COVER STORY, MAY 2011

RETAIL LENDING ON THE RISE
Business steadily improves as the economy recovers.
Savannah Duncan

Lenders throughout the Southeast have seen significant improvement this year in terms of retail lending. For the past few years, not much retail lending has occurred due to concerns about the economy and tenant failure. As the economy is slowly picking up and tenant base is growing, lenders are starting to see business steadily improve. Several lenders feel that business is the best it has been in more than 3 years.

“One big difference today versus a year ago is there weren’t a lot of lenders doing any sort of lending and now there are a lot of conduits that are back in the market and doing a lot of lending,” says Scott Bois, director of commercial mortgage originations at Wells Fargo Bank. “Probably the most amount of property types that have been securitized so far have been retail loans. Retail lending is definitely alive and well nationally and also in the Southeast.”

Robert Hernandez, senior vice president and managing director of
NorthMarq Capital, says that lenders aren’t quite as concerned about tenant failure because they feel it has bottomed out and stabilized, and therefore tenant growth will occur slowly but steadily during the next several years.

“When your tenant base continues to improve, your income stabilizes and it makes it much easier to finance properties,” Hernandez says.

The improvement in the economy is also boosting lenders’ confidence. Consumers are spending more, rents are stabilizing and vacancy rates are dropping. Victor Pickett, senior vice president of Grandbridge Real Estate Capital’s Norfolk, Va., office, feels that as employment rates also rise, the market will continue to get better.

“Are we out of the woods? No but we’re certainly much better than we were,” says Pickett. “We’re optimistic and guarded, albeit we are doing a fair amount of retail financing as we speak.”

Pickett says that financing is good on a relative term. Interest rates are low, leverage is starting to increase and the buy/sell gap isn’t there anymore. However, more important for retail lending is leverage.

“Leverage has increased from the 50 to 60 percent loans in 2008 (best case scenario) to now 65 to 70 percent being the norm and, on occasion, 75 percent,” Pickett says.

In terms of capital, it is much more accessible now then it has been in the past few years. Bois says that on the CMBS side, there is a large amount of capital available. He says there are 25 to 30 conduits that are lending.

“Capital is greatly improved, with bridge lending, mezzanine lending and first mortgages. There’s much more capital and they are more willing to make loans on retail,” says
Hernandez.

Without a doubt the type of retail property lenders are most interested in is grocery-anchored shopping centers with little to no local tenants.

“It’s the strongest asset type based on performance,” says Bois. “You have a good grosser that has good sales and brings in a draw to the rest of the center. [Grocery-anchored centers] typically run better in all economies, especially a down economy.”

Next, lenders are interested in properties with a stable, national anchor, such as hardware or department stores. These kinds of retailers do have a draw, but it’s significantly less than the draw a grocery store would have. Hernandez explains that these kinds of properties stabilize rent rolls and bring traffic to the local tenants. Finally, he says third is an unanchored strip center with several local tenants on short-term leases.

“There is money for that product as well, however, it’s the most conservatively underwritten,” Hernandez says. “[These properties have] higher cap rates and lower loan devalues.”

Equally essential to the kind of property, however, is the operator of the center.

 “[Lenders] want to make loans to investors and developers who don’t have a bunch of legacy problems, don’t have contingent liabilities, have a good clean balance sheet and a good track record of performance in that retail sector,” says Hernandez. “They don’t want to make a loan to somebody who has a retail center but doesn’t really understand them.”

Despite the promising outlook, lenders definitely still have their concerns. Rent rates and borrower credits are the main source of distress for many lenders. Bois says that it is key for lenders to make sure that rents are within the market.

Hernandez agrees. “We see a lot of centers we underwrite where the rent on the local space is still too high for them to support it,” he says. “[Lender concern is that] when it’s time to renew those leases, the local tenants are going to renegotiate their rate to a lower level, suspending their lower volume of sales, and that can devalue the center. That’s [been] the main concern during the last 3 years: That [tenants] can’t support the rent they were paying because their volume dropped off and they would renegotiate lower rents. We had to be very cautious in looking at properties and underwriting the income in place. We believe tenant failure and rents that were unsustainable bottomed out, especially in local tenant space.”

Additionally, Pickett is worried that if employment rates decrease and there is no job growth, then retail will suffer. Another cause for concern is that with rising gas prices, people might not be able to afford to drive.

Still, lenders remain hopeful for the coming months. Pickett says availability of capital is there and interest rates are exceptionally low from a historical perspective.  

“The lending climate is just going to continue to improve during the next 2 years,” says Hernandez. “Everybody is cautiously optimistic.”

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