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Yes, Lenders Are Interested in Financing Retail Properties

Mortgage bankers and lenders across America want real estate owners to know one very important fact: Loans for retail properties are widely available after a tough few years.

“People are still trying to figure out whether there is debt for retail properties,” says Tom Melody, managing director of Walker & Dunlop. “They’re wondering whether they should be out in the capital markets, talking to lenders, and they’re curious whether they’ll be able to get attractive prices. The answer is yes, to all of that. But I don’t think much. From now on people know that it is so.”

Melody notes that the lion’s share of the capital was “not really interested” in the retail sector in 2021. And if they were, their interest was limited to grocery-anchor centers, which are widely viewed as the most recession-resistant asset types within the retail sector. ,

But lender sentiment has changed significantly, Melody says. Last week, he attended the 2022 Commercial/Multifamily Finance Conference & Expo in San Diego, hosted by the Mortgage Bankers Association (MBA). During the event, he dined with heads of real estate or loan originators for 22 different lenders.

“When I asked, ‘Who wants to invest in retail?’, most hands went up,” recalls Melody.

After witnessing the performance of different types of retail assets during the pandemic, lenders are feeling more comfortable with the asset class. According to Claudia Steib, managing director of JLL Capital Markets, however, the current composition of their existing portfolio is of equal importance.

Most lenders, whether they are life companies or debt funds, are heavily weighted on “hot” asset types, especially multifamily and industrial. As a result, they need to balance their portfolio.

By focusing on multifamily and industrial loans for more than two years, lenders have created low-yield portfolios. Now, they are realizing that they should diversify into other asset types to increase yields, not just for personal loans, but for their overall portfolio.

“Retail is no longer a four-letter word,” Steub says. “For the longest time, when I’d call a lender, they’d say, ‘Please tell me you’re not talking about a retail deal.’ Now they say, ‘What do you have?'”

Sponsorship matters more than ever

A few months ago, Steub and his capital markets team helped an affiliate of Lone Star Funds find debt financing to acquire Legacy Place, a 424,500-square-feet company. The open-air retail center at Palm Beach Gardens, an affluent community 70 miles north of Miami that ranks among the wealthiest and most exclusive areas in the country.

Completed in 2006 to 2007, Legacy Place’s open-air concept offers walkable formats and outdoor common areas with dining options. It is operated by Best Buy, Barnes & Noble, Total Wine & More, Michaels and Petco, all of which are the center’s original tenants. Other tenants include Ethan Allen, Miami Children’s Hospital, The Container Store, Bassett Furniture, The Capital Grille, Chili’s Grill & Bar, and Five Guys.

According to Steub, the deal had a strong value-added component with re-leasing plans and some potential redevelopment opportunities, which required a flexible lender and a floating-rate loan.

Sponsor Strength drew interest from about 50 percent of the lenders that Steub and his team had contacted. The numbers dwindled as the deal moved into the underwriting stage, and Wells Fargo Bank eventually provided a three-year, floating-rate loan.

Steub acknowledged that if she had come to market with the deal today, she would have received more interest from lenders. However, he doubts the outcome will be any different, given that he and his team were able to negotiate with Wells Fargo.

“The first question I get from lenders today is: Who is the sponsor?” Stebb says. “Irrespective of the type of retail asset, lenders want an experienced sponsor. They don’t want to catch a falling knife. They want to work with borrowers who have established relationships with retailers and who know how to operate these properties.”

Additionally, lenders are distinguishing between different types of retail properties. “Some retail fared well during COVID, and some retail didn’t fare well (and probably never will again),” notes Melody. “Lenders are interested in retail sectors and properties that have proven to be stable even during a pandemic.”

And somewhat surprisingly, even unpopular retail property types like attached malls aren’t getting immediate thumbs up from lenders.

“When I call a lender and say I have an attached mall, they’re no longer hanging on to me. They’re asking for details,” notes Steub. “Retail can’t be multifamily or industrial in one place, by any stretch of the imagination, but nothing is off the table.”

Driven by the ghost of rising interest rates

According to preliminary data from MBA, loan origination for retail properties increased by 73 per cent in 2021. The retail sector was second only to industrial, which saw a growth of 140 per cent in origination.

The increase in origination can be attributed to both acquisition and refinancing activity. According to real estate data provider Real Capital Analytics (RCA), retail investment deal volume rose to $76.9 billion in 2021, up 88 percent from the previous year. RCA attributed some of that rebound to one-off entity-level transactions. However, when focused only on personal asset sales, volumes were up 65 percent in 2021 compared to 2020.

Of course, the pandemic skewed the year-over-year comparisons. To provide a more comprehensive view, consider the five years of 2019, when deal activity in retail averaged $77.2 billion. According to RCA, deal volumes for 2021 are in line with past trends and certainly higher than some of the recent years.

Melody says that on the refinance front, it’s not just loan maturity that prompts borrowers to take on new loans. Although tens of billions in outstanding retail property loans will mature this year, according to the MBA, many borrowers are refinancing their loans several years before they are due because they are concerned about the interest rate hike that economists expect over the next 12 months. has predicted.

Melody says even the prepayment penalty isn’t enough to deter borrowers from refinancing. Lenders are doing the math, comparing the prepayment penalty to the amount they would have to pay if they refinance their loan at a higher interest rate.

“A prepayment penalty may seem significant on the surface, but if a borrower is moving to a new 10-year, fixed-rate loan, the prepayment penalty is amortized over 10 years,” says Melody. “It could be 25 to 30 basis points, but if you think rates are going to go up by 100 basis points or more, that makes sense.”

Currently, the spread for floating-rate loans is LIBOR plus 200 to 300 basis points, and the spread T-plus for fixed-rate financing is 200 to 300 basis points. The overall rates for both floating and fixed-rate loans still look attractive – around 4.0 percent or less.

“The reality is that sometimes the market isn’t great when borrowers go to refinance,” says Melody. “It’s really cool right now, and there’s a group of people who want to take the risk off the table and be able to sleep at night, instead of worrying about where rates will be in two years.”

Increase in retail allocation from all lenders

The good news for retail property owners is that there are many sources of debt financing available today. Banks, life companies, CMBS and investor-run debt funds are all actively lending to retail assets, and most have increased their allocations in recent months.

For the long term, fixed-rate loans on fixed retail properties, life companies and CMBS lenders remain an attractive and viable option, Steub says. Both offer non-recourse loans, although life companies are playing in the 50 to 60 percent LTV range, while CMBS is expanding to 70 percent LTV.

“CMBS is an interesting story right now,” Steub says, noting that issuers are focusing more on protecting the pool from anything that could go wrong. “They are structuring around the termination of the anchor tenant with increased reserves to ensure that the borrower has the funds needed to re-rent the property if the anchor does not renew. There is a correction over the years where they wanted interest reserves and debt service reserves.”

Last year, CMBS issuance for retail assets increased from $2.78 billion in 2020 to $9.93 billion. According to Trap, the share of retail properties in the annual CMBS issuance in 2021 was 9.1 per cent, which is almost double in 2020.

For retail properties that are in transition, perhaps with a value-added component or an upcoming lease renewal for an anchor tenant, financing is available with national and regional banks. However, many banks are limiting their retail asset lending to sponsors with whom they have existing relationships.

“Right now, banks are very sponsor-focused and very relationship-focused,” Steub says.

Debt funds tie up borrowers with flexible terms

Meanwhile, many borrowers are increasingly turning to debt funds to finance their deals. In addition to many life companies seeking high returns, several investment firms have raised debt funds, such as MetLife, PGIM (a subsidiary of Prudential Financial) and Voya Financial.

Although the cost of debt is higher with debt fund loans, most borrowers are not willing to pay a premium for the flexibility offered by debt funds. Typically structured as a two- to five-year, floating-rate loan, these loans provide a 60 to 65 LTV, as well as “good news” financing when the property reaches certain milestones related to property improvement plans. Is.

First, National Realty Partners (FNRP) is just one example of a retail property investor that has secured financing from a debt fund. Red Bank, the NJ-based firm, was one of the most active buyers of grocery-anchored shopping centers in the US in 2021, closing in on more than $500 million in acquisitions.

According to Jack McLarty, managing director of Debt Capital Markets, FNRP’s strategy of acquiring and holding assets for three to five years means that life companies and CMBS loans are less attractive. He specifically points to the lack of future financing facilities as a drawback for this category of lenders.

“Future funding features are extremely important to us, because the extent to which we can leverage them will help us deliver higher returns to our investors, which is ultimately our goal,” says McLarty.

With so many deals in FNRP’s pipeline, McLarty is regularly in talks with a variety of lenders. “Ten years ago, retail was not a sandbox in which everyone was playing,” he says. “But now there’s a lot of liquidity from a lot of different sources,

Including some people who dropped out a while back, but now they are back and want even more.”

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