It has been a challenging year for investors and owners of net-lease retail properties. With the economy slowing to a crawl and just a 0.1% increase in retail spending in December 2000, several retail stocks have declined significantly due to lackluster earnings and decreased sales. This created a ripple effect in the financial markets that means financing is scarce for some net-lease retail properties.
Many lenders have begun to back away from lending on transactions in which tenants have a non-investment-grade bond rating (equal to or below BB+ by Standard & Poor's). Consequently, there is less opportunity for buyers that require financing to complete their purchases of net-lease properties. Many landlords that used floating-rate loans, mini-perms and other short-term loan structures to purchase properties with non-investment-grade tenants are finding the first half of 2001 difficult due to the lack of liquidity.
Rates are low, but there is no financing available for owners of net-lease properties in industries perceived as financially weak. Landlords and potential buyers of net-lease properties in certain industries that are thought of as over saturated with competition are also having a tough time finding financing. Cash is king now, and the credit crunch has created opportunities that we have not seen in some time for all-cash buyers. Contrarian buyers are bargain hunting for net-lease properties and are finding higher cap rates and lower prices.
The economy: a self-fulfilling prophecy?
As many economists have indicated, our own perceptions, beliefs and confidence in the economy have created much of the economic turmoil in the United States. As lenders back away from financing retail properties with non-investment-grade ratings, companies will be unable to grow, causing no growth or negative growth in the economy. To many retailers this will mean less expansion, which will lead to less development and create more layoffs throughout the economy. This will create further downside pressure on retail sales, earnings and individual stock prices.
The U.S. economy depends on the retail development that has kept developers, general contractors, subcontractors, architects, city employees, lenders and brokers working during the expansion. Many of the previously mentioned real estate executives and tradesmen are also the consumers that retailers depend on to purchase their goods and services in local economies throughout the United States
Financing is still available for most investment-grade retail tenants (Standard & Poor's rating equal to or higher than BBB-), although some industry groups are closely monitored for over saturation in certain markets. Buyers and landlords of net-lease retail properties can currently expect rates in the 7% to 8% range depending on the credit rating, size of loan and industry in which the tenant is involved.
Maximum loan-to values are ranging from 70% to 100% and debt-coverage is ranging from a minimum of 100% to 130%, depending on the loan type, amortization and other loan particulars. Additionally, many lenders will deduct for a vacancy, management and capital expenditure factor to determine the maximum loan amount possible.
Healthy numbers for retailers
In January 2001 we witnessed a healthy retail sales increase of 0.7%, which was much better than December's 0.1% increase. Many economists attribute this healthy increase to discounted promotions designed to rid retailers of inventory that was not sold during the holiday shopping season. The current rate decreases and easy money policy engineered by Federal Reserve Chairmen Alan Greenspan, as well as President George W. Bush's proposed tax cut and government spending, should have a positive effect on the economy and retailers in the second half of 2001. This stimulus should bring more liquidity to owners and buyers of net-lease properties that desperately need financing to keep on track with their expansion plans.
The rate cuts and tax decreases should also give consumers additional money to continue shopping, which should increase sales and profitability for many retailers. A most recent survey conducted by New York-based Commercial Mortgage Securities Association (CMSA) stated that liquidity should slightly improve in 2001. The survey also indicates that there is the potential for spreads to narrow in 2001.
What will the future bring?
If history repeats itself, oil prices will decline, creating lower cost structures for many retail companies and the consumers that buy their goods and services, adding further stimulus to the economy and retail sales. The interest rate decreases that Greenspan has engineered by lowering the overnight interbank lending rate and proposed tax cuts by Bush should also help to propel retail sales. Hopefully, lenders will take a long-term approach to lending on net-lease retail properties and not become overly conservative with their underwriting standards.
Christian Marabella specializes in arranging financing for net-leased properties through his company, Marabella Commercial Finance, Escondido, Calif.