The advent of the conduit lender and creation of an efficient market for commercial mortgage-backed securities (CMBS) in the mid-1990s was supposed to homogenize the commercial real estate lending business. People thought that once the secondary market for the CMBS paper matured, there would be little difference between loan terms quoted by Lender X or Lender Y, much like the residential finance markets of today.
But there are still significant discrepancies between loan pricing from lender to lender for a number of reasons. The main reason — and the reason CMBS did not alter commercial lending as originally thought — stems from the complexity of commercial transactions compared to residential transactions. A commercial transaction is not merely understood using a loan-to-value and credit report. In many cases, a lender does not take the time to fully understand a deal, and if the complete story is not understood, the quote cannot be competitive. Or, conversely, the quote may be too aggressive and could be re-priced during loan underwriting.
Other reasons for the sometimes-large differences in loan quotes can be due to the varying degrees of expertise at a particular lender. A lack of comfort with various property types can lead to out-of-the-market quotes to dissuade business.
On the other hand, borrowers can benefit from where a particular lender is in its securitization cycle. If you shop around enough and ask the right questions, you usually can find out if your deal would make a welcome addition to a lender's next securitization pool. Most lenders have target dates projected for their next pool. If your deal can close before the pool's deadline and that lender needs the property type you have, that lender may be willing to get aggressive. They also will be motivated to close the loan quickly, which also makes loan closing much more palatable.
In the retail lending arena, grocery-anchored retail is the lenders' favorite. At the top of this group stands the neighborhood center that has very little local shop space — 25% or less — with a credit grocery tenant that is showing strong sales per square foot.
In the first quarter, rate spreads for these deals were low, but they can vary quite a bit from lender to lender. Based upon first-quarter quotes, spreads for these projects ranged from a low of 200 basis points to more than 230 basis points over the corresponding Treasury. These spreads were true for the basic 10-year conduit loan and even the more traditional 20-year full-pay loan. An aggressive full-pay loan would be sensitive to the length of the anchor's lease, loan as compared to project replacement cost, anchor sales and the strength of project's particular trade area.
Grocery-anchored retail projects with a higher percentage of local space will see pricing in the 205 to 240 range depending on location and a particular lender's appetite at that time for the transaction. The pricing discussed in this section and the entire article assumes maximum loan proceeds in the 75% to 82% loan-to-value (LTV) range. Obviously, pricing will drop if LTV is reduced and if the lender has the ability (or desire) to accept a lower long-term yield.
Unanchored retail strip centers
Except for the single-tenant sector, unanchored strip centers see the widest range of spreads for loans. This wide range in pricing is due to a number of factors that include whether the property is “shadow anchored” by an adjacent credit tenant that generates traffic for the subject center. Other factors may include strength of the market area, age of the property, borrower quality, leverage level and the tenant line-up.
Assuming a full loan, spreads for unanchored retail centers are in the 230 to 260 range and may be higher under certain circumstances. Borrowers do not always understand that even though they may have a large tenant anchoring the property, lenders may not underwrite the project as an anchored property. This usually comes into play when the “anchor” is not a credit tenant — “BBB” or better as rated by Standard & Poor's — or the anchor is out of favor with that particular lender. A particular lender may have a large exposure already to that tenant and may price the loan accordingly to get you to go next door to another financial institution.
If you do not shop around, that lender will be happy to price your deal 30 basis points wide of the market. Unanchored centers have other issues such as heavy tenant rollover costs that when underwritten, limit loan dollars and cause lenders to require significant reserves.
Big box power centers
With ongoing consolidation and corporate failures in the retail industry, many lenders see big-box power center transactions as risky endeavors. Often, these projects are a group of four to seven large national boxes of 60,000 to 120,000 sq. ft. each, creating a large footprint of hollow walls.
Lenders have nightmares trying to mitigate the risk of losing a tenant due to the continuing retail contraction in the category killer sales arena. Additionally, most big-box leases are 10 to 15 years. This intermediate lease length causes problems with underwriting due to its conflict with loan maturity dates. For a lender to give full credit to a tenant lease, the lender usually wants to see the lease maturity date at least two years past the maturity date of the proposed loan. As such, most of these power-center leases do not fall within this guideline, causing the lenders to assign heavy reserves for the possibility of tenant roll during the loan term.
Rate spreads will directly reflect the credit or lack thereof of the tenant lineup. Having one bad credit in a line-up can significantly affect the entire loan quote, as the loss of one tenant can reduce debt coverage to 1.0 or lower. Still, there are a number of considerations when it comes to pricing, but spreads generally will range from 215 over the Treasury to 260 or higher.
Regional malls pose some of the same difficulties as power centers, with additional issues concerning loan size and anchor-tenant complexities. Unless the project is a small regional mall, these loans routinely exceed $100 million. Because of the large deal size, regional malls represent significant risk to the lender in exposure issues — especially if the lender securitizes its loans. A single regional mall loan can easily represent 10% or more of a lender's entire loan pool that might form the collateral behind a mortgage-backed security issuance.
As such, these loans are usually underwritten more conservatively using higher debt coverage and reduced loan-to-value ratios. These more conservative underwriting guidelines are used to placate the rating agencies and help these large loans pass muster with securities buyers. In many cases, a lender may look for other lenders to participate in the deal, spreading the exposure risk between a group of lenders.
Because of loan size, the number of lenders willing to take on a regional-mall loan is smaller than with other property types. Regional malls pose other issues including anchor operating agreements, operating costs, tenant occupancy costs and sagging anchor sales. Due to these issues, full loan amounts for this property type range from 65% to 70% of appraised value.
This lower leverage does have its benefits in giving the lender strong debt coverage from property operating income and improving the borrower's chances of refinancing the loan upon maturity. Because of the lower-leverage nature of these loans, rate spreads can be 200 to 230 over the Treasury index. Again, shopping around and finding the lender with the right appetite can result in significant loan pricing improvements.
Single-tenant deals are the most dynamic area of retail finance and change the greatest from day to day in terms of pricing. This is due to the close relationship between loan pricing and the credit quality of a particular tenant. As with regional malls, the world of lenders interested in single-tenant transactions is much smaller than with the more traditional multi-tenanted project. There are two types of loans for these transactions — the credit tenant lease (CTL) loan program and the more traditional balloon loan. The CTL program matches the loan term to the long-term credit lease term, resulting in a fully amortizing loan. These CTL loans usually feature near 1:1 debt coverage depending on the credit of the tenant and can generate high loan dollars. Be careful, as closing costs can be high for these types of loans.
The other financing alternative for single-tenant transactions can be the typical conduit balloon loan. Similar to multi-tenant deals, the underwriter will make cash-flow deductions for vacancy, management fees and reserves. Conduit loan amounts can be close to CTL programs and sometimes even exceed them because a longer amortization period is usually used. The aggressiveness of the lender depends on the credit of the tenant and the tenant rent as it compares to market rents. Maximization of loan proceeds by pushing the amortization period past the lease maturity can cause problems upon refinancing of the loan. Rate spreads for single-tenant transactions are directly related to the credit rating of the tenant and can range from 190 over the Treasury to 400 or more.
Single-tenant transactions are the best way to reinforce my overall point. Talk to multiple lenders about your transaction, as pricing does differ from lender to lender based upon many variables. One lender may get aggressive with a deal, while another lender may hammer the income and generate a low-ball quote. Another lender may call the transaction or anchor tenant “toxic” and politely pass. All these factors indicate that it's essential to shop around when borrowing money in the commercial real estate loan arena.
Mark Rowell is vice president of lender relations for Atlanta-based NetFunding.com, a quote-to-close e-marketplace that connects borrowers, brokers and lenders of commercial real estate capital.