COVER STORY, SEPTEMBER 2012

SHOPPING FOR A LOAN
Lenders in the Southeast weigh in on retail financing.
Savannah Duncan

With the retail market in the Southeast continuing to strengthen, lenders are increasingly bullish on the sector, especially grocery-anchored retail. In our November 2011 survey, approximately 57 percent of lenders and mortgage brokers indicated that grocery-anchored retail provided attractive investment opportunities in the Southeast. The only higher-scoring category was multifamily.

Southeast Real Estate Business (SREB) spoke with several lenders to get their take on trends, loan maturities, and the health of the retail market. Participants included Al Rex, senior vice president of Walker & Dunlop’s Capital Markets division in Fort Lauderdale, Florida; Bob Stout, president and CEO of Q10 Capital’s Nashville, Tennessee, office; Matt Rocco, executive vice president and national production manager of Grandbridge Real Estate Capital’s Charlotte, North Carolina, office; and Shippen Browne, principal of Capital Advisors, Inc.

SREB: Please describe the current retail market in the Southeast.

Stout

Bob Stout: On a national basis, retail spending is back at pre-recession levels and the Southeast is benefiting from this trend. With a few exceptions, the retail real estate market in the Southeast is improving; vacancies are declining and rents are improving in most markets. There continues to be some over-leveraged properties, particularly large mall and power center deals, but there is more capital available than in the last couple of years for properties that need repositioning — provided the owner can buy the note at a discount.

Matt Rocco: The current market is bifurcated. Generally, we have a stable retail market throughout most U.S. markets. In select markets with grocery-anchored or power centers, I would even say we have a healthy retail market for well-located assets. The struggles occur when the centers have weak anchors, or when the centers are junior-anchored or unanchored in secondary locations or weak markets.

Al Rex: The overall retail market is healthy. There’s been limited new development and continued recovery, albeit slow, in the economy.

Browne

Shippen Browne: We continue to see the retail sector strengthening in the Southeast due to a number of factors. Primarily, retail growth is being driven by relocation of people from the Midwest and the Northeast to the Southeast. Companies and employers are expanding in the Southeast as well — all of which translate into increased retail sales.

SREB: Retail is a varied universe by property type (malls, lifestyle centers, stand-alone retail, grocery-anchored retail and even airport retailing). Which sphere of retail are you targeting for lending purposes?

Rex: We represent a wide variety of lenders from CMBS to life insurance companies and pension funds, so our business runs the gamut. We’re doing the most activity in grocery-anchored retail or community-sized shopping centers that are not grocery-anchored. We’re doing some stand-alone retail like drugstores and banks. Some lifestyle and some malls. We have a little bit of activity going in all those things.

Stout: We deal in all types of retail properties with grocery-anchored, unanchored or shadow-anchored strip centers and single-tenant buildings representing the majority of our deals.

Rocco: Our primary focus is on grocery-anchored and credit tenant retail facilities followed by strong shadow- or junior-anchored centers. To a limited extent, we have done some mall and lifestyle center financing, but by and large it’s grocery-anchored and single-tenant credit.

SREB: Many retail loans are maturing this year and will be maturing in the next few years. Are borrowers having to add more equity in order to refinance, or have property values risen to the point to where that’s no longer the case?

Stout: There is no question that we are far from being through the loan maturity cycle. The period of 2015 through 2017 will contain a record level of maturities based on the dollar volume. There are, however, two very different investor experiences in the maturity wave. First, in the life company portfolios delinquencies are near historic lows and the leverage levels are such that refinancing is likely to occur without substantial restructuring. There are going to be exceptions, of course, but in general, we did not see the high leverage on the first mortgage and the layering of additional mezzanine debt and/or preferred equity with life insurance company lending that we saw in CMBS lending.

In our opinion, we will continue to see the need for additional de-leveraging and additional equity — for deals that can justify additional equity — with CMBS maturities. The fact that CMBS delinquency rates continue to run at record levels tells us the worst is probably not over in that lending segment.

Rocco

Rocco: Loans that were properly margined, even loans that originated back in 2005 to 2007, are about the “haves” and the “have nots.” Good properties in good locations are much easier to finance and negative equity is very limited if it exists at all. The other group of assets, often associated with over-leveraged properties in weaker markets and/or occupied by weak tenants require additional structuring or equity paydowns in order to get out or to be refinanced.

Loans originated at the peak of the market in 2007, with the underwriting of high rents, represent the biggest challenges for sales or refinance. We can still make deals work with some structured equity and mezzanine financing for these highly leveraged retail centers as long as they are quality assets in good locations.

Browne: There seems to be a disparity. For Class A, core assets like the grocery-anchored centers, cap rates have gotten to a level where additional equity may not be needed. In the case of unanchored shopping centers or centers where there is no strong anchor, there really seems to be a need for equity or some type of mezzanine financing to bridge that gap.

SREB: What are you seeing in terms of loan-to-values, length of loans, debt-service coverage ratios, interest rates and amortization schedules?

Rex

Rex: People that are long-term holders are seeing rates at historically low levels and going for longer-term financing with matching amortization schedules, i.e. 15/15 and 20/20 year term and amortization schedule. A lot of what we are doing (on loan-to-value) is in the 65 to 70 percent range, but we’re also doing deals in the 75 to 80 percent range.

Stout: Loan-to-values continue to be concentrated in the 65 percent range with a minimum debt service coverage ratio of 1.25. Most lenders are continuing to be conservative in their underwriting. Rate is most often a function of leverage and the quality of the property and the borrower’s track record. The most common interest rates for 10-year terms are in the low 4s to low 5s. Much lower rates can be obtained in floating-rate short-term loans; however, most of our borrowers are opting not to take on that type of interest rate risk.

Rocco: In the retail space, we have closed loans fixed for 10 years up to 75 percent loan-to-value for grocery-anchored retail, at 3.50 to 4.15 percent. Amortizations are typically 30 years for these quality transactions and we rarely have DSC issues because of the very favorable interest rates. Generally speaking, there is a premium added for retail that is unanchored or shadow-anchored and these typically require more conservative underwriting and you’re really talking about loan-to-values closer to 60 or 65 percent with amortizations no more than 20 to 25 years. Those rates would be in the 4.25 to 4.75 percent range. As a final note, there is very little capital available for older assets in weak markets.

Browne: Most people are looking for a 10-year loan. That type of product is available across life insurance companies and CMBS. The average loan term for a permanent lender is going to be 10 years, but shorter products are available, as are longer products.

SREB: What specific deals has your company has been involved in?

Rex: Earlier this year, we financed the acquisition loan for Pompano CitiCentre. We provided a 65 percent loan-to-value on that acquisition; it was a six-year deal.

Stout: We did a freestanding retail deal in a small market in South Carolina placed with a life company. The loan amount was $6.3 million, which was a 75 percent loan-to-value, and included a rate of 5.5 percent on a 10-year term with a 20-year amortization schedule.

Rocco: In Lorton, Virginia, we provided a $23.5 million loan for a grocery-

anchored center. The rate was quite attractive, 2.90 percent on a seven-year term with a 30-year amortization schedule. The loan-to-value was 60 percent.

SREB: Are borrowers today more interested in fixed-rate financing or floating-rate financing and why?

Rex: We’re doing more fixed-rate financing than anything else. There’s not much difference between fixed and floating, so people would rather fix it and take the uncertainty out of the equation.

Stout: The demand we see for floating-rate financing tends to come from borrowers who plan to sell a property in the short term and are therefore looking to maximize cash flow through a short-term floating-rate loan.

Rocco: We have not found a borrower who does not recognize the long-term value of and appreciate having such a low interest rate given where we are in the cycle. Unless there’s a proposed capital event within three years, or an opportunistic play for an asset, most of our clients have elected to take 10-year, fixed-rate terms or longer. Many investors and owners recognize that if you lock in today’s interest rate and fix your largest expense — debt service — you can create a favorable arbitrage over the asset’s net cash flow. By doing this, borrowers are able to monetize that gap and create a real estate equity bond when centers have long-term leases in place.

Browne: I would say there are two sets of borrowers. Long-term borrowers are interested in longer term, fixed-rate financing in an effort to take advantage of today’s low rate environment. Most builders or people who are trying to capitalize on where the real estate market is today want to have short-term, floating-rate debt so they can maintain their flexibility.

SREB: How much in deal volume did your company complete in retail loans 2011 versus 2010, and how is deal volume in 2012 tracking year-to-date? Can you estimate deal volume through the remainder of 2012?

Rex: Walker & Dunlop’s total originations in 2011 were $4 billion and $217.6 million of that amount was retail financing. With no particularly upward pressure in rates, buyers are agreeing to buy and sellers are agreeing to sell at the pricing and cap rates that are currently being set in the market.

Stout: Our retail production was approximately $827 million in 194 loans in 2011 and we expect to close around $1 billion in 2012. Retail lending has been approximately 30 percent of our total production the last two years.

Rocco: We did $4.8 billion in 2011. We expect to originate about $5 billion in 2012 and retail will represent approximately 35 percent of our transaction volume.


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