What’s Your Story?

With lenders getting more granular in underwriting, retail borrowers are finding a backstory helps to promote their properties.

By Taylor Williams

Lenders and borrowers alike have come to recognize some fundamental truths of the retail financing market in the e-commerce era: Most big box users need to downsize their store footprints and prototypes; new construction in urban settings needs food and entertainment components; and friendly loan terms are increasingly predicated on the sponsor’s track record.

Direct lenders of all types have remained active in the retail arena, with certain capital sources aligning themselves with specific sub-types of the asset class. For example, CMBS lenders often focus on stabilized properties with cash flow concerns, whereas regional banks might be better bets for new construction or redevelopment deals in high-growth markets. Properties distressed by tenant turnover or rent roll uncertainty can appeal to debt funds, and life companies seem to have a soft spot for grocery-anchored product.

“The biggest point of optimism for the property type in 2019 lies in the fact that lenders are still lending on retail,” says Chad Owens, vice president in NorthMarq Capital’s Houston office. “Specifically among smaller life insurance companies, CMBS lenders and banks, retail is still a big part of their businesses.”

Owens says that there is ample capital available for good retail deals with qualified borrowers, provided it’s well located and has a good story. To that end, borrowers are honing the narratives of their properties to include both qualitative and quantitative attributes.

“Everyone loves a good story, and lenders are no different,” says Jason Ford, president of Houston-based retail investment firm Williamsburg Enterprises. “Lenders want to understand why the borrower is purchasing or developing a particular asset. If the borrower cannot tell them why they are buying the property, what they intend to do and how they will do it, lenders won’t have faith that the borrower can execute on the plan.”

Williamsburg Enterprises recently acquired two Texas properties: Klein Square, an 80,836-square-foot property located in the northern suburb of Spring, and Plantation Plaza, a 98,141-square-foot property located in Clute, about 55 miles south of Houston. Williamsburg plans to renovate the properties, which were both less than 50 percent occupied at the time of acquisition, during the first half of this year.

Key Factors

Every deal is different, but capital markets experts concur that lenders of all types are generally financing retail deals at 65 to 75 percent loan-to-value (LTV). New projects that can show strong preleasing or stabilized properties with higher debt service coverage ratios may get 80 percent LTV for a construction loan or refinancing, but that’s fairly rare.

“A new form of retail is taking shape, and capital sources have become less hesitant about retail as an investment,” says Jason Piering, executive vice president at JLL’s Dallas office. “Pricing has tightened and LTVs have increased, though not to levels of other asset classes like office, industrial and multifamily.”

Piering adds that in today’s market, it’s particularly incumbent on borrowers to know their properties top to bottom — to be able to identify weaknesses and come to the negotiating table armed with solutions to address them.

As retail lenders work to make deals pencil and maintain liquidity, borrowers are highlighting both traditional and new-era aspects, such as online sales, of their properties. Now more than ever, borrowers are attaining favorable loan terms by assembling holistic pictures of themselves, their business plans and their assets.

“The criteria and metrics behind retail financing were more straightforward in the past,” says Brandon Wilhite, senior director at Metropolitan Capital Advisors (MCA), which is based in Dallas and has an additional office in Denver. “Borrowers are discussing patterns like ‘bricks drive clicks,’ and at what footprints and rental rates a retailer’s other stores in the market renewed. It’s all a process of crafting the story and getting the inside information.”

The sales and credit of the retailers, as well as the sponsor’s pedigree and relationship with the lender, are as important to lenders now as they were before the e-commerce onslaught. But other factors — the percentage of preleased space for new construction, the rate of successful lease renewals at market rents, how a user’s online marketing impacts total sales — are also creeping into the conversation as well.

Borrowers can create opportunities by emphasizing a particularly internet-resistant tenant roster, a value-add plan that boosts rents or a plan to roll out smaller-format stores with pop-up spaces at their centers — and everything in between.

New Construction

Say what you will about e-commerce, the retail apocalypse and the replacement of power centers and malls by mixed-use developments as premier shopping and dining destinations. But the fact remains, since the beginning of 2017, the American retail real estate scene has seen thousands of store closures.

According to CoStar Group, the total amount of American retail space that “went dark” in 2017 and 2018 exceeded 200 million square feet. Brands that once owned shares of their market, like Sears and Toys ‘R’ Us, have slogged through various degrees of bankruptcy and liquidation, while brands like Gap Inc. and Old Navy have completely restructured their operations to give priority to stronger-performing stores.

As such, new construction of pure-play retail projects can be one of the trickiest property types to finance. Preleasing is an important criteria for new projects that have anchor and junior anchor spaces upwards of 20,000 square feet. But again, other factors, both quantifiable and intangible, can influence the final loan structure.

“Preleasing can be a game-changer in terms of leverage because strong preleasing translates to lower perceived risk,” says Owens of NorthMarq. “But pricing on the construction side is still largely driven by the lender and borrower’s relationship. In today’s market, there’s also a focus on how much liquidity the sponsor is carrying to cover any misses in construction costs or changes in TI allowances.”

Construction materials and labor costs both continue to rise across all project types, but developers can also face significant discrepancies among bids and quotes from general contractors and their subcontractors.

As for TI allowances, developers have generally loosened their purse strings, the logic being that greater investment in retailers’ build-outs and aesthetics will drive sales and encourage lease renewals.

In 2018, MCA placed construction debt for Epic West Towne Crossing, an $88 million project in Grand Prairie, Texas, that includes a 120,000-square-foot fitness and entertainment center. Prior to the groundbreaking, the developer, Weber & Co. negotiated leases with an array of power center retailers: Ulta Beauty, Ross Dress for Less, Petco, Burlington. The development team was able to utilize these deals with national-credit retailers — plus the nearby draw of a newly constructed IKEA — to bring in a regional bank to finance the project at favorable leverage.

Scott Lynn, principal at MCA, points out that the Epic West Towne Crossing deal closed in the middle of 2018, a period which he views as “right in the heart of the Amazon scare.” He notes that the retailers that signed leases at the development took spaces that are 20 to 30 percent smaller than their old prototypes called for.

“The deals we’re attracted to have a theme to them,” says Lynn. “If it’s shop space or small-tenant space, we’re looking at the tenant lineup for resistance to e-commerce. If it’s big box, we’re seeing tenant right-size and become savvier with regard to their distribution. And we’re looking for levels of preleasing income that cover the loan in terms of amortizing debt service coverage.”

MCA also placed equity for the development of The Shops at Chisholm Trail Ranch, a 215,000-square-foot project in Fort Worth. The developer, Street
Level Investments, secured leases with high-credit retailers like Marshalls, Old Navy and AT&T prior to the closing of the deal.

Finished Product

According to Wilhite of MCA, existing developments are often more difficult to finance than new construction. This is due to the obfuscation of sales data in the e-commerce era; not only are private retailers not always required to report in-depth sales figures, the numbers can be misleading.

“Sales is one of the first things any lender asks about with a retail deal,” says Wilhite. “A retailer’s sales at a certain location could be decreasing on paper, but with brick-and-mortar driving online sales and vice versa, it’s tougher to draw accurate conclusions from reported sales data. So borrowers have to focus on other factors to help their lenders get comfortable with that tenant’s long-term occupancy.”

Wilhite adds that with regard to established properties, lenders are also looking at whether a tenant’s current rent and footprint are consistent with that of its prototype, as well as the market averages in the current cycles. But he also concedes that retail by nature is very nuanced; every property really is different and lease comps only tell so much of the story.

Owens of NorthMarq notes that the sponsor’s track record is equally important to lenders when assessing deals for stabilized product. But in this context, it’s more about whether the borrower has successfully executed a plan similar to the one in question.

“When we vet a deal for a lender, we’re not only looking at liquidity and experience, but also the extent to which the sponsor has mimicked the deal,” he says. “For example, have they re-tenanted a grocery anchor before? Have they successfully executed renewals under the terms of the original lease? These are the kinds of questions you have to ask to get a property’s real story.”

—Taylor Williams is associate editor of Texas Real Estate Business, a sister publication of Shopping Center Business.

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