Owners of shopping centers throughout the United States have been refinancing properties by the thousands of late. And for good reason.
"It clearly is a borrower's market," says Robert Schneiderman, executive vice president of New York-based Parallel Capital Corp. "Borrowers are responding almost instinctively, asking for more and more and more. And they're getting it."
"It's loosened up a lot," agrees Michael Yancey, president of San Francisco-based Crown Capital Mortgage. "Pricing has come down. Dollars have gone up. Lenders' appetite for retail is much stronger than it was not too long ago."
Why the frenzy? The reasons for the more liberal lending climate are many, including the general strength of the economy. Also of note are lower U.S. Treasury and LIBOR rates, which by reducing borrowers' monthly outlay make centers less likely to lose money. But the most important reason is the returning strength of individual retailers, says Yancey, whose firm does deals from $3 million on up.
"We thought the Kmarts, Wal-Marts, Targets and all the other big-box stores were going to put everybody else out of business," he says, "but with the improved economy, small shop spaces are leasing once again. Shopping centers are in high demand by both lenders and investors."
David Murdock, Midwest managing director in the Chicago office of San Francisco-based Nomura Capital Assets, concurs. "It's been very positive to date because we see retailers stabilizing," he says. "Tenants are getting stronger financially." Nomura, he adds, makes loans from $1 million to $400 million.
Other observers claim the most important reason for lenders' appetite for shopping centers is the sheer competitiveness of the lending market. Speaking of the financing market in general, Schneiderman labels the competition as "bordering on cutthroat." Spreads, he says, are dropping to near historic lows as lenders try to outdo one another in making everything as borrower-friendly as possible.
"Our spreads are reactive to the marketplace, and we're cutting them to the bone," says Schneiderman, who notes that Parallel offers loans from $150,000 to about $30 million.
Low rates, fixed rates There is no question that money is available. "There's plenty of capital in the marketplace," says Bart Tabor, a senior vice president with Houston-based L.J. Melody & Co. "Many would argue there's too much, but whatever the case, it is very easy to get financing now. It's as easy as it ever has been, maybe easier."
Most of the money is coming from Wall Street, which is securitizing the loans and selling the packages to the public, according to Elliot Eichner, a managing director with New York- and Los Angeles-based Sonnenblick Goldman Co. It is the aggressiveness of Wall Street, he maintains, that is driving the current market.
All of this is good news for property owners, and from the borrower's perspective, there is considerable incentive to refinance now.
First, interest rates are the lowest in 30 years. Most acquisition and refinancing loans are getting rates in the low to mid 7 percent range, although Tabor says a few top performing properties are coming in below 7 percent.
Furthermore, most rates are fixed. A shopping center owner that refinances now can lock in today's low rates for the next five to 30 years, depending on the circumstances of the individual property. For borrowers that recall the uncertainty of floating rates common in the late 1980s and early 1990s, the option to get a low, fixed rate can hardly be more attractive.
Few observers expect rates to go significantly lower. Even if rates do decrease, it makes more sense to borrow now rather than wait for them to drop a quarter or half point six months or a year from now.
"If I'm playing the market and have the chance to refinance at 7 to 7.5 percent, which is historically very low, am I going to wait for the market to get lower or take the rate in hand?" asks Michael Guterman, a director in the Los Angeles office of Phoenix-based FINOVA Realty Capital. "In the meantime, I'm paying 9 percent. Why not lock in 7 percent now than take the risk of waiting for something that might not happen?"
According to Joseph Cunningham Jr., president of Sacramento, Calif.-based Liberty Mortgage Acceptance Corp., the number of refinancings is up and will continue to grow over the next year even if rates rise significantly, which he does not anticipate.
"Probably 80 percent of commercial loans roll over every five or seven years," he explains. "So there's always a steady stream of refinancings, but anyone without a prepayment penalty is most likely going to accelerate existing loans to take advantage of the market."
Bill Miklos, a senior vice president in the La Jolla, Calif., office of Chicago-based Aries Capital Inc., anticipates the wave of refinancings will grow considerably stronger very soon. "We're going to start recycling transactions coming due on all the 10-year notes made at the height of the last boom. There's lots of money to be made there," he comments.
Miklos anticipates Aries will do about $250 million in retail loans this year, but he does not know what percentage will involve refinancing. He reports the company typically does deals above $2 million, but it will do single-tenant financing below that level.
Pulling cash out of property Rising values give landlords even more reason to finance, experts say. This is especially true for companies that bought at or near the bottom of the market or have a lot of equity in their property. By refinancing at currently appraised values, they can take money out.
"Quite a few are using the money for additional investments. Some are pulling cash out to make distributions to their partnerships," says Guterman, who reports FINOVA did about $450 million in total retail financings last year. Other borrowers, he adds, are refinancing at the present loan amount to get lower payments and more cash flow.
Still others are pulling money out to pay for remodeling, retenanting or expansion. "We're beginning to see a lot more development happening in combination with refinancing," says Mike Higgins, managing director for CIBC Oppenheimer, New York.
Higgins reports that his firm will have about $2 billion in retail refinancings on the books from January through midsummer. CIBC Oppenheimer is one of the few nonbank lenders able to do both permanent and construction lending, he says, which is an advantage for borrowers that cannot pull sufficient equity out of their property to cover redevelopment costs.
Higher LTV Along with low rates, today's borrowers are enjoying access to higher loan-to-value ratios than was the case two or three years ago. "There's a tremendous amount of liquidity. In the single-tenant net credit lease [sector], there's liquidity even up to 100 percent," says Mark Finerman of Boston-based CS First Boston, who estimates his company did about $1.3 billion in retail refinancing just in the first quarter of 1998.
Most loans, however, seem to be hovering in the 75 percent to 80 percent LTV range, with only the surest bets coming in above that. A surprising number are coming in with an LTV ratio below 70 percent and even 60 percent due to borrower rather than lender preference. Smaller investors whose properties have escalated substantially in value often would rather lower operating costs by keeping the loan amount at current levels but with lower rates, says Guterman.
However, this tactic can cause problems a few years down the line. "Someone who refinances at 65 percent LTV today may have trouble selling five years from now because he will have paid the loan down to 55 percent LTV," he says. "That means a new buyer will have to pay 45 percent down to get the property, and there aren't many buyers willing to do that."
While five- to 10-year terms have been standard in the industry, many lenders have begun to offer longer terms as another way to compete for business. "We will often go to 15 years," says Murdock.
Creative financing Another plus for those trying to refinance today is the introduction of bridge, or mezzanine, financing, a type of loan becoming increasingly popular as a way for lenders to minimize their own risk while maximizing opportunity for borrowers.
A bridge loan typically runs for six months to two years at a comparatively high rate, then rolls over into a permanent loan at a lower rate providing the property reaches predetermined performance goals.Of course, if the goals are missed, the rate remains high.
While that is the most common format for a bridge loan, there are other ways to structure them. Cunningham gives an example detailing an innovative mezzanine tactic that Liberty has developed:
An owner has a shopping center that is only 75 percent leased and that a lender might be able to fund at $1 million using a traditional approach. Unfortunately, the owner needs $1.5 million in order to bring the center up to full occupancy.
In the new scenario, the lender provides the $1.5 million at market rate of, say, 7.5 percent, but the deal includes a two-year trigger. If at the end of two years the center has achieved a specific target - say, 95 percent occupied - e rate stays put. On the other hand, if the target is not reached, interest on the extra $500,000 jumps to 10 percent.
Other lenders will break the loan in two at the beginning, offering $1 million at 7.5 percent and $500,000 at 10 percent, with the provision that the 10 percent will drop to 7.5 percent if the center reaches its predetermined target.
To make the transaction even more attractive, some lenders will structure a refinancing so the borrower pays interest only during the bridge loan period. [See Eastmont Mall case study, page 34.]
Many lenders say they regard retail refinancings quite favorably, although not necessarily more favorably than acquisition or permanent financing.
"Theoretically, there is no preference," says Miklos. "We would prefer anchored retail over unanchored because it offers the best pricing, but we'll look at new as well as existing loans."
Lenders also say they do not favor one region over another. All transactions are examined on their own merits, they say.
What's ahead? The big question is: How long will the current lending climate last? Few observers see any significant change in the next 12 to 18 months, although some say the competition among lenders is set to ease off.
"People are speculating that some players will be dropping out this year because margins are becoming too thin," says Schneiderman.
Already, according to the Sacramento Business Journal, a few small California banks have announced decisions to cease commercial real estate lending to new customers.
At the same time, at least three new northern California banks are in the process of opening for business, and other financial services companies are inaugurating lending offshoots.
Higgins speculates that a number of lenders not only will stop making new loans but also cease to be in business in a few years.
"The players who have been around for a long time will stay, but I think some of the newer players won't survive," he says. CIBC Oppenheimer, he points out, is among the former group, having been in business more than 100 years.
Even if some lenders do drop out, borrowers will probably enjoy at least another 12 to 18 months of good times, observers say.
"There's always a lot of talk about overretailing, so we have to keep an eye on that, but I've seen no indication of overbuilding in the markets I work in," says Murdock.
"As we make new loans, we will be constantly reviewing the situation to see if we need to pull back," he says. But for the moment, I'd say retail property owners have little to worry about. If they have a good property, or one that can be made good, they will get the money and get it at a good rate."
The refinancing of Harbor Place Shopping Center in Fullerton, Calif., had several twists, according to Michael Guterman, director of the Los Angeles office of Phoenix-based FINOVA Realty Capital Inc.
To begin with, the owners, a married couple from Hong Kong, speak no English, and the transaction was conducted through an interpreter. The couple came to the United States specifically to refinance, giving themselves only 30 days to do it.
The property manager of Harbor Place, a real estate broker, referred them to Guterman, with whom he had worked in the past. The referral played a major role in his firm's getting the deal, he says, because the Chinese tend to emphasize personal relationships in their business dealings.
At the time, Guterman's employer was Belgravia Financial Capital, which was not a direct lender. But during the course of the transaction, FINOVA acquired Belgravia, and just by coincidence, FINOVA held the original Harbor Place note.
The deal had a significant complication. The owners also wanted to refinance another center, Plaza del Sol in San Diego, and would not consider refinancing one without the other. Unfortunately, Guterman says, the amount outstanding on the San Diego loan was too high to allow refinancing at an attractive rate.
Making the deal more complicated, the 114,000 sq. ft. Harbor Place was a standard supermarket-anchored center, but the 49,943 sq. ft. Plaza del Sol had only a bank anchor. As Guterman points out, given the rate at which banks are merging today, bank branches are not regarded as reliable long-term tenants. Adding another layer of complication, Harbor Place was in the final stages of environmental cleanup by a previous owner, who was required to post a letter of credit for the deal to go forward.
The owners' goal, says Guterman, was to get 80 percent of the total value of both properties without having to pay a premium. "If you go above a 75 percent LTV, you generally have to pay an additional 20 to 25 basis points," he explains.
According to Guterman, who was assisted by Carol Houst, also a director in the Los Angeles office, FINOVA finally worked the deal by lending a higher amount on Harbor Place than originally intended to compensate for the shortfall on the Plaza del Sol loan. The total value of the two loans matched the sum the borrowers hoped to get, but one loan was lower than they contemplated and the other higher. In the end, they received $11.45 million on Harbor Place and $3.2 million on Plaza del Sol and did not have to pay a premium.
"Like every deal in today's market, it became an appraisal issue," he says. "Was Harbor Place strong enough to support a higher value? We were willing to take the risk that it was."
Guterman calls the original loans for the properties typical floating rate deals, which at the time of refinancing had stabilized at 350 to 400 points over LIBOR. The new loans came in at 165 points over 10-year Treasuries, for an effective rate of about 7.5 percent. "The refinancing saved them at least 200 basis points," he says.
Eastmont Mall is a project that, even in today's liberal lending climate, many lenders would shun. Located in the heart of one of the poorest neighborhoods in Oakland, Calif., the 20-year-old project had lost all its anchors, including JCPenney, the Emporium and a four-screen cinema.
Fremont Investment & Loan, however, saw opportunity rather than risk. As Bruce Krall, a vice president in the San Francisco office of the Anaheim Hills, Calif.-based institution, puts it, Fremont built its portfolio on "nonconventional structures." And Eastmont was most assuredly "nonconventional."
Fearing the loss of another of the dwindling supply of shopping and employment resources in East Oakland, the city began meeting with owner Eastmont Town Center Co. LLC two years ago to devise a way to save the project. ETCC owned the property by default - by double default, in fact. It acquired Eastmont when its parent company acquired the assets of a failed savings-and-loan, which itself had the property as a result of the previous owner's bankruptcy. ETCC was only too happy to have help figuring out a way to salvage the asset.
The solution the parties came up with was to convert part of the property, including the former JCPenney building, into a community health services center. Public health agencies would provide both a dependable rent stream and a steady supply of customers for the shops. Management also devised a plan to retenant much of the remaining 150,000 sq. ft. of retail space. Several existing tenants, including H. Salt, Esq., Payless Shoes, Thrifty Drug (now RiteAid) andBank of America, stayed on.
Among the initial new tenants are a medical office, an outpatient and ambulatory care facility run by Alameda County, Total Renal Care and Planned Parenthood. The county's social services department will move in later.
With the promise of a new, if atypical, beginning for Eastmont, Fremont felt completely comfortable refinancing it, Krall says. But to protect itself, it structured the loan to provide a base level of funding at the beginning, with provisions to increase the value of the loan in incremental steps.
According to Krall, the package included an initial 18-month interest-only bridge loan to finance reconstruction, refurbishing and initial retenanting expenses. The rate was 350 points over LIBOR. At the end of that period, the loan rolled over into a permanent loan at 325 points over LIBOR.
As of June, Krall reports, the loan had reached $12 million. He expects the total could go as high as $20 million as new tenants are signed and funds are required for additional reconstruction, leasing commissions, tenant improvements and earn-outs.
As an indication the redevelopment strategy is working, he says, three or four grocery chains are negotiating to take over the supermarket space. In the past, it was difficult to get one chain to look at the site. Other new retail tenants, including the 98 Cent Clearance Center, also have signed leases.
Unlike most Fremont loans, Krall notes, Eastmont's is full recourse. That requirement, however, will be deleted when and if the project stabilizes, which he is confident will occur.
"The healthcare facility breathed new life into the project," Krall remarks. "Even though it's not a retail use, we felt it was compatible and capable of adding support to the retailers that are there."
The downside to the loan, of course, is the higher cost. Two points over LIBOR is considered high in today's market. Three and a quarter points over is extremely high. However, the current loan comes due in five years, at which point the owners will be able to negotiate a new mortgage that reflects the project's record at that time.