By Steve McLinden (Shopping Centers Today)
With the health of retail real estate hanging in the balance, proposed fiscal fixes remain few in the face of the loan maturities and value losses looming over the industry. “If we can’t get the capital market going for good loans and sponsors, then we create even more stress in the system,” said James E. Maurin, SCSM, chairman of ICSC’s Government Relations Committee. To ignore the problem is to create a double-dip property recession, he says.
More than half of the roughly 18,000 retail property loans that are set to mature this year and beyond, valued at a total $168 billion, do not qualify for refinancing under current standards, according to finance industry estimates.
Many are under water, certainly. But others do pass cash-flow and debt-service tests — though not loan-to-value requirements, owing to falling values. Since peaking in October of 2007, commercial real estate values have plunged 35 percent, according to Moody’s Investors Service.
“It’s frustrating, because there’s really no place to renew these loans,” said Maurin. “The Fed has to step up and be willing to take a first-loss position, as in the residential mess. Right now nobody’s taking ownership.”
Most of the commercial loans coming due are nonrecourse loans, meaning they are secured only by property collateral and not by the individuals or groups initiating them. Hence, many lenders “don’t want to renew these, but if they don’t, they’re stuck with [devalued] assets,” said Donald Shackelford, a past chairman of America’s Community Bankers and currently a corporate director for three financial institutions. “But the owner still has to convince the lender that he’s better off working with him than against him.”
Lenders are not equipped to manage properties, says Donald Casto, a partner at Columbus, Ohio–based Casto, which owns 23 million square feet of commercial property. Thus far commercial real estate ills have generated minimal press compared to home mortgages, says Shackelford, who has served on the boards of several retailers. “But commercial real estate is the next sub-prime-mortgage mess.”
Some of the scenarios and sticking points likely to have an impact on recovery follow below.
CMBS substitutes wanted
Commercial-mortgage-backed-securities operations have ceased, leaving virtually no one to reconcile them. “If it’s a CMBS loan, nobody’s home,” said Peter H. Framson, founder of the X-Team National Retail Partners consortium and the founding principal of Bethesda, Md.–based Green Light Retail Real Estate Services. “Banks aren’t going to inventory construction loans forever,” Casto said. “Between Wall Street and the government, there’s going to have to be some system to roll over long-term debt. A replacement for CMBS has to be created.”
Good bank/bad bank?
This scenario, where the government acquires a failing bank’s devalued assets under a “bad bank” umbrella, has yet to be proposed for commercial real estate. The government’s Term Asset-Backed Securities Loan Facility, recently extended to 2010, does plug some holes but does not fully account for more-toxic assets, developers say. “Insurers are more likely to be bailed out than developers,” Shackelford said.
Lenders that take back many potentially defaulting properties will still be obligated to have adequate reserves to settle their bad debt. “Where are those going to come from?” Framson asked. “Will the government remove some of the toxic loans like they did with Fannie and Freddie? The Fed is going to have to get ready for this.”
‘Phantom’ tax amnesty
The tax code requires a lender that forgives commercial real estate debt to report the sum, called “phantom income,” to the IRS, which obligates the borrower to pay taxes on it. To address that issue, the Mortgage Forgiveness Debt Relief Act was passed in 2007. “At what point do we create a tax-amnesty program to allow a more orderly disposition of commercial real estate assets?” Framson asked. “At least those assets will start moving when this is addressed.”
Consumer/retailer roles
“Since consumer debt and housing were major drivers of the downturn, I don’t think the consumer can lead us out of this one,” said Casto. “Even if you have a job, you’re getting poorer, because your house is worth less.” With unemployment at nearly 10 percent and an “underemployment” rate at an estimated 16 percent, retailers “really need to sharp-pencil their strategies,” according to Shackelford. Consumer psychologist Kit Yarrow, a professor at San Francisco’s Golden Gate University, says the post-fallout shopper is much more cautious and selective. “You’re really going to have to satisfy their needs in every way,” said Yarrow. Luxury retail will not die as so many fear, Yarrow says. “Consumers still want better service, better design and better fabric,” she said. “But they’re going to want more value in luxury.”
REIT relief
Though smaller developers are in credit limbo, recent capital renewals plus a key court decision should help larger REITs limp through the downturn. In late summer Simon Property Group saw credit markets loosen enough to help the firm fund looming maturities and acquisitions of failing rivals. Simon recently doubled its previously announced debt offering to $500 million by reopening notes coming due in 2014. Duke Realty added $250 million in 10-year bonds to its own $250 million offering.
In August a judge rejected creditors’ motions to split off several properties from the General Growth Properties bankruptcy, clearing the way for the firm to negotiate long-term debt.
Recovery timelines
Lenders remain mired in an “extend and pretend” mind-set, delaying the inevitable, says Mark Dotzour, an economist at the Texas A&M Real Estate Center. Commercial value will continue its slide nationally in the near term, with cap rates reverting to 2002 levels, but by 2012, property values should begin growing slowly. By 2013, values should start rising as cap rates fall, he said. Philip F. Blumberg, chief of Blumberg Capital Partners, who in August likened TALF extension to tossing dental floss to a drowning man, says he sees five to seven years of slow growth ahead.
The market can start reversing itself in as little as three years, said 20-year industry veteran Gill Warner, senior director at Tulsa, Okla.–based Stan Johnson Co., a net-lease broker. “But only by taking our medicine now,” Warner said. “If you’re stuck on using two-year-old [valuation] instruments, that’s going to be a rocky road.”
As of April, lenders held some $3.5 trillion of outstanding debt linked to commercial real estate, according to Moody’s. Because of skewed loan-to-value ratios, most of those could be defaulted, says Framson. “It’s a tricky equation,” he said. “Are lenders better off converting to a cash-flow scenario or going in and getting the borrower before the borrower gets them?”
Unless the industry can figure out which loans are toxic, there will be no climbing out of the doldrums, Framson says. “Nobody’s going to lend, because they don’t know the value, and nobody’s going to borrow for the same reason,” he said. “We’re setting ourselves up for a zero-sum game.” In an informal poll of X Team’s 33 national offices, none are hearing “substantial conversations” on the issue, and few are seeing lenders actively determining new values, Framson laments. When the credit markets do unfreeze, “distressed properties will be where the business is,” Framson said. “Some developers will adjust their business models. Others won’t be here.”
Shopping centers will probably find themselves signing smaller retailers and more pop-up shops catering to shorter consumer-attention spans, says Yarrow.
If extend-and-pretend continues, many small and medium-size owners will be out of business, says Casto. Moreover, troubled center owners who hang back and wait to declare their troubled positions “run the risk of having a smaller buying pool when their assets do emerge,” Framson said. And Shackelford said: “The guys that get in early and negotiate with tenants and lenders will come out ahead.”
