Following a year when getting a loan for a retail project seemed about as likely as hitting a Powerball jackpot, prospective borrowers are sensing that lenders may remove the vice grip on their purse strings in 2010. The big question is whether capital will flow only to a select group of institutional grade projects and borrowers, or if that pool of lucky recipients will expand.
“As a retail borrower, we faced multiple headwinds in 2009,” says Mark Garside, managing director at Columbia, S.C.-based Edens & Avant, a shopping center owner and developer. In 2009, retail real estate owners and developers found financing incredibly difficult to come by. The credit crunch has featured a virtual shutdown in the commercial mortgage backed securities (CMBS) market and a major pull-back from traditional lenders such as banks and life insurance companies.
In addition, the recession instilled fears about defaults that led lenders to embrace incredibly strict underwriting standards while demanding borrowers put more equity into any deal. This was especially true for retail where a collapse in sales and a rash of store closings and bankruptcies pounded fundamentals. “Lenders in general were wary of retail," Garside says.
But as 2009 progressed, "a lot of the traditional lenders—banks and insurance companies—slowly came off the sidelines." Many in the commercial real estate industry are hoping that the worst is over, and 2010 will bring gradual improvement. “I think as soon as we hit January 1 there will be a psychological shift, and more money will enter the market,” says Kenneth M. Fox, CCIM, a managing director at Chicago-based Cohen Financial. Although lenders remain conservative, there are signs that capital is loosening with more life companies and investment funds that appear to be returning to the table.
The big question for 2010 may not be how much capital is available for retail properties, but where the money will end up. Refinancing obligations will gobble up much of the available capital. More than $1.4 trillion in commercial real estate loans are scheduled to mature between 2009 and 2012, including $320 billion next year, according to ING Clarion Real Estate.
In addition, size may be a factor. Cleveland-based KeyBank has traditionally been one of the top lenders on retail properties in the country. It is too early to estimate the bank's final 2009 numbers or make projections for 2010, but it is clear that it has been extremely conservative in evaluating opportunities. The bank is focused on doing deals with existing clients to maintain those relationships.
“So most of our lending in the retail space will be concentrated with institutional clients with more of a corporate finance orientation,” says Daniel Walsh, executive vice president and managing director at KeyBank Real Estate Capital Markets. “I think 2010 is going to be very difficult, although I think capital is poised to loosen up to take advantage of distress in the market."
More money available?
In general, capital for commercial real estate remains less available and more expensive than it was at the peak of the market in early 2007. Across the board, mortgage rates are up 100 to 150 basis points compared to two years ago.
A quarterly index of originations produced by the Mortgage Bankers Association (MBA) came in at 53 during the third quarter, with 100 equaling the origination volume of an average quarter in 2001. In contrast, the index was at 116 a year ago and peaked at 352 in the second quarter of 2007. That puts 2009 well on pace to come under the total origination volume of $181.4 billion in 2008 and $279.1 billion in 2007.
Similarly, the retail originations index was at 71 during the third quarter. That's down from 83 during the second quarter but higher than the figures of 43 and 47 posted in the first quarter of 2009 and the fourth quarter of 2008. For retail, the index peaked at 392 in the fourth quarter of 2006. The volume of retail loans in particular declined 68 percent from $71 billion in 2007 to $22.7 billion in 2008, and some experts predict that retail loan originations could be less than $15 billion in 2009.
According to a 2010 Banker Sentiment Survey by Jones Lang LaSalle, nearly 75 percent of the bankers surveyed said that they expect their commercial real estate loan production to increase next year. The majority of those lenders (85 percent) anticipate that their lending for properties, notes and new construction will increase by as much as 30 percent.
Banks in particular remain wary of their exposure to commercial real estate as the volume of distressed mortgages continues to rise. “In general, a lot of banks are looking to shrink their overall real estate exposure,” Walsh says. The delinquency rate on commercial real estate loans held by banks and thrifts reached 4.1 percent in second quarter and was expected to climb to 4.7 percent by the end of third quarter, according to Foresight Analytics in Oakland, Calif. If there is a thaw, it could be the product of growing confidence that the U.S. economy is pulling out of the recession. Consumer spending helped U.S. GDP grow at a 3.5 percent annualized clip during the third quarter. “If that continues, I can only imagine that lending would become—perhaps not looser—but a little bit more friendly as we go forward,” says Greg Genovese, president of the securities division at Thompson National Properties in Irvine, Calif.
Next page:REITs tap capital
REITs tap capital
REITs are one of the few entities that have experienced a dramatic improvement in accessing capital markets during the last six months. Many REITs are finding success accessing both debt and equity markets. They are using that capital to improve financial footings by paying down debt and refinancing maturing loans.
Take Simon Property Group. Between March and August the debt costs dropped considerably. Back in March, when credit markets were virtually shut down, Simon sold $650 million worth of senior notes priced at 10.35 percent. The notes were priced at 97.578 percent of the principal amount to yield 10.75 percent to maturity. In May, conditions had improved enough that a new $600 million senior notes offering by Simon was priced at 6.75 percent. The notes were priced at 98.960 percent of the principal amount to yield 7.00 percent to maturity. Then, by August, Simon had re-priced the May issue. In that adjustment, the notes were priced at 105.029 percent of the principal amount plus accrued interest from May 15, 2009 to yield 5.46 percent to maturity.
In addition, retail REITs' public equity started flowing back into the REIT sector in second and third quarters. “You had REITs that were both well positioned, and even those that were balance sheet challenged REITs, that were able to access the equity markets,” Garside says. In a lot of cases, they were doing so at a huge discount—especially in the case of REITs that were struggling. “But that access to equity has really helped to either repair balance sheets, or in the case of healthy companies, improve balance sheets and position them well to take advantage of the investment opportunities that everyone thinks are coming,” he adds.
Publicly traded REIT prices plummeted along with the rest of Wall Street and bottomed in March. At that time, the Morgan Stanley REIT index had lost nearly 80 percent of its value from its early 2007 peak. Since then, however, the index has clawed its way back up and more than doubled in value. The 23 publicly traded retail REIT stocks have posted year-to-date returns of 16.59 percent through Sept. 30, compared to 2008 returns of -48.36 percent, according to NAREIT.
On the non-traded REIT side, the fact that people are looking for diversification, non-correlated assets away from the stock market, and investments with a better income stream has fueled investment in REITs in the last six to eight months. By law, 90 percent of REIT operating income has to be distributed. “Investors are looking for diversification and capital preservation, but what really gets investors off their hands is the valuations that are out there right now, considering you can get good quality, tenanted real estate with higher cash flows than you could 24 months ago,” Genovese says.
Seizing on that opportunity, in August, Thompson launched its TNP Strategic Retail Trust, a public, non-traded REIT, to take advantage of some of the buying opportunities in the retail sector. The goal is to raise $1 billion in equity by mid-2013. “Broker-dealers and the public are not willing to throw money at brand new sponsors, but the fact that we have strong relationships with the broker-dealer community and a long history have really helped us,” Genovese adds. Thompson currently has about 200 selling agreements in various products with 100 different broker-dealers.
Next page: Tougher underwriting
Ultimately, the commercial real estate industry as a whole is going to need more than one solution to fix the credit crisis that has stymied investment activity. Government programs, more participation from life companies, and hopefully, a revival of the CMBS market—even on a limited basis, will all help to thaw the frozen capital markets. “The solution to capital returning to the marketplace is going to come from a number of different sources, some of which we haven’t seen yet,” Hughes says.
Some industry observers are hopeful that the government’s Term Asset-Backed Securities (TALF) program will have a positive impact on the CMBS market. There are a number of issuers, such as the Royal Bank of Scotland, that have said they are bringing transactions to the market. Those deals could provide a much-needed kick start for capital markets. “When that happens, I suspect that it will tend to loosen things up in the financing arena, and we will have some limited CMBS issuance in 2010 with multiple asset and multiple borrower pools,” Hughes says.
In addition, there are a few single-borrower TALF-backed deals in the works for REITs such as Developers Diversified Realty Corp., Inland Western Retail Real Estate Trust Inc. and Vornado Realty Trust. Although the Federal Reserve has been wary of the risks associated with supporting a single-borrower offering, DDR is reportedly moving ahead with its proposed deal. The REIT announced in early October that it had obtained a $400 million loan from Goldman Sachs Group Inc.
In the end, the goal is to convert that loan into a private CMBS offering through the TALF program. Although borrowers are hopeful that more capital will be available in the coming year, there is no indication that lenders are planning to budge on staunch underwriting practices. Lower leverage, recourse loans and greater property scrutiny are all in the cards for 2010. Two years ago, the typical leverage on stable retail properties was 70 percent to 80 percent. Today, 50 percent to 55 percent loan-to-value ratios are the norm, with properties being valued at an 8 percent cap rate. Inferior properties are seeing even lower loan-to-value ratios and being valued at higher cap rates.
Life insurance money in particular is focused on very low leverage deals, best-of-class retail, such as drug or grocery-anchored retail with good history. The insurance companies are wary of centers where there is exposure to risk, such as a large tenant that is sitting on a short-term lease. “You need to have sound tenancy, solidly leased properties with rent rolls that have some duration left on the tenancies,” Fox says.
Those banks that are still loaning on retail properties are offering recourse only loans at between 55 percent to 65 percent loan-to-value. Generally, banks are only offering fixed rate deals with 5-year terms at rates in the mid to high 6s. After that the loan converts to an adjustable rate loan for a balance of typically 10 years.
Even if capital markets loosen in 2010, the environment for retail property financing will continue to be very, very challenging. Lenders will continue to gravitate to best-in-class properties and borrowers. “You want to have good sponsorship, because right now all companies are under some level of stress with the economic downturn,” says KeyBank’s Walsh. “So you have to partner with people you know are going to be there for the long haul.”