Will The Coronavirus Be A Death Knell For Retail Lending?

Many landlords held their breath on April 1, waiting to see if tenants would pay the rent. Lenders were also waiting in suspense, especially those holding debt on America’s shopping centers and malls, a sector already beleaguered by years of competition with e-commerce.

“As a landlord, I feel like a ping-pong ball going back and forth between our tenants and lenders, trying to figure out what will work for everybody,” Edwards Realty Co. President Ramzi Hassan said.

His Orland Park, Illinois-based firm owns and operates nearly a dozen shopping centers in the Chicago area, where most retail tenants lost all or much of their revenue once the state went into a mandated lockdown in March. That put a lot of pressure on Hassan.

“I’ve never worked harder in my life than I have in the past month," he said. "Sometimes it’s meant listening as a tenant with a small store sobs on the phone saying, ‘I can’t pay the rent, and don’t know what the future holds.’”

With little revenue coming in, mortgage holders in the sector will need to scramble like Hassan and figure out new ways to survive, whether that means seeking out loan modifications, including payment deferrals, refinancing or finding new investors willing to pour in capital. Federal regulators have sent lenders clear signals to go easy on borrowers, but that will only buy landlords a few months.

After that, the sector may face a reckoning, especially if whole categories of retail suffer severe hits as the coronavirus keeps scaring away patrons. Remaining investors may decide to stick with the top-performing assets and shy away from all others, leading to a wave of foreclosures and permanent shutdowns even as the pandemic subsides.       

“I am not sure how any property, or any business, that was not doing well in the previous economy can come out of the other side,” Alliant Credit Union Head of Commercial Lending Charles Krawitz said. “This could be their death knell.”

Alliant is a Chicago-based organization with about 500,000 members and nearly $1B in outstanding commercial real estate loans across the nation. Its roughly $200M balance in retail includes many deals worth between $8M and $35M, including loans secured by lifestyle centers such as the West Tropicana Center in Las Vegas, a 90K SF development where Alliant made a $14.5M loan. 

“Retail is a property type that I am not looking for greater exposure to at this point,” Krawitz added. “I turned down two possibilities yesterday. It would take one hell of a retail deal for that to change. I’m sure that day will come in the future. Unfortunately, it’s not today.”

“The vast majority of lenders out there are going to have problems closing retail loans,” Flagship Capital Partners Director J.C. Clemens said.  

That includes banks, which can’t underwrite loans on retail properties with no rental income, and large collateralized loan obligations lenders out of New York, he added.

“That business model has gone away for the time being,” Clemens said.

That doesn’t mean no one will show interest. Private lenders such as Houston-based Flagship are lining up capital and looking at potential deals.

“There is a bunch out there just like us,” Clemens said. “Everyone who has survived multiple cycles understands there's inherent value in every kind of real estate. Private lenders will be the ones to help shepherd retail owners into the new normal for the foreseeable future. We’re underwriting new retail deals right now; my phone is ringing off the hook from guys looking for new partners.”

But Flagship will stick with top properties of whichever class, ones that present little long-term risk, no matter what troubles they experience today.

“What we’re looking to do is find the winners in the market, those that have a track record of weathering the storm,” Clemens said.

The loss of so many sources of capital will put huge segments of the retail sector at risk, and storm clouds are already gathering. The retail marketplace was a bloodbath in March, when sales plummeted 8.7%, the sharpest drop on record. The number of CMBS loans considered late also soared.

In March, borrowers on 1.7% of retail CMBS loans were late making payments and in danger of becoming delinquent, according to Trepp, which monitors the federally regulated market. By April 20, that percentage jumped to 11%, or nearly $14B of the more than $124B outstanding. By comparison, just 2.2% of loans for the office sector were tagged as late, a slight decline from March.

“Unfortunately, these numbers above could be on the low side of what's to come,” Trepp noted. “There are many examples of loans for which the April 1 payment was made, but for which the watchlist comments now indicate a forbearance has been requested.”

The current state of the rest of the market remains obscure.

“There aren’t any other solid numbers out there other than CMBS at this point,” Mortgage Bankers Association Vice President of Commercial Real Estate Research Jamie Woodwell said.

The organization is collecting data on delinquencies in the retail sector for regular bank loans, which it will soon publish.

The coronavirus is just the latest hit to the retail sector, which was already struggling.

Ten Chicago-area malls are backed by CMBS loans, and three properties were already on the brink before the pandemic, according to Trepp’s data.

One is North Riverside Park Mall, a 1.1M SF, Class-B shopping center at 7501 West Cermak Road in North Riverside, Illinois. A CMBS loan covers a 424K SF portion, and it entered foreclosure proceedings after it was due on Oct. 6, Trepp reported. The owner, New York-based Feil Organization, has a $68M outstanding balance on the loan, but in November the property was reappraised and found to be worth $48M, a decline of $22M, according to documents filed with the Securities and Exchange Commission.

The mall’s general manager, Harvey Ahitow, told Crain’s Chicago Business last fall that its outlook was brightening. Several new tenants, including amusement store chain Round One, Amita Health and Blink Fitness, took part of the space vacated by Sears, and the mall soon reached 98% occupancy.

“This is a center that's going to survive,” he said. “There's no question about it. That's because we have an owner who's willing to invest in it.”

Ahitow did not return calls or messages seeking comment.

“The lender will dual-track foreclosure/receivership proceedings while simultaneously continuing discussions with the borrower until a resolution is reached,” according to a recent comment in Securities and Exchange Commission documents by the loan’s special servicer, Miami-based LNR Partners.

The North Riverside mall’s loss of value is not an isolated case. Green Street Advisors' Commercial Property Price Index in January showed U.S. malls lost 15% of their value in the previous 12 months.

It’s not yet clear what will happen to such troubled loans. But the hard decisions will most likely not have to be made for at least several months.

“It’s still early, but what we’re seeing is that ultimately, most borrowers that are impacted will get payment deferrals,” George Smith Partners Managing Director and principal Bryan Shaffer said.

Shaffer’s Los Angeles-based firm raises equity and arranges loans for commercial real estate borrowers and has placed about $5B in loans for properties throughout the nation, including $1.5B in shopping centers. The company also helps clients navigate the present crisis by negotiating with their lenders, which range from credit unions to large financial institutions.    

Getting loan deferrals got a lot easier on April 3, Shaffer added. Federal regulators such as the Federal Deposit Insurance Corp., the Consumer Financial Protection Bureau and the Board of Governors of the Federal Reserve System published a joint letter advising banks and other lenders to be flexible, including giving borrowers the opportunity to defer payments.

Woodwell said federal regulators are playing a key role in giving the market some breathing room to deal with the crisis.

“They don’t want lenders and servicers hamstrung in their ability to work with borrowers.”

But the federal letter doesn’t mean borrowers are simply in the clear.

“It’s a powerful statement, but you’re going to have to be able to prove the impact,” Shaffer said.

That means documenting how many tenants have shut down or partially closed, how much rent they can afford to pay, what their prospects are for the next few months and whether the borrower is sitting on a lot of cash, as well as providing several years of tax returns and property financials.   

Whatever the short-term outcome, borrowers will have to pay up eventually.

“Lenders are not simply agreeing to forgo these payments, they are just pushing it to the end of the loan,” Shaffer said.

Both Krawitz and Hassan said they are prepared to make it through the next few months.

“We’ve tried to find an accommodation wherever possible,” Krawitz said. “I want to find a solution for everybody, so we are offering relief on a case-by-case basis. We’re not squeezing anyone in a way that would jeopardize the long-term success of their assets.”  

Alliant offered some retail borrowers straight-up deferrals, he added, including an elderly couple who own a Red Lobster outlet.

“One of them is in the hospital,” he said. “We have a heart.”

In other cases, it allowed borrowers to only pay off their loan’s interest for a few months. The credit union can be accommodating because it makes conservative loans. Its properties are stable and feature mixes of national tenants and local service providers that generated strong cash flow.

“There is usually something that has been offered back to us as a gesture of good faith by the borrowers, and it’s not unreasonable to ask them to do a capital call and return some profits back into the property,” he said. 

In at least one case, Alliant is allowing a borrower to keep building a reserve that will eventually help reposition portions of the property, including a JCPenney store, a retailer which began considering bankruptcy due to the pandemic, according to a report last week in Business Insider.

“We believe we are serving the property’s long-term value by not drawing down those funds,” Krawitz said. “We have our arms around this issue in our portfolio, as most of our borrowers prepared themselves for a rainy day, although not necessarily a monsoon. But I’m confident we will get to the other side without significant losses.”

Hassan’s lenders were willing to modify property loans, in tandem with the breaks Edwards Realty gave tenants on rent.

“As always, this business is built on relationships, and we’ve always had great relationships with our existing lenders,” he said. “We did not just go to our lenders and say, ‘We need a 90-day reprieve on all of our loans.’”

But with some large corporate tenants saying they could not pay rent for 90 days and Edwards still paying for trash pickup, cleaning and other expenses, some lenders agreed to deferments, while others agreed Edwards Realty could for several months pay only the interest on its loans.

Hassan takes that as a sign that the lending community is willing to help both tenants and landlords get through at least the next few months.

“It all comes down to how banks treat these assets and what their motivations are. I don’t think banks are just going to fire sale assets unless they are forced to.”

Getting through the first months of the crisis is a necessary first step, but the danger for retail may lie not in the shutdown itself but the likelihood that even when the worst of the pandemic subsides, stay-at-home orders will ease up but not entirely vanish, leading to diminished sales and unpaid mortgages.

“I don’t think we’ll see crowded movie theaters in malls even after the stay-in-place orders end,” Trepp Senior Managing Director Manus Clancy said. “This may be that last thing which pushes them over the edge and makes the owners just say, ‘Here’s the keys, I’m calling it a day.’”

Hassan's firm frequently purchases shopping centers plagued by high vacancy, and then repositions with new tenants, including the 200K SF Burr Ridge Village Center in Burr Ridge, Illinois, which it bought last year for $15M. He said both landlords and tenants may have to reimagine retail’s economic models. Built-in assumptions like how much revenue a restaurant can generate may no longer be valid, especially until a vaccine for the coronavirus is developed, which experts say will most likely not happen until 2021.

“Even if everyone gets through the first 90 days, what does the rest of the year look like?” Hassan asked. “Are restaurants going to have less seating because of social distancing guidelines, and will shopping habits change? We just don’t know if some renters are ever going to hit the sales levels they did before.” 

“It would be hard for me to get a loan for a retail property right now, because we don’t know what the rents will be,” he added. “We could never have modeled not getting 80% of our revenue.”

“We’re keeping our eyes open for opportunities, and although we’re not seeing a ton out there because everything is in flux, there is light at the end of the tunnel, and we want to make sure to capitalize on it.”