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 this week the situation transformed from an inconvenience to a major threat. Suddenly, one of the largest owners of shopping centers in the United States, Australia-based Centro Properties Trust, is on the verge of collapse unless it can pay down or refinance $3.4 billion in debt by February 15, 2008.

The big question now is whether any other publicly traded real estate companies will follow suit. Investors, unsurprisingly, panicked this week, selling off REIT stocks en masse following the announcement. Meanwhile, rating agencies have begun to take 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 this week. 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. Further, only two REITs have more than $1 billion in debt maturing in 2008, General Growth Properties at $2.8 billion and Simon Property Group at $1.5 billion.

In Centro's case, in 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 CMBS debt in the U.S. and permanent financing in Australia. That plan worked for a while and there was little reason to think it wouldn't come to fruition. In fact, as recently as August, Centro was able to issue $300 million in 10-year U.S. CMBS notes. The same month, Standard & Poor's rated New Plan's unsecured debt at BBB citing Centro's solid business plan and conservative financial profile.

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, an industry newsletter. Month-to-date in December, CMBS issuance in the U.S. is 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. On Monday, the firm issued a press release and presentation on its Web site.

Centro declined to comment for this article, but in an official statement, the company's chairman, Brian Healey, said: "Up until late last week, we were of the view that our short-term debt obligations could be refinanced on a long-term basis. We never expected nor could reasonably anticipate that the sources of funding that have historically been available to us and many other companies would shut for business."

As a result of Centro's troubles, Fitch Ratings on Wednesday downgraded ratings for Centro NP LLC (New Plan's former debt) from BBB+ to CCC. It also downgraded a $350 million revolving credit facility and senior unsecured notes worth $830 million from BBB+ to CC/RR6.

Centro's lenders, the largest of which include Australia & New Zealand Banking Group Ltd., BNP Paribas, the Royal Bank of Scotland and Commonwealth Bank, agreed to give the company until February 15 to come up with the money. That means if Centro doesn't find a bank willing to refinance its loans in the next eight weeks, it will be forced to start selling off assets, with New Plan, which carries one of the highest debt loads in the company’s portfolio, a prime candidate for disposition, according to a note from UBS analyst Stephen Rich.

Given Centro's financial situation and the quality of its assets, however, Rich gives it a 10 percent chance of surviving the current crisis. The firm's market capitalization has shrunk to less than A$700 million from A$4.8 billion as its stock has fallen from A$5.16 a share last week to A$1.21 a share at the close of trading on Wednesday in Australia. (The 52-week high is A$10.06 a share).

Meanwhile, the firm is still saddled with debt. Overall, Centro and its subsidiaries have A$7.3 billion in debt maturing in the next 12 months. Citi analyst Peter Cashmore in a December 18 note wrote that the firm will need to reduce its leverage ratio to 40 percent before any bank considers refinancing its loans.

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. In both September and October, the volume of retail properties sold dropped 50 percent year-over-year, according to Real Capital Analytics, a New York-based market research firm. In all, $2.2 billion worth of deals were completed in October and currently about $2 billion in deals are scheduled to close before the end of the year.

"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."

As a result, analysts in Australia have estimated that Centro may have to sell its assets at a 15 percent discount, losing A$2 billion in the process off the estimated A$17 billion value of its U.S. portfolio.

American implications

One of the sticky points in a possible sale is the fact that Centro's problems triggered a new round of sell-offs of U.S.-based REITs. In the past five trading days, the sector has dropped more than 8 percent, according to Morningstar Financial, with many firms, including Developers Diversified Realty Corp., General Growth Properties, Inc., Macerich Co. and CBL & Associates Properties, Inc., hitting new 52-week lows.

The question is whether investors should be concerned. Standard & Poor's on Monday downgraded the corporate credit rating for Weingarten Realty Investors, a Houston-based REIT with a 42-million-square-foot retail portfolio, to BBB+ from an A-. In an official statement, analyst Elizabeth Campbell explained that her decision was based on Weingarten's higher-than-expected leverage ratio, at 44 percent. The U.S. average is 39 percent. In the aftermath, Weingarten shares hit a 52-week low of $32.56.

Across the board, however, U.S. retail REITs are not facing the same kinds of refinancing risks that tripped up Centro. Even if the CMBS market doesn't stabilize for months--which Moore notes is a distinct possibility--U.S. REITs should have no problems tapping existing lines of credit or getting other financing they need from banks. This is because the firms have maintained conservative leverage ratios and quality asset portfolios.

As evidence that it's still possible to get funds in this climate, the same day Centro announced its troubles, New York City-based Related Companies, a diversified firm that builds affordable housing, offices, mixed-use, multi-family properties and retail, announced it had lined up a $1.4 billion infusion from Goldman Sachs, the investment arm of the Abu Dhabi government and MSD Capital, an investment firm run by Dell, Inc. founder Michael Dell. Then on Tuesday, net lease REIT CapLease Inc. announced a $129.5 million 10-year secured fixed rate non-recourse loan--financing that replaces a floating-rate short-term warehouse line.

Also, General Growth Properties announced on Tuesday that it had completed $1.4 billion of mortgage financings since the end of the third quarter, including $366 million of debt maturing in 2008. It also has binding commitments for secured financing worth another $900 million that will close in January. The $2.3 billion "represent significant progress towards funding our capital needs for the coming year," General Growth CEO John Bucksbaum said in a statement.

Still, lining up financing is more challenging.

"The lending institutions are asking for more equity on deals; you can't have as much debt as you did before," Moore says. "If you have a lot of leverage, which Centro does, you are more likely to end up in a situation like that. And beyond debt, they will look at the quality of your assets."

Among U.S. retail REITs with the highest level of debt maturing in 2008, according to Deutsche Bank's calculations, is Ramco-Gershenson Properties Trust, which will have 23.2 percent of its debt, or $180 million, due next year; Kimco Realty Corp., which will have to pay 17.2 percent of its debt, or $760 million, in 2008; and General Growth Properties Trust, which will have to pay 10.5 percent of its debt, or $2.8 billion. Deutsche Bank Securities REIT analyst Louis Taylor remains convinced, however, the aforementioned companies are fundamentally sound.

"As we look at [U.S.] coverage universe, the vast majority have modest debt, plenty of available debt capacity on their credit lines and minimal debt maturities in 2008 and 2009," Taylor wrote in a note on December 18.

By Elaine Misonzhnik