By Patrick Ward, Founder of MetroGroup Realty Finance
As we close out the fourth quarter and prepare for 2016, many are wondering what’s in store for the retail market. In 2015, we saw retail rebound and return to its former glory as a desirable product type for the lending community.
The primary questions are — what can we expect from this product type in the coming year, and how will financing for retail properties change in 2016?
Retail Trends We Expect to Continue in 2016
As the New Year approaches, we expect to see a continued shift in real estate needs for retailers, especially as major retailers continue to create specialized concepts to capture different demographics. Target Express, Forever 21’s ‘F21 Red’, Macy’s ‘Backstage’, and Whole Foods Market’s ‘365’ are all targeted approaches to expand and grow major brands by reaching a variety of target audiences, and these concepts need smaller spaces than their parent brands. We anticipate that more retailers will create specialized concepts to reach differing demographics in 2016 and beyond, contributing to a continuing change in real estate needs.
Another significant shift in 2016 will be a continuation of large, publicly held retailers leveraging their real estate to drive share prices. Many large retailers — such as Darden Restaurants, Bon-Ton, Hudson’s Bay Co. and Sears Holding Co. — are beginning to move their real estate assets into REITs. In doing so, retailers are able to take advantage of the underlying value of their real estate. While we see this trend continuing to grow in 2016, several companies have studied this idea and concluded that over the long term, the strategy will increase occupancy costs and adversely affect the flexibility of their retail properties.
Retail Lending in 2016
With regard to financing for retail assets, we anticipate that capital supply will remain strong throughout 2016. There will be ample sources of capital available to finance a wide variety of retail properties — from small, unanchored retail centers to regional malls. Financing will also be readily available for retail investors to acquire assets, and for retail owners to refinance maturing loans.
With this positive activity, we will continue to see the proceeds gap widen between portfolio and CMBS lenders. There has always been a difference in the underwriting standards between the two types of lenders, but as a result of the competitive nature of the CMBS market, this gap will continue to grow throughout 2016.
Portfolio lenders — including life insurance companies, structured finance companies and large banks — will continue to maintain strict criteria when it comes to analyzing tenant uses, tenant sales, and lease terms. These lenders are likely to adhere to increasingly conservative underwriting standards as the year progresses.
Alternatively, CMBS lenders will use more optimistic and aggressive underwriting assumptions to arrive at larger loan amounts.
This difference is important for owners and investors seeking retail financing in 2016. Depending on a borrower’s overall goal, there are options available for both conservative and aggressive borrowers — even the best lenders can’t be everything to everyone.
For example, we recently arranged $155 million in financing for a 12-center portfolio in South Orange County and North San Diego. The buyer wanted aggressive loans on a portion of the portfolio, and also wanted to stage the maturities of the portfolio. Based on the differing maturities, which they wanted to range from ten to twenty years, as well as the varying levels of leverage requested, we procured the loans from four different sources: two life insurance companies and two CMBS lenders.
Interest Rates: Will They or Won’t They?
Another factor to consider in 2016 is interest rates. The lending community and U.S. economists have been predicting a rise in interest rates for the past two years. While rates remain historically low at the end of 2015, we certainly anticipate that there will be a moderate increase in short-term interest rates in the New Year. It is likely that this increase will not have a significant impact on long-term interest rates, which is a good sign for retail owners and investors seeking financing over the next year.
While the cost of capital will not be at the 30-year lows we saw in 2015, it will remain relatively low throughout 2016. Loans that are set to mature over the next 24 months were initially originated in the low-to-mid five percent ranges. Today, rates are in the low four percent range. With a moderate increase in long-term rates, we anticipate that loans set to mature in 2016 will be refinanced at or below where rates were when those loans were initiated in 2006 and 2007.
Overall, the 2016 retail market presents a strong opportunity for investors and owners. There will be ample capital available to finance or refinance retail properties, interest rates will remain moderately low, and as retailers continue to grow and evolve, this product type will remain desirable to both investors and the lending community throughout 2016.
Patrick Ward is the founder of MetroGroup Realty Finance, a private, Newport Beach-based mortgage banking company that specializes in providing capital advisory and mortgage banking services for properties throughout Southern California. Contact him at pward@metrogroupfinance.com.