By Scott Lynn

By any definition, there has been a pivotal shift in attitude toward commercial retail real estate over the past few years. Has it become more difficult to obtain debt and/or equity for retail properties? Absolutely. Are retail deals being underwritten to a higher standard of diligence and risk mitigation? Definitely. Can you even get financing for retail properties today that justifies pursuing retail investments or development? No doubt.

MCA is getting retail deals done despite concerns over long-term valuations of retail properties, shrinking and competitive tenancy, increasing interest rates, and the ‘Amazon Effect.’ In fact, we have arranged over $300,000,000 of debt and equity financings for retail properties since the beginning of 2017 which represents 30% of our $1 billion production book. Our view is that the disruption in the retail sector has created opportunities to acquire properties at attractive valuations. REITS and other institutional investors have stopped buying retail properties, and many are trying to reduce their exposure which further compounds the lack of buyers in the market. The result is that some investors are picking up retail properties at attractive Cap Rates.

For example, one of our clients recently acquired a grocery-anchored shopping center in a secondary market at a Cap Rate slightly below 8%. 24 to 36 months ago, the property would have likely traded at a 6.5% Cap. With a going-in Cap Rate at 8%, our firm arranged 67% loan-to-cost, fixed-rate debt on an interest-only basis that provided an attractive current yield on the investment.

On the construction front, our firm has just completed the placement of a $34,250,000 construction loan to develop a 274,000-square foot shopping center which is anchored by Burlington Coat Factory, Ross, Michael’s, and Conn’s. So, what made this project financeable in an environment where lenders and investors are in retreat on providing financing for new development? First, the Client/Borrower is one of the most experienced and credible developers in the market with the necessary deep-rooted tenant relationships to overcome the hardships of assembling the necessary pre-leasing. Second, the Sponsor had an impressive list of internet resistant/experiential tenants that had ‘right-sized’ their store concepts. Finally, the Borrower had substantial cash equity invested. The loan-to-cost was just over 60%. Point being, construction debt is available for projects with “Best-in-Class” sponsorship and tenancy.

Whether a property is being acquired or developed, lenders and investors are digging into better ways to mitigate risk. Understanding the location, demographics, and local market sentiments with respect to rental rates, occupancy, concessions, and tenant finish is Step #1. Paying careful attention to co-tenancy clauses that give tenants the right to either reduce or abate rent if other tenants close their store should be addressed in any thorough property underwriting process. Other closely watched underwriting factors in retail include analyzing the tenant’s sales history, valuating the current store size/footprint and, of course, having a comprehensive understanding of the tenant’s credit and financials. Finally, not being overly aggressive on property valuation will be helpful in getting a capital provider to pay attention to a deal.  As one experienced developer recently stated to summarize the dilemma in retail property valuations “I can buy great centers right now at a 9% Cap…why should I try to build them?”

Retail financing is definitely more difficult in today’s changing retail environment but most certainly not impossible. With continued upward pressure on interest rates, now is likely the best time to lock in a favorable interest rate on either an interim or permanent loan.

The author, Scott Lynn, is the Founding Principal of Metropolitan Capital Advisors.  To learn more about retail and how your commercial retail or other projects can be financed, Scott can be reached at slynn@metcapital.com (972) 267-0600.