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Borrowing Bonanza Continue$

With interest rates in the attractive 8 percent range, the competition among lenders reaches a new pitch. Extreme caution no longer seems to be the catch phrase guiding lenders when it comes to retail. "Everyone's looking to place money. For the capable and experienced borrowers, the combination of interest rates and capital availability has created the most favorable borrowing environment in the past decade," declares Lisa Weitzman, director of Hidalgo & Co., a boutique investment banking firm in New York that provides total capitalization services for an exclusive roster of clients.

According to Robin Sofio, vice president/product manager in the Capital Markets Group at First Union Bank, Charlotte, N.C., all segments of the market look strong. She reports First Union, which did more than $70 billion of retail lending in 1996, is lending in every category, including unanchored and shadow-anchored strips. Many loans, she says, end up being securitized for the capital market, which is competing head-on with institutional investors for deals.

This does not necessarily mean lenders have opened the flood gates -- although a few indeed appear to have done that -- only that their confidence in the market has returned.

How long the confidence lasts depends on consumer spending patterns, the outcome of consolidation trends and, ultimately, the outcome of current deals. Given what happened at the beginning of the 1990s, it probably won't take many foreclosures, or threats of foreclosure, for lenders to grab a tighter hold of their wallets.

Few anticipate such a scenario, however. Those surveyed for this article express assurance lenders are exercising full due diligence before signing off on a loan.

"I don't think they're compromising on their underwriting," states Weitzman. "It takes a pretty in-depth analysis before a decision is made. Each deal is examined very closely."

Perhaps what is most noteworthy about today's lending market is the variety of sources looking to do deals. Public REITs, private REITs, conduits, life insurers, pension funds, banks, savings and loans, and even individual investors are seeking attractive retail opportunities.

Competition heats up The types of deals each lender will do varies greatly, which theoretically could mean a lot of searching to find the right source. In practice, however, the search is rarely difficult. Competition is so intense that lenders and their agents are doing much of the scouting themselves, hoping to land the good deals before someone else gets them.

Because the lending market has become so extremely competitive, many lenders openly acknowledge they will do what it takes to land deals.

"There isn't much we're not able to do," avows Martin T. Lanigan, senior vice president of structured finance and securitization for GMAC Commercial Mortgage Corp., Horsham, Pa.

"If there's a way to make economic sense of it, we'll deliver it."

What this means for developers and investors is lower rates, better terms and quicker closings.

John Christiensen, senior vice president of Fleet National Bank in Boston, confirms pricing is definitely under pressure. While Fleet has a rated REIT as a sponsor, which limits the amount it can cut, a few lenders appear willing to cut their margins to the bone, trusting volume rather than rates to generate profit.

"I think you see pockets of things you kind of raise your eyebrows to. You'll see deals that may go beyond what you may deem as prudent," says Lanigan.

The margin for error, he adds, is considerably lower than it was 18 months ago. "You were lending at 350-point spreads. Now you have to cut 125 to 150 [points] off that," he says.

Lanigan's calculation seems to be conservative. According to Christien- sen, Fleet's rates for construction loans average 150 to 200 points over LIBOR, with three- to five-year terms, although he notes acquisition/rehab deals sometimes get lower spreads.

Some quote even lower spreads for permanent loans. For example, Gregory J. Spevok, vice president and director of originations for Bear, Stearns & Co., reports his company makes many deals at 140 points over three-year Treasuries and has gone as low as 120-point spreads with 30-year amortization for quality-anchored deals with high loan-to-value (LTV) ratios.

Mike Jameson, a vice president in the San Francisco office of Atlanta-based Prudential Capital Group, quotes spreads of 100 to 150 points over three-year Treasuries, with LTV ratios in the 65 percent to 75 percent range. Weitzman says a typical Hidalgo placement could come in anywhere from 125 to 200 points over 10-year Treasuries, depending on the tenant credit.

Fixed rates appear to be the rule, but Lanigan says GMAC has done quite a few variable-rate deals. Twenty-year amortization with 10-year terms is common, but 25-year and 30-year mortgages are not difficult to get, according to several respondents.

As expected, anchor quality and lease arrangements play a major role in determining terms. Untested products like entertainment centers and urban specialty centers face higher spreads and shorter terms, while A-quality and better malls at the higher-dollar end and neighborhood centers with expanded supermarkets at the lower-dollar end command the best deals.

Geography has little influence over the deal, yet demographics do matter. And not surprisingly, most lenders prefer primary markets and hesitate about second- and third-tier markets. Hesitance does not, however, mean avoidance, especially with regard to second-tier markets. Hesitance more likely means a somewhat higher rate and larger percentage of credit tenants will be required.

According to Spevok, Bear, Stearns is aggressively quoting deals in every market, including the smaller markets that most national lenders avoid for fear cheap land will attract competing projects. He says the smallness is what makes these markets attractive. "The barrier to entry is the fact that the market is small and the existing center already occupies the key location. That makes competition unlikely," he explains.

Regional malls Regional malls remain the favored retail product for institutional investors, especially now that many of the weakest centers have been weeded out and the sites converted to other uses.

Ostensibly, institutional investors and REITs are battling one another for control of these assets, but the growing trend by life insurance companies and especially pension funds to invest in REITs blurs the picture.

Jameson notes REITs are more active on the equity side, while insurers and pension funds are more active at the mortgage end. But he emphasizes that's not at all a fixed rule. According to Lanigan, most regional mall executions are being designated for securitization. Competition is pretty strong in this regard, he says.

Some malls do face problems in getting financing, and lenders are fairly selective. Jameson says Prudential wants to finance high-quality, well-anchored malls in major markets. Properties outside those criteria most likely will have to look elsewhere.

Power centers Less than a year ago, concern about retailer consolidation was making lenders think twice about power centers. While some may still be cautious, most appear to have resolved many if not all of their worries.

Christiensen says the threat of retailer consolidation is not seen as a major obstacle right now. "I think one of the benefits on the anchor side is you've seen most of the consolidation already. The major retailers have been through the wringer, and those that have survived, for the most part, are healthy," he says.

A burgeoning area of concern with regard to power centers, Christiensen continues, is the potential for home shopping to deal a blow to power center retailers. Although the threat from technology is not around the corner, it could loom larger in five to 10 years. Consequently, he says, Fleet looks for significant equity contributions from credit tenants now in anticipation of this fledgling retail medium.

Community and neighborhood centers Community and neighborhood centers remain very much in favor with lenders, although Weitzman warns that the supermarket anchor generally has to be present in its most current format (or at least planning renovation and expansion) in order to be considered for more favorable financing terms.

"The bread-and-butter that we're doing are neighborhood shopping centers, especially in locations that are irreplaceable. We're looking at sales per square foot," says Spevok.

According to John Quibodeaux, a senior analyst with Belgravia Capital Corp. in Irvine, Calif., Belgravia aggressively seeks food- and drug-anchored centers and will sometimes accept an LTV ratio of 80 percent on them. The maximum rate, he says, is less than 200 points over prime.

He reports Belgravia will finance new as well as established centers, based on pro forma, unlike life insurers, which typically look only at deals with a stabilized history. "New centers generally have better quality tenants and a better facility," he explains.

Outlet centers In general, outlet centers draw negative reviews from lenders. "Virtually everyone has flagged outlet centers," David Shotwell, senior vice president in the Sacramento office of Portland, Ore.-based U.S. Bank, said at a recent Urban Land Institute conference in San Francisco. The reason is two-fold, he explained: Other retailers today are able to match outlet prices while providing more convenient locations; and if an outlet center goes under, its remote location will make it difficult to retenant with any kind of use.

The attitude is softening somewhat as smaller outlet centers find their way into more urbanized settings and larger ones add major entertainment elements that both bring in customers who otherwise would not have come and generate regular return visits.

"I think outlet centers are viable, and the success of many of them proves it," says Christiensen, who notes that many manufacturers' insistence on three- and five-year leases provides another reason for lenders to dislike the format. As manufacturers have become more confident that outlet stores can boost the bottom line, they have become more willing to do long-term leases, eliminating that objection, he adds. On the other hand, Christiensen acknowledges that Fleet has not lent on outlet construction.

Spevok says Bear, Stearns does outlet centers but wants higher coverage ratios, approaching 140. "We review them as inherently riskier, but we're not averse to them," he says. Quibodeaux reports that Belgravia also is happy to take on outlet centers as long as they meet underwriting criteria.

Entertainment centers Many lenders express caution about entertainment and urban specialty centers, primarily because neither project type has a sufficiently long record by which to evaluate them.

"We don't do too many entertainment and hybrid centers," says Jameson. "We would always consider them, but we would be concerned about the track record and the longevity of any new concept. We tend to look at properties that provide a consistent track record."

At the same time, most communities of any size can claim to have at least one large entertainment complex in operation, construction or discussion. Since many are already under way, financing is obviously available. Municipal bonds and other forms of public subsidies help many of these projects along, with public agencies underwriting some of the risk.

But just as many are totally private projects. Quibodeaux says Belgravia is very open to funding entertainment centers. Spevok says Bear, Stearns likewise regards them favorably, while Christiensen reports Fleet is not adverse to funding their construction but has not had the opportunity.

Small strip centers and street retail In percentage terms, probably the least likely projects overall to get funding are small strip centers and small retail buildings found along city streets. The reason is not that such projects are ipso facto unattractive to lenders but rather that this is the realm most likely to attract inexperienced developers that pick inappropriate sites or lack the expertise to bring a deal together.

Viable projects of this size, on the other hand, especially in urban locations, attract a lot of interest from banks. At the ULI conference mentioned above, Shotwell categorized small urban retail projects as high on U.S. Bank's list of favored projects.

He said the bank looks particularly favorably on urban projects that combine retail and residential uses and reported it recently provided construction financing for projects of this type in Sacramento, Portland and Seattle. "They've all been successful and we had no trouble taking them out," he said.

Strip centers, according to several respondents, can get financing based on location and pre-leasing by qualified tenants. Credit tenants are not necessarily required for smaller in-fill projects, depending on the equity and record the borrower brings to the table.

Freestanding stores Demand for commercial net leasing continues as more retailers discover the financial advantages of freestanding buildings under their own control.

According to Gary Ralston, president of Orlando-based Commercial Net Lease Realty Inc., CNL not only provides equity funding but also helps line up tenants and helps with lease negotiations and development. CNL is an equity REIT with 45 different retailers in its portfolio.

"From a financing perspective, we do a lot of pre-sale work with developers. We come in and do a pre-construction purchase that allows the developer to finance out of the deal. We can help facilitate getting the lease executed," he says.

"We have very efficient access to capital. Our stockholders are interested in long-term, stable properties," he says, citing on-going relationships with three banks.

CNL can expedite all stages of development and financing, Ralston avows. "When a developer has a site under control and a tenant with a business letter signed, we turn on the turbochargers. We'll help him finish the lease, and he can take that into a bank," he says.

Ralston says the company will do sale-leasebacks but generally prefers to hold the property.

Paul McDowell, vice president and general counsel for Capital Lease Funding Corp. in New York, says his company specializes in sale-leasebacks.

"We are able to finance a property by relying on the credit of the tenant. The result is we're a discounted cash flow lender. We can give borrowers very high debt service cover," he says.

The exit strategy, he continues, is to pool and securitize.

McDowell reports the firm is constantly introducing new products. Among them is extended amortization, which incorporates the first renewal period into the original loan, giving the borrower more time to amortize the loan.

This provides significant benefits to borrowers, he explains, by giving them both more loan proceeds and tax benefits by allowing them to defer phantom income.

Another advantage of Capital Lease's type of programs, according to McDowell, is that it permits LTV ratios of 95 percent and higher because the tenant's lease rather than the property serves as collateral.

"The tenant pays off your debt, yet there's always a residual value in the property. So the lender is virtually fully protected. The only problem is if a tenant goes under too soon, which is why we work only with top credit tenants," he says.

United Trust Fund (UTF) of Miami, in partnership with Metropolitan Life Insurance Co. since 1988, also helps retailers transform their real estate holdings into capital. "When a retailer has all of its money tied up in real estate, it can't buy merchandise," explains Sidney Domb, president of UTF. "And selling merchandise -- hamburgers, shoes, etc. -- is where retailers make money, not in bricks and mortar."

UTF buys (and leases back) retail or warehouse sites, with two caveats: they are single tenant buildings and have a value of at least $3 million. The second caveat is negotiable, Domb says, if the client brings several properties to the table, making the overall value of the deal exceed $3 million. "We're very flexible," he continues. "At the end of the deal, though, United Trust Fund is the landlord."

Like CNL, UTF will buy existing land and buildings or property under option that can be assigned to UTF. In the second scenario, UTF would then develop a building to the retailer's specifications. "We're not developers," Domb says, "but we'd get the building built."

Future prospects Most respondents expect interest rates to remain fairly stable for the next 12 to 18 months, probably longer.

"We're in a period of stabilization of pricing," says Quibodeaux. "I don't think [pricing] can continue to contract as it has over past year. There's not enough room."

Although some are concerned about how narrow spreads have become, Lanigan maintains that the increasing efficiency of the capital markets allows low spreads without endangering profits.

"The market's becoming more efficient. As more people use capital market strategies, the benefits are passing through to the consumer," he says.

But because pricing is so tight, lender differentiation increasingly relies on service -- on turnaround time, flexibility in structuring deals, reliability and the potential for long-range relationships -- rather than rates.

Quibodeaux notes that new financing sources are entering the market every month, heating up competition. At the same time, Lanigan anticipates a shake-out among lenders, particularly in the capital markets.

"I think you'll see more consolidation. Maintaining a large origination and underwriting staff is a big commitment. Instead of the 17 to 20 conduits you have today, you'll probably have only 10 or a dozen by 1999," he says.

The biggest challenge going forward, Lanigan continues, is maintaining discipline as portions of the market approach saturation.

"The constraints the ratings agencies maintain is helpful, but we're hoping the agencies will look carefully at the underwriters and start rating them. It's not a question of 'if' but 'when' that will happen. If it doesn't happen soon enough, we may start to see some problems," he says.

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