— By Gary E. Mozer, Principal/Co-Founder, George Smith Partners —
Retail financing, both debt and equity, has become a challenge for many owners, developers and investors throughout the U.S. based on negative press about retail, a perception that the internet will take down many tenants and the weak financial condition of a number of large retailers.
Though capital markets are strong, many property owners and investors are finding it difficult to identify lenders willing to provide the type of financing they need for their retail developments, acquisitions and redevelopments.
Some lenders are not providing enough money. In other cases, borrowers are finding that the cost of capital is not feasible. Often, lenders and investors aren’t saying no —they are simply offering capital at too high a rate.
This squeeze could not come at a more pivotal moment for retail investors.
The fact is, now is a very good time to invest in retail. With so many players exiting the market, an overcorrection is underway. This creates a huge opportunity for others to invest in retail, which can be a great value if you find the right deal at the right basis.
So why is retail harder to finance?
Because of the herd mentality, the majority of investors and lenders are on the sidelines, waiting for the market to sort itself out. With a lack of supply of capital, the cost is going up, and the price of retail is going down.
But the smart money can find huge opportunities in today’s retail real estate market.
Due to the complexity of retail as compared to other product types, lenders need to understand the business plan, the marketplace and the sponsor’s ability to execute to realize the value in retail transactions.
In order to realize retail’s tremendous value through development, redevelopment, repositioning, revising a tenant mix and/or remarketing a center, borrowers must first find the capital that fits their business plan.
The right capital might be defined as cost of capital, flexibility of capital or amount of capital.
But how can owners go about securing the capital they need today?
First, they must demonstrate the feasibility of the business plan that works within the marketplace and prove their own track record to execute.
Second, they must market to a broad array of lenders and investors to find the correct capital source that will meet their needs.
Preparation Makes a Difference
Today’s lenders are careful and thorough in their diligence as to properly price their capital to the risk of the transaction. Therefore, borrowers must be prepared to explain their opportunities.
In order to get comfortable with retail financing, lenders need to be shown and understand exactly what makes the property’s value proposition compelling.
The first step is to take a careful look at the business plan.
Property location, tenant mix, rollover risk, tenant credit and remaining lease terms, co-tenancy clause and most importantly health ratios (occupancy costs — comprised of rent + common area maintenance charges — divided by tenant sales), will all be essential.
The physical makeup of the center is also critical.
Is there enough parking? Are the boxes right-sized for the tenant? Is there good visibility, ingress and egress, etc.?
The next part of the business plan is how the sponsor is going to change the property makeup to create value.
Is it a cosmetic face-lift, re-tenanting, physical upgrades, right-sizing tenants, etc.?
When the lender is comfortable with the physical attributes and business plan, they will focus on the quality of the property’s cash flow.
Next, the lender will want to understand market data.
A property does not exist in a vacuum – it must compete. For that reason, a borrower must be ready to explain why certain centers are or are not in its competitive set.
We recommend assembling comparable rents for anchors, mid-box, inline and pads.
Creating this data for the lender enables them to reach a conclusion more easily. It will also help in the appraisal process.
Finally, the borrower’s resume and experience as well as credit and financial capacity must be expressed so the lender/investor can understand the sponsor’s ability to execute the business plan.
For example, our team recently worked with a retail investor who was acquiring a shopping center in a Hispanic neighborhood in the Western U.S.
Rather than bringing in more Americanized tenants, the owner secured a lease commitment with a Hispanic grocer and a DD’s (Ross Dress For Less’s Hispanic concept), which better served the local Hispanic community’s needs.
By obtaining these tenants, we were able to prove to the lender that the property would be feasible. Retail tenants understand their ability to succeed in a neighborhood, and their commitment to a center is strong feasibility proof to lenders.
The value proposition for this center was its ability to differentiate itself in the market by serving the needs of the local Hispanic population. For consumers, this provides access to places they want to shop, which in turn creates more value for the sponsor, ultimately making the center more secure for the lender.
Another recent example was an empty 80,000-square-foot shopping center in California. Our client pre-leased space to Sprouts Farmers Market and Marshalls, while also securing letters of intent from many other tenants based on the property’s strong location.
We provided our client with an 87 percent loan-to-cost, non-recourse, non-participating financing.
We were able to achieve this given the strong pre-leasing and letters of intent, sponsor track record and strong market location.
The investment was a success. After stabilization, we could have secured financing for 100 percent of the cost. In this case, however, the owner decided to realize the profit by selling the asset.
Capital Markets are Inefficient
Different lenders and investors perceive risk differently, and price it accordingly.
At times, we will go to 50 to 60 capital providers to find the right one because the market is so inefficient and there are outliers.
Other times, we may go only to three or four capital providers to preserve time. For example, a CMBS loan will not be as widely marketed because the market underwriting parameters are relatively standardized.
Bridge loans and equity for certain retail and secondary markets will require a more extensive marketing process to achieve the best results for our clients.
Strategic Packaging is Essential
There is a finesse to creating a strong investment package. Even when armed with piles of research and data, the value of a retail property must be communicated clearly to lenders in order to achieve competitive financing.
Lenders want to see why a retail property is compelling. They need to understand how the property will survive and thrive. Success comes down to strategy — there must be a clear value proposition.
The exit strategy for lenders and investors is critical. Once the business plan has been achieved, they want to ensure there is liquidity in the marketplace to get repaid.
The Bottom Line
At its core, retail financing is based on what it always has been: a strategic, feasible business plan; a unique position in the marketplace; and a strong, capable sponsor with the ability to execute.
That said, even with all of these elements in place, today’s capital markets can prove to be inefficient for most borrowers. While there is plenty of money out there to fund retail transactions, they must be correctly presented in order to gain approval.
Relationships with decision makers are also essential. It is easy for a loan officer to follow the herd and say no without investing the time and effort to do the critical analysis. That’s why it is critical to have an understanding of the packaging process and relationships to get the proper attention.
— Gary E. Mozer is Principal and Co-Founder of George Smith Partners, a national commercial real estate capital advisory firm that has arranged more than $52 billion in financing since its inception. Contact him at [email protected].