Shopping center deals seem to be coming fast and furious this year. In Dallas a nontraded REIT sponsored by Cincinnati-based Phillips Edison & Co. acquired the 70,500-square-foot Northpark Village; in the Cleveland suburb of Beachwood, Devonshire REIT, of Whitehouse, Ohio, bought the 249,900-square-foot Pavilion Shopping Center; and in Fort Lauderdale, Fla., Marcus & Millichap announced that a Brazilian buyer had acquired the 32,700-square-foot Plaza Del Mar shopping center.
It is odd, therefore, that observers are showing concern about the lack of properties — at least the A-quality ones — available for sale despite a huge amount of liquidity in the marketplace and buyers that are ready to pounce. “There is still not as much attractive product as the market wants,” said Ben Thypin, director of market analysis at Real Capital Analytics. Indeed, the volume of transactions involving commercial-mortgage-backed securities, usually the most common financing method for retail properties, was running behind 2013 levels — though Thypin also points out that there is usually a flurry of deals in the fourth quarter, meaning that those numbers can still change radically.
“There is a ton of liquidity, there’s just not a ton of product trading,” said Jimmy Board, a Houston-based senior vice president at Jones Lang LaSalle. “I’m surprised the CMBS market slowed down. Wells Fargo, for example, issued a report saying the bank was behind [the] 2013 numbers by $500 million in overall CMBS. In the past CMBS was the biggest part of the retail lending market.”
CMBS financing accounted for 48.26 percent of retail deals last year. So far this year, that has slipped to 47.7 percent, according to Real Capital Analytics.
The market for retail has taken on odd turn. Through the middle of the second quarter, the volume of deals driven by private purchasers surpassed the year before, says Real Capital Analytics. The bigger players are being more selective, and many, including the real estate investment trusts, are selling off their ‘B’ properties, taking the opportunity of the healthy demand for retail to improve overall portfolio performance by sloughing off the lesser performing properties.
One company that does not mind financing such ‘B’ property transactions is Prudential Mortgage Capital Co., though it depends on the sponsor. “We have done these deals, but they are very specific to the borrower and the market,” said Marcia Diaz, a Los Angeles–based managing director and the head of originations at the firm. “Generally, we are going to go with a strong operator, because you need to have the benefits of the operator’s retail relationship.” The terms are going to be more conservative than they would be for a top-tier mall, Diaz says.
When the higher-quality properties do come on the market, competition is fierce, which leads to a decline in cap rates. Real Capital Analytics data support this. Cap rates for malls hit 8 percent on average in 2010, and by the second quarter of this year, they had dropped to near 6 percent; strip center rates were 8.5 percent in 2010 and have since fallen to almost 7 percent. And so while deals for good properties are getting more expensive, transactions are getting done because the capital is prevalent and the cost is cheap.
CMBS remain the biggest source of capital for retail, followed by banks — the local, the regional and the too-big-to-fail. Deals financed by national banks hit 9.38 percent of the retail market last year, while regional and local banks financed 11.87 percent of retail deals, Real Capital Analytics says. Those numbers jumped this year to date, to 13.04 percent and 19.04 percent, respectively. “The national banks are lending everywhere, with a focus on CMBS loans, which are marketable to institutional investors,” Thypin said. “The local banks don’t have conduit operations, so they are making balance-sheet loans, and they are best-positioned to compete for those loans in markets where CMBS is unwilling to go.”
Big developers and shopping center owners can play bank participation in numerous ways. Phillips Edison has executed a $350 million line of credit led by Bank of America, Citigroup and KeyBank as lead managers. “When we are acquiring assets, we are either buying them all-equity or drawing on our line of credit,” said Phillips Edison CFO Devin Murphy. “We are not looking to CMBS financing. To tap CMBS, the cost of capital would be about 4 percent. We can draw our line of credit at LIBOR plus 130 basis points — that’s about 250 basis points inside of CMBS. For us CMBS is expensive.”
Phillips Edison acquired a 1.2 million-square-foot mall in Parma, Ohio, near Cleveland, including development and redevelopment components. “We were able to acquire Parma at a significant discount and favorable basis due to the complex nature of the asset, large size and market,” said Ryan Moore, vice president of capital markets at Phillips Edison. “Given our track record through economic cycles and deep relationships with the lending community, lenders have been willing to aggressively lend and partner with us on these types of transactions.”
Phillips Edison seeks to borrow in the investment-grade, unsecured bank market, says Murphy. “We think that gives us the greatest amount of flexibility and the cheapest cost of -capital,” he said.
So far this year the volume of insurance company capital for retail deals is running way behind the volume for all of last year. Insurer-financed deals totaled 15.8 percent of the market last year, but as of midyear 2014 the total was just 6.6 percent, according to Real Capital Analytics. “One of the reasons why insurers were so high in previous years was that they did a lot regional mall business, and those were very large loans,” Diaz said. “Those deals aren’t getting done on a secured basis much anymore. The retail REITs are moving into the unsecured markets just because pricing is better.”
Or this could be considered a harbinger of the poorer quality of transaction in the marketplace, because insurers like the good stuff, although Sandy Sigal, CEO of NewMark Merrill Cos., says his company has been using insurer dollars for special situation, nontraditional deals. Apparently, even the insurers are going out on the risk curve to get deals done. NewMark Merrill has been more seller than buyer of shopping centers because the pricing has been “crazy dollars,” especially with the CMBS investors who seem to have unlimited capital, says Sigal. “They have money and want to spend it,” he said.
On a straightforward deal, the life companies will lend 60 to 65 percent loan-to-value, banks 65 percent to 70 percent, and CMBS securities 75 percent to 80 percent. For CMBS, the borrower will pay more going up the loan-to-value risk curve, says Broad. Nevertheless, for a 10-year, interest-only mortgage at 75 percent to 78 percent loan-to-value, one may find 4 percent CMBS money, says Stephen Coslik, chairman of The Woodmont Co. The firm put a C-quality shopping center on the market. “We bought an existing center in the Greater Dallas–Fort Worth area last year, put a little lipstick on it, and we are now selling it for around an 8 percent cap rate,” he said. Most of the trading in retail properties is taking place at the B- and C-property level, Coslik says. “That’s what is available on the debt market. You are not getting high-LTV loans, but when you are only paying 4 percent on your money, there is plenty of value to be created at your property.”
For Prudential, a generic, A--property, grocery-anchored, shopping center loan for 10 years, interest-only and at 65 percent loan-to-value will run anywhere from 140 to 150 basis points over the 10-year Treasury rate. Prudential would love to finance more grocery-anchored deals — if it could find them.
“It is challenging to find all the deals to meet our appetite,” said Diaz. “There are not enough deals for all of the capital out there. Partly, there is so much capital that wants real estate because it is perceived to be a better investment than other fixed-income plays. But also, we robbed ourselves in the past three years doing a lot of early refinancing. We have taken some of that pipeline out, but going forward in 2015, 2016 and 2017, there will be a wave of ‘re-fi’ coming up.”
