In Centro's case, last February the firm reached an agreement to acquire New Plan for $6.2 billion. It closed the deal in August, assuming $1 billion in debt and took out bridge loans and joint venture financing that it intended to refinance through a combination of commercial mortgage-backed securities (CMBS) debt in the U.S. and permanent financing in Australia. That worked for awhile. As recently as August, Centro issued $300 million in 10-year U.S. CMBS notes.

But in the four months since, the bottom has completely fallen out from under the U.S. CMBS market and the cost of capital globally has risen. After reaching an eight-year high of $38.5 billion in March of 2007, U.S. CMBS issuance went down by half in November, to $17.1 billion, according to Commercial Mortgage Alert. As of December 20, CMBS issuance was just $3.5 billion. As a result, Centro came up against a December 7 deadline to make a $1.1 billion loan payment but didn't have the cash. Centro's lenders agreed to give the company until February 15 to come up with the money. If it is not able to refinance by then, it will be forced to start selling off assets.

Given Centro's financial situation and the quality of its assets, however, one analyst gives it a 10 percent chance of surviving the current crisis. In the days after the announcement, the firm's market capitalization shrunk to less than A$700 million from A$4.8 billion.

But if Centro is forced to sell assets — it owns more than 700 shopping centers in the U.S. — it will be doing so in a market that's become considerably less friendly to sellers. In fact, it may end up with no takers at all says Rich Moore, an analyst with RBC Capital Markets. “Assets just aren't trading, there aren't a lot of sales going on right now,” says Moore. “You can draw whatever conclusion you want about the quality of Centro's assets…. But to think they can go out there and get good prices, I think that's a mistake.”

On the positive side, the chances of a Centro-style blowup at any U.S. retail REITs seem remote. Across the board U.S. retail REITs are not facing the same kinds of refinancing risks. Even if the CMBS market doesn't stabilize for months — which Moore notes is a distinct possibility — U.S. REITs should have no problems getting necessary financing from banks. For example, General Growth Properties announced on the day after Centro's announcement that it had completed $1.4 billion of mortgage financings during the fourth quarter of 2007, including $366 million of debt maturing in 2008. It also has binding commitments for secured financing worth another $900 million that will close this month.