February 19, 2019
By Patrick Ward, MetroGroup Realty Finance
Q: What is the current climate for retails deals? Are you seeing a healthy appetite or interest from debt capital sources for retail properties?
A: We are seeing a continued appetite of capital for financing retail properties. However, I would be careful to call it “healthy.” All of the lenders we work with continue to provide financing for the retail asset class and size that they always have in the past. There is no dramatic policy change or prohibitions on the various classes of retail properties they are financing today. However, they are clearly more diligent in their underwriting and analysis. The only asset class that is very difficult to finance is the older, traditional indoor-malls in smaller markets. Historically, these malls have been occupied by the second tier of retail users, and if the sales of in-line stores are not in the $500-per-square-foot per-year range, they are very difficult to finance today.
What is new to the market is in the commercial mortgage-backed securities (CMBS) world. Sponsors of mortgage pools are putting a 30% limit of the retail class of asset in the pool. We don’t see this as dramatically limiting availability of funds for retail properties – only allocation discipline in the CMBS space.
Another interesting trend is the more favorable treatment of unanchored service retail centers. What in the past was considered a secondary source of security for real estate lending has now, as a result of the e-commerce effect, become more favorable and more desirable collateral. These centers are historically occupied by the service sectors: personal care, tailors, local ethnic food, insurance, real estate etc.
Q: What should retail owners focus on to secure financing today in Southern California?
A: Owners and potential buyers have obviously been sensitive to the effects of e-commerce on retail properties. Properties with good demographics have adjusted well to the transition. Prudent owners are looking to more than income in their demographic studies, they are emphasizing age, spending and dining tendencies.
Q: What is your expectation for retail financing activity this year in Southern California? What will be the biggest challenges for retail investors this year?
A: All of the lenders that we represent and work with, which includes all sectors of the real estate finance industry, including life insurance companies, national banks, regional banks, CMBS, Credit Unions and debt funds, all have ambitious allocations and budgets for 2019. The major metropolitan areas in the U.S., including Southern California, are fortunate to have an abundance of capital sources available to access. Existing owners and perspective buyers will continue to have multiple attractive options and sources of capital for their commercial properties. These include long-term attractive fixed rate options from the life insurance and CMBS sources, to more flexible, short-term loans from the banks, credit unions and debt funds.
The biggest challenge we see for investors in the retail asset class in 2019 is the availability of good quality properties for sale. The historical run-up in values, coupled with investors’ concern about rising interest rates, could create challenges. Sellers and buyers may see a difference in 2019. What we have seen in our 35 years of providing capital for investment real estate is that cap rates move to neutral leverage – that is to say cap rates are at a similar level as a 30-year mortgage loan constant. So the cash-on-cash return remains equal to the cap rate.
– 4% 30-year amortization equals .0573% loan constant.
– 5% 30-year amortization equals .0643% loan constant.
So, we may see an upward adjustment of cap rates, therefore pricing, as a result of the anticipation of rising interest rates.
For comments, questions or concerns, please contact Dennis Kaiser