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Making a point

Money was the topic at breakfast when NREI and sister publication Shopping Center World, gathered together nine finance professionals during the recent ICSC Convention in Las Vegas.

The industry players talked about the property types being funded, the impact of REITs on the retail lending environment, and how the current competition is making shoppers out of borrowers. They're all in the game, it seems, to make a point or two.

NREI: What types of properties are you funding right now? Where are the hot areas that each of you sees?

Ben Butcher: We're doing a lot of reuse financing. We're very interested in the 70% to 75% loan-to-value permanent mortgages. We've done a number of conversions to office - well, partially office, partially retail - but a lot of reuse. In the development cycle we're in now, we're looking at a number of ground-up developments in regional malls.

Steve Malloy: Let's see, how many grocery stores do we need in this country? We see a lot of Walgreens, a ton of Rite Aid and Winn-Dixie, and we continue to see Home Depot and Wal-Mart expansion. Just about all the retailers are expanding. You see a lot of battlefronts in the consumer electronics industry, with one trying to beat the other. There's a CVS on one corner and right across the street there's a Walgreens. I'm not sure where the end is, but it sure looks to me like the bubble's got to burst some day.

Jonathan Rice: We're seeing a lot of neighborhood shopping centers, a lot of revised, a lot of permanent debt. But our clients are also bringing a lot of long-term situations.

Steve Jones: The 70% to 75% or 80% loan-to-value or conduit loans are really where we have an appetite. Probably 25% to 30% of the conduit business we've done in retail is in shopping centers. We have a credit tenant lease program in the net-lease financing area that is very active, and the majority of the business is in the retail sector.

Lisa Cunningham: Likewise, we see a lot of redevelopment and the Walgreen's going up everywhere. But the thing I find really interesting is you have a lot of city development going on. There's a couple of new redevelopments. Downtown Highland Park, Ill., has a new retail, office, apartment project going on. And those are actually happening in several other areas. So those are really interesting projects that are in urban infill sites.

Mark Wise: On the large loan front, the loans over $75 million, I'm actually seeing a lot of portfolios that are in trading between MEPC and TrizecHahn and CPI. And a lot of these mall companies look to go down to the triple-B-minus leverage, which historically is 65%, almost 70%. Because the money's cheap, you can still finance that under 7% today, and typically you can do it under 7% interest - although if cap rates continue to go south, the 65% to 70% LTV, triple-B-minus lever really isn't there anymore. It's probably closer to 50% to 60% LTV. But there's a tremendous amount of volume being pushed into the system right now, and secured debt is how a lot of these retail REITs are financing a good chunk of their acquisitions.

Steve Wilson: At GMAC, we're really involved in all of the above. Our forte has not historically been retail. We've been a lot more multifamily-oriented as a primary product. But we're looking very strongly at programmed funding for retail chains. And we're shifting our emphasis to some degree away from the multifamily into retail. We think there's stronger fundamentals and we've been successful in appointing some folks who have a good, strong retail background.

Greg Spevok: We deal more in retail than in any other single product class by a considerable amount. But our search for yield has not yet taken us to mezzanine finance. We concentrate on 75% or less LTV doing high-quality loans, and we're finding just a ton of that out there.

Mike Connolly: At First Security, we're in a great many niches. Retail falls under the umbrella of our general commercial program. But within that general commercial program, we're trying to expand out into regional offices to get a little closer to the people and the real estate. We viewthe type of retail we're doing as very important: bread-and-butter, neighborhood , unanchored and anchored, or perhaps anchored but not with the most popular grocery store or drugstore. So what we're finding is the closer we can get out there - we opened an office in Atlanta and most recently in Washington, D.C. - that allows our people to play touchy-feely with this because it really is nuts-and-bolts real estate. And what we're seeing is, as competition heats up, everybody's looking for higher loan to values, whereas lenders are looking for higher yields. So we too are looking to add bridge and mezzanine-type financing to try and marry the two interests - our need for a little bit of yield and profitability and the borrower's need and desire for a little more loan dollars.

NREI: Where does the entertainment center fit in? Is that a product you like, don't like?

Wilson: We're even thinking of formulating an entertainment group within GMAC Commercial Mortgage. We think that's really an emerging opportunity.

Malloy: I think that on the entertainment side we are seeing some theater growth as well. I might also add in the other expansion what we see are a lot of the credits are trying to plug the holes where they're not strong in markets, particularly we see upgrowth growing west. When you look at credit, most of the investment-grade credit seems to be on the East Coast, and far less on the West Coast. Now if you looked at foods, for example, you would find almost a dozen investment-grade food credits on the East Coast, and you're hard-pressed to find one or two on the West Coast. But you see Walgreen's go into San Francisco. So you see a lot of market filling and, in particular, a lot that are pushing toward the West Coast.

NREI: Those aren't as common as the CVSs on every corner. Do you see that phenomenon?

Jonathan Rice: A couple of our clients based in Atlanta are looking to do ground-up entertainment centers on the East Coast and in all the major markets, across the regional malls. We've had a couple of requests recently for construction perm product for ground-up entertainment complexes.

NREI: How big?

Rice: $25 million to $50 million. One was 19 screens and the other was 24.

Butcher: We're also seeing the grand entertainment complexes, big urban centers coupled under the $300 million mixed-use, maybe live theater, things like that. Whereas at most 10 markets will support that, you're seeing a lot more than 10 markets proposing it and more than one in some markets. I guess I question how far we'll go with a request for, you know, the B-word, billion-dollar commitment.

Spevok: You probably don't want to do a mortgage holder on a cinema complex that is going into these central cities. But what I'm also seeing is movie complexes going up in more rural areas. You wonder how far people can drive.

Butcher: Back to the reuse concept, these big-screen complexes are knocking the fours and sixes out, and a lot of those four- and six-screen theaters are sitting on pads in malls and are very good real estate. There's going to be a lot of ex-movie screen space available. A lot.

NREI: Have you done any adaptive reuses?

Butcher: Screens? No. But there's a lot of real estate out there that's going to be taking in money.

NREI: It seems as though the freestanding concept has really taken hold, but are we seeing too much of that?

Malloy: Like I said, when does the bubble burst? How many grocery stores can we take? Everyone's pushing hard for their turf, and the only way to get the turf is to be in the market. And how many feet can the market handle? Time will tell. I think Wall Street's reaction is one of concern. Some of the paper is harder to sell long-term. Certainly in the electronics industry, there's always a fear of where it will be 20 years from now, who's alive and who's not? Theaters, same thing.

Cunningham: At these city locations, we're seeing a lot of the arts theaters going in, so I see that as an interesting thing because I don't know what's going to happen with their covenant to keep it as an arts theater.

NREI: But you all can control the expansion, right?

Malloy: You really don't because you're controlled by the market. If the market will buy your product, you'll continue to push the product. For most, the conduits are really selling in the market, so obviously someone wants to pay for it, and there's always a price for the risk. Theater is not getting done at 110 over. Theater deals get done in the 200s. It's a risk-reward game.

NREI: Michael, do you think we're going to see a pullout, or what's going to happen in the near future?

Connolly: I guess I think about that daily. But I do hear what you're saying. I think we are in control somewhat. But the way we're in control is exactly what Steve was saying. I guess I'd view us as a manufacturing shop. Why would I buy raw materials, i.e., originate a loan, if I can't sell it to somebody, securitize it, or make money out of it as a portfolio lender, or what have you? So we're constantly trying to assess what our end product, our finished product is going to sell at, and that's really the question. It goes right back to Econ 101, whereas real estate defied all that years ago, before Wall Street securitization capital markets, and then you had some ivory-tower CEO somewhere either blessing the whole thing or wiping the slate clean. It was not an off switch, it was not a dimmer switch, if you will. And I think that the capital markets have allowed it to be a dimmer switch, and price is the control now.

Wise: If nothing else, the capital marks are an incredibly efficient vehicle. We've tried to cleanse our balance sheet four times a year, and if we make a mistake we're gonna know it pretty quickly. That's going to come back in adjustment in pricing or adjusting in debt service coverage, but it's not like we're holding a loan on our books for three years and we find out all of a sudden three years later we made an enormous mistake. We may have made a mistake two months ago, and that'll be affected two months later, not two years later.

Malloy: The interesting part is the companies that have been lending forever seemingly are now copying Wall Street. So the portfolio lenders all of a sudden are doing loans again, but now they're doing them to securitize. So they're trying to go into Wall Street's business. I remember doing the MBA conference, I think it was January '95, and we were just starting our program and I think outside of DLJ/ Column and Nomura there was no other investment bank presence. There were a couple guys like myself sniffing around, what's happening here. And you go to the conference this year and they completely dominated. But we're really at the tip of the iceberg when it comes to public ownership of real estate.

NREI: That's a good segue into REITs. What has been their impact on the marketplace in general, in terms of retail financing?

Malloy: Enormous impact on the cap rate, and where they're buying deals. They're driving the market so hard, but when you look at how REITs are structured internally and what they need for FFO, your everyday investor cannot compete and get the returns that we can get through their structures. When you look at how they're run, you see that they can do deals at lower rates and get the returns they need. You're also seeing a ton of pressure from the 1031 market, particularly in our business. And we see cap rates driving deals down, certainly down in the 8s consistently now. We've even heard a few or maybe seen a few that are in the 7s. Does that make any financial sense, where's the bottom? But cap rates have moved almost a full point probably in the last three months.

Wise: And not just in the retail sector, but just the ability to trade partnership units to avoid the tax gain is an enormous advantage for the REITs. Look at the CPI transaction, a multibillion-dollar stock ownership trade, which, if there had been a cash exchange, would have triggered billions of dollars in taxes.

NREI: Are they trading on the value of their stock as a currency?

Wise: Absolutely. But if you look at the net result to the seller, the after-tax gains to the seller are so much higher because they can avoid taxes for sig nificant periods of time, that it's no comparison when they're looking at that vs. an all-cash offer. Except for those people who have tax situations, it almost becomes a no-brainer.

Spevok: Embarcadero being a good case in point in the last couple of weeks and the delay of taxes by the current owners. I'm not seeing REITs hugely affecting our business in conduit land, shall we say at $5 or $6 million loans, just not actively or aggressively buying those properties in much larger centers.

Malloy: Globally you're starting to see a lot of push for sale-leasebacks. And especially the credits that were at the lower end, four or five years ago they couldn't dream of really going out and doing a 20-year sale-leaseback deal without being super-high cost. Today, your cost of funds is so close to the same cost as if they were putting up corporate debt without having it affect their balance sheet, that I think you're seeing a drive in the sale-leaseback market and particularly by those credits that are a little lower on the rung but now can get into the markets that they couldn't get into just three years ago.

NREI: You are obviously competitors. How stiff is the competition these days? How is that impacting the way you do business? Are deals being shopped to 10 companies today as opposed to five companies three months ago?

Spevok: I'd say competition is fierce, every deal is aggressively shopped, borrowers have never been better represented. And they've never better represented themselves. They're using multiple intermediaries in some cases. We get most of our business through mortgage bankers, and they rarely have control these days. They rarely get exclusives.

Butcher: One of the real changes, too, is that I was a developer for a long time and you really had to pick a lender at some point and then travel along the path through third parties, etc., as you went along.

The amount of time that you have to play lenders off against each other up until your closing date is lengthening, because the fundable third parties, they transfer fairly easily.

Malloy: The funny part is, every day we fight our deals for five or 10 basis points and ultimately we see competition, nowadays with conduits as well, with credit deals, on the back of a conduit. But I watch the borrowers fight for five basis points, and it's an amazing thing. There were some deals where we principaled the transaction effectively and there are some best-efforts deals still being done out there. I say, hey, you know, the bond market moved eight basis points yesterday. In the month that we talked about these five, we lost 25 in the market. So did you win or did you lose? To me, we didn't really lose anything, I was pure in the market today, we go in, we hedge, it doesn't really affect us. We'd like to see rates go north of the 7, but you see a lot of competition on that side. To counter, we focus much more on service. We find we do a lot of repeat business. We have 22 people totally dedicated to just single-tenant financing.

Wise: I agree. We just sold our $1.4 billion Grande Two last week and of the 10 loans that were in the pool, six of them were repeat borrowers. And you know, dealing with a securitized lender the first time or any lender the first time is a little bit painful. You have to go through the legal documents and understand what the hot buttons are for both sides. Once you do that, then you can call up and once you agree on the financial terms, you just take the documents and you can get it done a lot quicker. We're seeing, with a lot of our reborrowers in particular, that time means nothing to them anymore.

If the reborrowers want a deal closed in 21 days, it's going to get closed in 21 days. And the only way they get that done is to go to someone who's lent them money before. Our competitive advantage is dealing with our clients who we have good corporate relationships with and who we've lent money to before, because then we can close loans that much faster.

On the large loan side, you don't see people shopping it to 10 lenders, because they typically do it themselves and they don't go through mortgage brokers. But they will shop it to four or five who will be intensely competitive and just drive down the profitability as much as if they'd shopped it to 100 people. They know the capital market so well that they know exactly how much money you're making and can push down that profitability. And when you're competing for a $200 million or $300 million portfolio, you're willing to work for less money, and it helps to round out a portfolio if you have a 65% mall portfolio diversified across the country. You'd love to have that in your pool. So I think that's where we see a lot of our competition, it's just sheer profitability, just dripping down to incredible lows.

Wilson: Price is really turning into the first differentiator among lenders, more so now than ever.

Rice: A lot of our business is repeat business. We can process through that and close those deals and give them the best pricing and deliver it in an efficient manner, regardless of what their hot buttons were or who the lender was last month.

Cunningham: We also are working on having more products in our basket. We have a fixed-rate construction-loan product that we can provide for someone in the right circumstances. We entered in the REIT market a little bit, we have some corporate financing. So, the more products and services we have available, the more spots we have to help somebody find something.

Wilson: That's how we're trying to differentiate ourselves, through the one-stop shop approach. We can do everything that needs to be done for the developer from equity to construction lending, interim loans.

NREI: What is the next big thing? What is the retail finance market going to look like two years from now?

Butcher: I think that 75% LTV, but I don't see the big bump in the road that's going to change things. It'll be at par trying to make a point. And there will probably be fewer lenders. But we're searching for yield, we're doing a lot of money of 90%-plus leverage. I think there will be probably fewer lenders in that area too, but that money is going to continue to be available. We work in concert and in competition with commercial banks.

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