Big write-downs on values for struggling malls are commanding attention across the retail sector for their shock value alone. A Waterford, Connecticut, mall is one of a growing number of such centers that have experienced a jolting drop in value. According to Trepp, it recently was appraised at $18.7 million, an 88 percent discount from its 2012 value of $153 million and well below the $95 million commercial mortgage-backed security loan on the property. The reduced value is a reflection of mounting woes at the center, which include the loss of Sears and Macy’s and rising vacancy.

Such write-downs raise some big questions for the values of lower-tier malls, which struggled with occupancy and revenue both prior to and during the pandemic. Are these isolated cases of distress, or could there be a widespread reset in property values in the sector, even among those properties with performing loans? And how much are write-downs weighing on the investment sales market?

A sharply lower reappraisal for a mall in Connecticut or Las Vegas doesn’t necessarily translate to a domino effect of write-downs in similar malls across the country. Write-downs directly impact only that individual loan or property. “But every time one of these properties gets written down, it’s another piece of data for investors,” said Trepp senior managing director of applied data, research and pricing Manus Clancy. That’s at a time when both lenders and investors are hungry for data that would shed light on current market values amid a dearth of fresh sales comps in the past year.

Sharply lower values have broad implications

Struggling lower-tier malls experiencing sharply lower reappraisals is not a new phenomenon. In the wake of the pandemic, however, values and potential downward pressure on them are on the minds of lenders, owners, prospective buyers and even consumers, notes Integra Realty Resources managing director William Miller. “We do have more of them that have happened recently,” he said. “Is every property down 80 percent? No, but there is a gradient. Better malls will still tend to do well, but everyone needs to adjust within markets.”

The properties at the head of the line for write-downs are lower-tier malls properties, as well as assets that had material debt. “In almost every case where we have substantial write-downs, it started with the anchor stores going dark or going through bankruptcy,” noted Integra Realty Resources senior managing director Michael Amundson. If a center loses its anchor tenant, it can trigger co-tenancy clauses that allow inline tenants to exercise their rights to potentially terminate their leases and exit the property or switch to reduced rent or percentage rent that reduces cash flow for a property. “So it’s a cascading effect once the anchors start to have problems,” he said.

There are a number of market implications if values on properties move materially. Potentially, lower value could weigh on decisions to buy or sell assets — or to give properties back to lenders. However, any new appraisal or reappraisal provides a snapshot of value for a particular point in time, notes Moody’s vice president and senior credit officer Matthew Halpern. In addition, appraisals are based on assumptions and there is recognition that values change over time. So a recent appraisal value is only one of several considerations that an owner, investor or lender is looking at when weighing decisions about a particular property, he says.

“Even if an appraised value does come in very distressed, if a borrower believes that they have long-term value in a property, they still might want to hold on to it,” said Halpern. “So a borrower is not going to look just at appraised value when making decisions about a loan.” The original loan-to-value ratio also matters. If a borrower had a 60 percent LTV to start, there could be a much larger drop in value and a borrower could still have significant equity in a property versus a 75 percent LTV. “Loan balance and LTV matter a lot when talking about new appraisal values,” he said.

Stress and maturities trigger reappraisals

The CMBS market provides the most transparency into new values; CMBS loans get appraised at securitization, and a reappraisal typically would be ordered by the special servicer if the loan becomes more than 90 days delinquent. The volume of retail property loan delinquencies is one gauge of the potential pipeline for reappraisals. According to Trepp, 10.9 percent of retail CMBS loans were more than 30 days delinquent at the end of March. That’s an improvement over the 14.8 percent six months ago but still elevated compared to the 2.9 percent in March 2020.

Lower appraisal values have big implications for CMBS bondholders. Malls that have failed have resulted historically in very high loss severities within the CMBS world, upward of 75 percent based on the balance of the loan at disposition. Some of the appraisals coming in now have been significantly below the original loan value. “You do have to look at it on a loan-by-loan basis, but we have seen very high historical losses for loans backed by failed malls,” said Halpern.

Outside CMBS, different factors can trigger reappraisals, depending on the structure or terms of the loan. Covenants set up in the loan usually monitor any credit issues at a property. For example, if occupancy, cash flow or debt-service coverage slips below a pre-set level, that might prompt the lender to take action, which could include a reappraisal to assess the loan-to-value ratio and a potential equity call.

Additionally, a reappraisal is standard for maturing loans that need to be refinanced. Mall loans are usually on short cycles, maturing in three, five or seven years, so a mall could be coming up for a routine loan maturity that prompts a fresh look at the property value. “Everybody in the industry who has an interest, whether it is a lender, owner, stockholder or bondholder — they are all looking at the value of a property,” said Miller. Yet in some cases, what is happening is not necessarily reappraisal of portfolios but ranking of properties into groups — top, middle and bottom — based on a wide range of issues or performance factors. Those rankings give stakeholders some guidance in making decisions on how to proceed, he adds.

More pain ahead?

Reappraisals of malls and new write-downs in values are likely to be part of an ongoing process over the next three to five years. UBS estimates that 80,000 retail stores will shutter across the U.S. by 2026, roughly 16,000 stores per year, reducing the number of stores from 878,000 in 2020 to 797,000. That forecast assumes that e-commerce sales will rise from 18 percent of total retail sales today to 27 percent in 2026. The hardest-hit retailers will be clothing and accessories retailers. UBS forecasts about 21,000 closures from this sector by 2026, many of the shuttered stores located in enclosed shopping malls.

Others have a less pessimistic outlook on closures, particularly as economic growth accelerates alongside reopening and a growing rate of fully vaccinated people. Additionally, the store-closure data does not account for new-store growth or creative repurposing of vacant space via non-retail uses. “My contrarian view is that if you haven’t shut your store yet, it probably means that you’re going to hang on to your store,” said Clancy. That has been borne out in the last few months, in which few announcements of retail bankruptcies or mass store closings have occurred, he adds.

As long as an owner has a property with a good location and good demographics, creativity tends to rise to fill empty space, in some cases with uses that were better than what existed before, adds Amundson. Some of the store closures ahead could create opportunities for owners to reposition centers, just as was the case pre-pandemic. “I still think there is a lot of optimism among the ownership group of shopping centers, but there is no doubt that they are going to have to endure some pain and some retenanting costs,” he said.

Mall appraisals also increasingly include the hidden value that may exist at the property. There are many examples of malls that have redeveloped vacant boxes to new uses, such as apartments or hotels, or sold off excess land or pad sites to developers, particularly as cities have relaxed zoning requirements related to parking, notes Amundson. “Owners are finding value on the fringes by developing or selling off outlots that helps to shore up the values of some of these properties,” he said. Even if a mall has become functionally obsolete, he adds, all of the value is not lost, as malls often are situated in good locations and have good demographics.