Retail Credit Quality Will Strain as CMBS Issuance Surges
Fueled by investors’ renewed appetite for risk and the relative stability of bond yields, CMBS issuance in 2013 is pacing far ahead of last year. By early May, volume had surpassed $30 billion, roughly three times the 2012 year-to-date tally. An uptick in the number of well-qualified borrowers is only part of the story. As it expands, the credit quality of the larger underlying pool shows signs of an increasingly flexible approach to underwriting. Too many investors are unfazed by the credit drift, largely content that anchoring to existing cash flow obviates risk along other dimensions. Fitted with blinders, those investors run the chance of being outflanked by new drivers of loss, including inadequate cushions against rising interest rates. As the cyclical attention to risk dissipates, a longer list of ratings agencies in the post-crisis era still brings fresh perspectives to the marketplace. It has also invited a new round of ratings shopping.
Barring a shock to the bond market or to the modest economic supports for property fundamentals, CMBS market participants see issuance rising to as much as $80 billion in 2013. That’s a far cry from the unsustainable market peak of 2007. It’s still a large enough leap from 2012 that it poses the question of how we’ll get there. Small retail properties are the stuffing in the CMBS turkey. That’s unlikely to change. With competition on the rise for lending opportunities across property types, the conduit cannot rely solely on expansion of market share in other sectors. There is the oft-cited wave of maturities, but we’ll have to dip into a deeper risk pool if unmodified refinancings are the answer.
Retail properties have already registered improvements in liquidity on account of better access to financing. The long and short of first quarter originations—including retail loans made by banks, life companies and through the conduits—shows some room to push the envelope but does not exhibit the underwriting conservatism a year ago:
• Underwritten cap rates on neighborhood and community shopping center loans averaged 7.0 percent in Q1 2013, down just 20 basis points from a year earlier. Retail’s perceived safe havens, including grocery-anchored centers, risk overcapitalizing current income. Valuations on regional and super regional malls showed bigger gains; mall cap rates declined 40 basis points over the year, from 6.8 percent in Q1 2012 to 6.4 percent in Q1 2013. Across all retail properties, the interquartile range spanned from 6.1 percent to 7.4 percent.
• Malls commanded lower cap rates but not lower debt yields. Across all retail properties, debt yields averaged 10.7 percent in Q1 2013. The interquartile range covered roughly 200 basis points, topping out at 11.5 percent.
• Against a loan-to-value ratio of 64.5 percent, the average interest rate on long-term fixed-rate financing was 4.4 percent in Q1 2013. Interest rates were substantially lower for malls than for neighborhood and community shopping centers; at comparable debt yields, debt service coverage was markedly higher at malls. Largely a function of their shorter lease terms, projected volatility in coverage was higher for shopping centers.