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Liquidity for Retail Assets Increases Even as Fundamentals Lag

Commercial real estate lending has loosened up considerably in the past six months, leading to more acquisition activity and making it easier for borrowers facing maturity to refinance their loans. And most industry experts feel that liquidity will only increase in 2011.

The bad news, however, might be that the capital marketplace has recovered from the credit crunch a bit too quickly, with many transactions spurred on by record low interest rates rather than improving property fundamentals.

Industry leaders gathered to discuss these and other topics at ICSC’s 2010 Capital MarketPlace Conference in New York City on November 8.

“The lending market has gotten much more aggressive than even a few months ago,” Wells Fargo Managing Director Joe Tufariello said during the “Is Stabilized Lending Stable Again?” panel at the conference. “And it’s still an evolving market.”

Wells Fargo, for instance, has been among a dozen or so banking institutions to put together a CMBS pool this year. In October, Wells Fargo and Bank of America brought to market a $735.9 million CMBS issue. The issue included 37 commercial mortgages originated by Wells Fargo, Bank of America and Basis Real Estate Capital II on 59 properties. Retail represented more than 30 percent of the loans in that deal.

By the end of the year, total CMBS issuance will amount to about $12 billion, according to Tufariello. In 2011, Tufariello projects the figure might spike to $40 billion.

Not only has it become much easier for retail owners to secure financing, including CMBS loans, but the terms of the transactions have gotten more favorable. In 2009, it was virtually impossible to secure a loan with a loan to value ratio (LTV) greater than 50 percent. Today, CMBS lenders are willing to go up to 75 percent, while life insurance companies have lately been offering up to 70 percent.

What’s more, with the Federal Reserve keeping the Federal Funds Rate below 0.25 percent, the prime rate banks charge their best customers stands at 3.25 percent. As a result, the best borrowers can secure fixed 10-year interest rates below 4 percent on some assets. Six months ago, getting an interest rate below 5 percent was unimaginable, Key Bank Senior Vice President John Manginelli said during a session entitled “Finance and Bridge Capital.” Today, “we are all nudging down from that,” he noted.

Asset quality, however, still matters. Most lenders want to see stable, existing cash flow before they agree to commit capital. They also want to have the retail sales and occupancy cost comparisons for tenants—information that many owners are unable to provide, according to Prudential Managing Director Melissa Farrell. (Farrell spoke on the same panel as Tufariello.)

If the cash flow numbers pencil out, conduit lenders have been willing to throw in some class-B assets, along with the higher quality stuff, into their pools, to get higher yields. But life insurance companies still prefer to stick with grocery-anchored shopping centers and regional malls in primary markets, says Farrell.

The life insurers also put an emphasis on strong sponsors and give more attention to those centers where the anchor tenants occupy the majority of the space.

Owners of centers populated by mom-and-pop shops might have better luck with the regional banks, which have local market knowledge and are more willing to look at properties with “a story,” according to Deanna Polizzo, New York-based vice president with NorthMarq, a capital solutions provider. While most other lenders concentrate on the bigger mortgages, regional banks have been a great source for loans under $10 million, she added. (Polizzo also spoke on the “Is Stabilized Lending Stable Again?” panel.)

The credit markets seem to have bounced back from the brink so quickly, longtime industry insiders like Michael Fascitelli, president and CEO of diversified REIT Vornado Realty Trust, worry that “we might have another financial bubble brewing with this.”

Fascitelli, whose company owns the Toys ‘R’ Us retail chain in addition to its real estate holdings, noted that retail CEOs are still seeing customers shop paycheck-to-paycheck. Fascitelli’s comments came during the event’s keynote address. Consumer confidence might be up from its low point in 2009, but it’s still nowhere near its long-term average, he added, which means that retailers will likely try to keep their real estate growth at a minimum in the coming years.

“We have seen cap rates come down and it’s not because the rents are up,” Fascitelli said. “The capital markets are ahead of fundamentals. They’ve always been ahead of fundamentals. The question is, are they right?”

Cap rate compression may be good news for some borrowers, as it means that many assets that were expected to come underwater in the next two years now won’t face defaults. But while lenders have been willing to bet on primary markets and on strong assets in secondary cities, most still avoid retail centers in tertiary markets like the plague. Many of those centers have not yet entered foreclosure, either because so far they’ve been able to hobble along or because lenders avoided dealing with troubled assets for most of 2010.

But as one conference participant put it, “the number of regional malls that are going to crater over the next couple of years is unimaginable.”

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