Retail Lending Gets Easier—Thanks in No Small Part to CMBS

CMBS loans are appealing to borrowers, be-cause the loans are nonrecourse, in contrast to traditional financing, which often stipulates that borrowers are on the hook for financial damages if the loan goes bad, said Dov Zabrowsky, the director of underwriting at Eastern Union Funding. The term of a typical CMBS loan is also longer than that of a traditional bank loan, said Mr. Zabrowsky.

With more flexibility offered by CMBS loans, developers and owners who want to revamp their properties are able to creatively finance projects that might look risky on paper, and finance projects at properties that were until recently the scourge of investors.

For instance, Eastern originated a $9.2 million CMBS loan for Westgate Mall in Brainerd, Minn., led by Morgan Stanley (MS). Investors Alan Retkinski and Alex Schleider bought the property from real estate investment trust DDR Corp. when about a third of the 240,000-square-foot property was empty. But after renovations, the new owner attracted new tenants: retailers Big Lots and Dunham’s Sports.

Borrowers in areas like Alabama and Florida— states that were, until quite recently, plagued by high default rates—have also used CMBS loans to turn around formerly underperforming properties, said Mr. Zabrowsky.

CMBS loans are even being used to finance projects in rural areas in the country that most banks and life insurance companies avoid.

“There’s less competition in secondary markets,” said Doug Mazer, the managing director and group head of Wells Fargo (WFC)’s real estate capital markets group.

And there are signs that investors are buying more properties of all types in secondary and tertiary markets, according to a May report by Wells Fargo. In the first quarter, total investment volume fell 12 percent year over year in major markets but rose by 20 percent in secondary markets and 32 percent in tertiary markets, according to Real Capital Analytics. Total investment in the first quarter was $82.7 billion. Retail investment grew the most out of any sector, increasing by 87 percent in major markets, 71 percent in secondary markets and 60 percent in tertiary markets.

And Mr. Mazer disagrees with the characterization that all CMBS deals are riskier for investors. CMBS lenders are still conscious of the standard underwriting concerns, such as the property’s sponsor, asset quality and tenants. “They’re higher in leverage but still solid loans,” he said. Stricter underwriting and more scrutiny from ratings agencies means that issuers are now putting out product that is a higher quality compared to before the recession, Mr. Mazer said.

CMBS loans also benefit the borrower, as they provide more flexibility in structure. For instance, if a retail anchor tenant’s lease is set to expire in five years and the CMBS loan has a term of 10 years, reserve money can be set aside to fund the cost of finding a new tenant for the space, said Mr. Mazer.

Other potential structural benefits include interest-only payment periods that can be easily extended and leverage points that increase to 75 percent or higher.

CMBS Bouncing Back

A forecast from the Urban Land Institute and Ernst & Young projects CMBS issuance rising to $88 billion in 2014, up from $75 billion in 2013 and $48 billion in 2012. Although the figures are only around half of the volume of 2007, when CMBS origination surpassed $200 billion, they represent a steady rebound after CMBS volume plummeted to around $3 billion in 2009.

At the same time, retail availability rates are expected to decline to 11.8 percent by the end of 2014 from 12.2 percent at the end of 2013, and rents are projected to increase by 2 percent in 2014, according to the forecast.

“Confidence in the market is coming back,” said Ayush Kapahi, a founding partner of HKS Capital Partners. Areas hit hard by the real estate crash including Florida, Arizona and Southern California have all begun to recover and are attracting new financial interest, Mr. Kapahi said.

CMBS borrowers range from one-man operations to global REITs, and loan amounts begin as small as $1 million. The nationwide CMBS loan delinquency rate was 6.4 percent in April, down from 9 percent in the previous year period, according to data from Trepp Inc. Retail was the best-performing property type, with a 5.6 percent delinquency rate in April.

Mr. Kapahi said that his company has originated $200 million in retail CMBS deals nationwide, and another $200 million in New York City in the past six months.

“I don’t see it slowing down,” said Mr. Kapahi. “I see it getting better and leverage going up.”

Follow the REITs

CMBS financing has also been attractive for some of the largest retail landlords in the country: real estate investment trusts such as Simon Property Group, General Growth Properties and the Macerich Company.

“There is a lot of appetite, because there are a lot of lenders out there,” said Fredric Altschuler, a senior counsel who focuses on real estate financing at law firm Cadwalader Wickersham & Taft LLP.

Real estate investment trusts have long been active in CMBS area, and they remain comfortable with the funding mechanism, even after the market froze immediately after the recession began.

Mr. Altschuler recently worked with Simon Property Group, the largest U.S. mall owner, on 10 CMBS transactions totaling more than $800 million on shopping centers located in New Mexico, Kansas, Virginia, California, Illinois, Iowa, Pennsylvania, Tennessee and New Jersey.

In another major deal, Simon and partner Turnberry Associates refinanced the Aventura Mall near Miami for $1.2 billion in December through a CMBS deal. Lenders included J.P. Morgan Chase & Co., German America Capital Corp., Morgan Stanley and Wells Fargo. The property is 99 percent leased with tenants including Bloomingdale’s, Macy’s and Nordstrom. The owners have also filed plans to expand the mall by 241,000 square feet, which would make it the second-largest mall in the U.S., behind the Mall of America in Minnesota.

Simon Property Group is also in the midst of spinning off 98 of its strip centers and smaller enclosed malls into a new REIT, Washington Prime Group Inc., in the second quarter.

In September, RFR Holding LLC and Tristar Capital closed a $580 million CMBS refinancing for Miracle Mile Shops, a 500,000-square-foot mall in Las Vegas, where tenants include H&M, Urban Out- fitters, Guess and Gap. The property also includes a casino and hotel. The 10-year loan was led by Cantor Commercial Real Estate and was the largest CMBS deal that the firm has completed.

And the more attractive to big landlords, who account for the bulk of the increase in CMBS volume through the past two years, the easier the financing should become for smaller players who need more wiggle room in their deals, sources said.

“All of the big players in retail have been very active in refinancing,” said Mr. Altschuler. “The environment is very attractive.”

Rocky Road Ahead?

But retail remains in transition, and competition from e-commerce and turmoil among big-box retailers may dampen further growth in the sector. Retail’s revenue growth still lags behind that of the multifamily sector, and vacancy rates remain high in some areas. Holiday sales in 2013 also grew at a slower rate compared to 2012, and major stores such as J. C. Penney, Sears and Best Buy, former stalwarts in the retail industry, have also been closing locations, creating more empty space.

Fitch Ratings stated in January that seven CMBS deals entwined with embattled J. C. Penney, would be minimally impacted by their exposure to the distressed retailer, and the properties affected could benefit from a different tenant. But continued problems could further widen the gap between weaker and stronger malls.

“Over the longer run, Fitch believes continuing struggles for major retailers may impede the general stabilization we have seen in the retail CMBS market,” the company stated. “If large-scale closures take place, we would expect dominant Class A malls to retenant space, while weak malls could be put under pressure.”