What a great time to refinance a shopping center — or is it?

The U.S. economy continues to signal that a pause in expansion is becoming more likely, according to Cross Currents 2001: An Outlook for the Economy and Real Estate Markets, published by L&B Realty Advisors, a Dallas-based investment services/property management firm.

Unfortunately, fighting the downturn in the economy by taking advantage of the predicted low inflation rates and current low interest rates has not resulted in a rush to refinance existing shopping centers.

“Borrowers are aggressively pursuing financing,” says David St. Pierre, senior vice president and district sales manager at Key Commercial Real Estate's Ohio office. “Unfortunately, most of that financing is new financing. It is just not cost effective to refinance today, despite lower interest rates.”

One type of refinancing that is benefiting from today's lower interest rates is the refinancing of construction loans into more permanent, long-term financing. The viability of refinancing construction loans is illustrated by the growth in shopping center development in those areas overlooked during the boom of a few years ago.

George Emmons, executive vice president and national manager, describes Key Commercial's approach. “We remain active in financing so-called ‘look-backs.’ We're active in financing projects where developers ‘look back’ into urban cores that may have been overlooked in the growth and expansion periods of only a few years ago. Areas with strong demographics offer tremendous potential for successful development today.”

For example, Key Commercial is positioning itself to refinance the Shaker Square project in Shaker Heights, Ohio, once the developer achieves critical occupancy levels. Shaker Square, according to Key executives, was one of the first lifestyle centers. The center declined, and the developer is now restoring it to its previous condition. Key Real Estate financed the acquisition and development of Shaker Square and is ready to refinance more permanent financing.

Ready for refinancing?

On the surface, at least, the shopping center industry would appear to be ready for refinancing. In the face of a slowing economy, a rash of bankruptcies and hundreds of store closures, America's shopping centers are braced for a rough year. “Retailers have enormous problems,” notes Milton Cooper, CEO of New Hyde Park, N.Y.-based Kimco Realty Corp., which owns 498 strip shopping centers across the country. “That means things can't be very good for the mundane retail REIT.”

Although privately owned firms control two-thirds of all malls, according to a July 2000 report by Prudential Real Estate Investors, publicly traded real estate companies still own a sizable number of premier properties. Retail REITs, however, posted a weighted average total return of 19%, as compared with 26.8% for REITs as a whole.

With an average debt-to-capital ratio of 55%, compared with a REIT average of 45%, retail REITs should benefit from today's lower interest rates. In fact, many analysts raised ratings on several high-end REITs, concluding that the lowered cost of capital would compensate for slowing retail sales.

However, a comprehensive survey of REIT policies conducted by E&Y Kenneth Leventhal Real Estate Group (EYKL) reported most REITs plan to take a conservative approach to financing and growing their businesses in coming years.

“Clearly the conservative approach to growth is still the main strategy for the REIT sector,” says Keith Locker, senior managing director of Bear Stearns, a division of EYKL. “While most REITs surveyed anticipate moderate growth over the next few years, few expect the explosive growth that pushed the sector to prominence in the late 1990s.”

Count on 2003

However, executives at some REITs say they would increasingly use structures such as joint ventures to pursue developments or make acquisitions. But what about refinancing? In terms of indebtedness, while most REITs are taking the conservative tack, the survey shows that more than 70% of respondents have debt maturing after 2003.

“We see very little debt maturing over the next two years, yet after 2003, there is likely to be a great deal of refinancing activity,” says Keith Locker, Bear Stearns' senior managing director.

Therein lies the rub, according to Key Commercial's St. Pierre.

“Shopping center developers and REITs are less likely to refinance because of lower interest rates or other economic factors than credit-sensitive home buyers,” he says. And because of the prepayment penalties so prevalent in commercial mortgages, “it is cost-prohibitive for shopping center developers and owners to refinance. Those prepayment penalties were designed to protect investors from prepayment. The securitization of these commercial mortgages was an important selling point for investors.”

To illustrate the point, take Archon Group L.P., the real estate investment affiliate of Goldman Sachs Group Inc. Archon recently established a new retail division, Archon Retail, which will invest and manage shopping center properties.

It plans to acquire existing retail real estate throughout the United States, particularly in regions where Archon already has assets under management, notes Steve Lipscomb, who has been hired to head the new operation. “We are particularly interested in retail assets that present opportunities to leverage Archon's resources and expertise in investment and asset management through redevelopment or repositioning, build-to-suit and/or new development,” Lipscomb says.

But no refinancing.

Mark Battersby is a Pennsylvania-based writer.

Crescent Real Estate reverses its fortunes

Crescent Real Estate Equities, a Fort Worth, Texas-based REIT, received so little respect in recent years that it was dubbed “the Charlie Brown of REITs” by one analyst.

Its stock price fell more than $20 a share; it got involved in a casino purchase deal that was not well-received by investors; and the company faced the necessity of taking out mortgages to pay off short-term loans.

In Nov. 1999, Crescent says it planned to buy back $500 million worth of its outstanding shares. As of Dec. 31, it had repurchased shares worth $281 million, nearly 12% of the shares outstanding.

“If the market doesn't want to own it, we do,” says CEO John Goff.

Today, Fleet Bank is reportedly in the market to refinance a credit facility for Crescent — with low pricing that is the talk of the industry. The REIT is seeking to refinance its $850 million credit facility currently provided by UBS Warburg and Fleet priced at LIBOR plus 23[]4% (LIBOR floating rate, plus spread of 23 basis points with a 4% fee).

The approximately $400 million refinancing — which was being shopped at LIBOR plus 13[]4% — also would eliminate the mortgage lien offered to lenders, thereby converting the facility into an unsecured deal. Given Crescent's recent credit rating of Ba3/B+, the pricing is considered razor thin by many analysts.

If successful, according to one anonymous banker, this refinancing could change the face of the entire real estate lending market. No REIT with a comparable credit rating has ever received pricing at these levels according to that banker.

A Crescent spokesperson confirmed that it was in the market to refinance its facility. However, no deal with Fleet or any other bank has yet been finalized.
— Mark Battersby