Improving liquidity is welcome news for retail owners and investors looking to finance acquisitions or recapitalize existing assets. Yet capital markets remain a bit choppy with rising rates and lenders that remain highly selective on deals they’re willing to do. “There is still a tremendous amount of liquidity from debt capital in the retail space,” said Michael Johnson, a JLL Capital Markets senior director based in Houston. That being said, he added, borrowers need to know where to look.

Local banks and credit unions have been the leading sources of capital both during the pandemic and now coming out of it. They understand the local market dynamics, they have a different cost of capital and they are able to get comfortable with specific retail properties and locations, noted Johnson. For example, JLL recently arranged financing for two neighborhood centers in Houston with a local credit union. It provided an $18 million, five-year, fixed-rate loan at a rate of 3.75% and 65% leverage.

Improving liquidity comes at a time when retail owners and investors are hungry for capital. Last year was a record one for commercial real estate transaction volume, and retail property sales jumped 88% to $76.9 billion, according to Real Capital Analytics. Borrowers also are watching interest rates carefully. The Fed raised the federal funds borrowing rate a quarter point in March, and there has been a ripple effect across markets as lenders adjusted rates accordingly.

“The volatility right now has really been a catalyst for a lot of people to evaluate their capital strategies,” said Johnson. For those owners that were considering a sale in 2022, many are now looking to pull those forward to a second-quarter transaction to get in front of additional rate hikes and any impacts rate increases may have on pricing, he said. The Fed has said it could increase rates as many as six more times in 2022. Concerns about potential higher rates ahead are encouraging many borrowers to consider refinancing now to lock in lower rates.

Capital Spigot Widens

Bigger banks also are putting their feet back on the gas for retail lending. As an example, TIAA Bank reported a record year of commercial real estate lending in 2021, originating nearly $1.5 billion in new loans, an increase of 83% over 2020. Retail accounted for 13% of the number of deals TIAA Bank did in 2021 and that has climbed higher to 20% for the deals done so far in 2022. “The bank is very interested in growing our commercial real estate footprint, and retail lending is a big piece of that puzzle for us,” said TIAA Bank senior vice president and commercial division leader Ellen Comeaux.

Although the spigot for retail wasn’t entirely shut off at TIAA Bank during the pandemic, new loans dropped significantly as the bank focused on requests for payment relief and helping clients navigate the financial challenges related to lockdowns and business disruption. In the second half of 2021, the bank resumed retail financing, particularly on neighborhood multitenant centers and single-tenant credit transactions. “Overall, we’re seeing the market opening up for retail, along with an increased flow of retail transactions,” said Comeaux.

TIAA Bank’s growing pipeline of retail property loans includes acquisitions, as well as cash-neutral and cash-positive refinance deals. However, it is underwriting relatively conservatively with leverage below 65% and debt service coverage ratios typically above 1.4x. Underwriting also means looking closely at how a property’s tenants weathered the pandemic. “We like to see centers with a solid operating history, a good pay performance with tenants, a good history of backfilling vacancies and decent tenant profiles,” she said.

CMBS Issuance Is Subdued

Access to capital remains a mixed bag for retail properties. Lenders are favoring solid performers like grocery-anchored centers; other properties anchored by strong tenants, such as Walmart and Target; and net lease. Life insurance companies generally are sticking to the safer waters of grocery-anchored retail, while retail remains a tough sell in the commercial mortgage-backed securities arena.

Although retail CMBS loan delinquency rates are improving, new-issuance volume suggests that lenders are still bearish on the sector. According to Trepp, retail CMBS issuance dropped sharply in 2020 to $10.05 billion and remained low in 2021. The $13.45 billion issued for retail properties last year represents about half the volume of the retail CMBS issuance completed in 2019 and a fraction of the $172.5 billion in total CMBS issuance in 2021.“Retail is very much a sector that the CMBS market has avoided and continues to avoid, and that is especially true in the mall sector,” said Manus Clancy, senior managing director and the leader of Trepp’s Applied Data, Research, and Pricing departments.

Problems with B and C malls were compounded by the pandemic. Going back eight to 10 years ago, CMBS was the main destination for mall borrowers. Many of the deals done at that time haven’t turned out well, ending up in special servicing and resulting in losses for investors, noted Clancy. “From 2017 on, the CMBS market has looked at retail shopping malls with a jaundiced eye, although high-quality malls could get refinanced from 2017 to early 2020. Since 2020, it has been almost impossible to get a shopping mall financed through CMBS.” Those few mall exceptions have been very high quality and done at low leverage, he added.

Glass Half Full?

The financing outlook remains mixed in what continues to be a bifurcated market of strong and weak assets. For those retail assets that are struggling, rising interest rates add a hurdle. Low rates that provided a potential lifeline for some borrowers could be disappearing, noted Clancy. In the example of a loan that was made at 5.5% or 5.75% 10 years ago and is now maturing, the ability to refinance at a lower rate of 4% or 3.75% would lower capital costs and improve the debt service coverage ratio. However, both Treasury rates and spreads have expanded since March, “so that safety net that some people were counting on to help them get through a refinancing has almost entirely disappeared,” he said.

If there are any savings to be had on a refinancing in the current market, it’s likely to be minimal. What that will do is make those properties on the cusp even more precarious, said Clancy, so more defaults could lie ahead. Retail CMBS delinquencies were holding at 6.48% in March, an improvement from 10.89% a year ago, according to Trepp.

On the positive side, COVID-19 appears to be moving into the endemic stage as operators like gyms, movie theaters and restaurants fully reopen. The return to the office will help bring people back to central business districts, and performance among some of those harder-hit retail and mixed-use properties in urban centers should improve as people return, noted Clancy.

Johnson sees more financing opportunities ahead for lenders and more transaction activity occurring within the retail space. “I love the retail story right now,” he said. “It is well-positioned coming out of the post-lockdown era.” Multifamily and industrial long have been the hottest asset classes. Now, yields in those sectors are incredibly compressed. Investors are looking at alternatives, and retail is very compelling, he said. At this point in the cycle, there is ample data to show who the winners and losers are coming out of the lockdown era. In addition, there has been limited new supply of retail development, which is contributing to good fundamentals and rent growth, said Johnson. “That presents a good opportunity for us as an intermediary to guide our buyers to the right capital structure and cost of capital because, with the rising interest rate environment, you want to make sure you have that dialed in.”