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Page 14 — Retail Properties Quarterly — November 2016
T he commercial real estate
lending market has remained
strong for the duration of
2016, however, this past year
also presented unexpected
(but not insurmountable) chal-
lenges. As the new year quickly
approaches and retail owners begin
developing their game plan for
2017, it’s helpful to understand how
dynamic the lending market was
this past year and how some life
companies’ criteria for assessing
retail properties evolved accordingly.
At the beginning of 2016, most
industry experts expected both
supply and demand for real estate
loans would be vigorous. However,
a tumultuous bond market caught
commercial mortgage-backed secu-
rity lenders by surprise with impli-
cations reaching beyond the secu-
ritized market. In December 2015, a
lack of buyers in the bond market
forced CMBS lenders to widen their
pricing significantly in order to
bring salable fixed-income offerings
to a bond market that was demand-
ing yield. This caused an overall
increase in CMBS interest rates of
approximately 0.75 to 1 percent,
an increase that lasted almost the
entire first half of the year – CMBS
credit spreads didn’t start settling
down until May.
Since the CMBS market suddenly
became a more expensive capital
source, many borrowers responded
by avoiding the CMBS market alto-
gether and sought capital from bal-
ance-sheet lenders like life compa-
nies instead. In fact, CMBS issuance
in the first half of this year dropped
by over 40 percent. (According to
Commercial Mortgage Alert, total
U.S. CMBS issuance
in the first half of
2016 was $30.7 bil-
lion compared with
$54.49 billion in
the first half of the
prior year.)
Ultimately, the
CMBS market’s loss
was the life com-
pany market’s gain
as the weak CMBS
market fueled life
company deal flow.
Life companies
already had been
expecting a busy
year due to the overall strength of
the real estate industry, but while
CMBS interest rates were high, chief
investment officers at life compa-
nies seized the opportunity to invest
loan dollars at relatively attractive
yields. The life company market
posted an incredibly successful first
half and despite record-size alloca-
tions of dollars for commercial real
estate lending, some life companies
literally ran out of money to lend by
midyear. This enabled the remain-
ing life companies in the market to
become more selective, because as
the year progressed, there was less
competition for each transaction. As
a result, life companies seemed to
grow increasingly selective across
all property types, however, here are
some specific topics that arose most
often in discussions about retail
properties.
• Grocery anchors. It’s been no
secret that many, but not all, life
companies have preferred grocery-
anchored retail properties for a long
time. However, in 2016, life compa-
nies placed even more emphasis on
assessing the creditworthiness of
each grocer and the likelihood that
each location will remain open for
business.
They primarily focused on three
criteria. First, life companies look
for store-specific gross sales figures
to exceed at least $400 per square
foot. Furthermore, a grocer’s occu-
pancy cost – also known as a health
ratio, expressed as a ratio of total
rent and reimbursements over gross
sales – should be less than 3 per-
cent. Second, in an effort to reduce
rollover risk, life companies strongly
prefer to lend on grocery-anchored
centers where the grocer’s remain-
ing lease term extends beyond the
maturity of the proposed loan. The
third criteria also is the most strin-
gent and doesn’t apply to all lend-
ers, however, as loan dollars became
scarcer over the course of this year,
some life companies decided only
to lend on grocery-anchored centers
with publicly traded, investment-
grade credit grocers. This was not a
widespread requirement in the life
company market; however, it’s an
example of how some life compa-
nies enjoyed strong deal flow in the
first half of the year, affording them
the luxury of being picky in the lat-
ter half of the year.
The impact of this criteria is sig-
nificant, as many grocers commonly
considered to be good operators are
not necessarily rated investment
grade and, in some cases, stellar
sales and superior location were
trumped by below-investment-grade
credit.
• In-line shop space. There were
no hugely significant changes this
year in the criteria life companies
used to assess in-line shop space
at retail centers. Much like last
year, lenders are most interested in
financing properties with experien-
tial, service-based tenant lineups,
meaning tenants whose sales are
less vulnerable to competition from
internet commerce. Examples of
attractive tenants include restau-
rants, coffee shops, hair and nail
salons, and health clubs. One point
worth noting, however, is that as life
companies grew more selective as
the year progressed, they became
increasingly sensitive to co-tenancy
clauses, as they fear an anchor ten-
ant’s departure can cause a domino
effect within an otherwise healthy
retail center.
Focus Shifts to 2017
Despite this year’s challenges in
the capital markets, the commer-
cial lending environment remained
robust and there was more good
news in the market than bad.
There’s no doubt that as mortgage
bankers, our roles became more
challenging in the second half of the
year as life companies became more
selective. Even though I haven’t
sugarcoated this reality, this year,
we will still place more life com-
pany volume than ever before and
most of our correspondent life com-
panies will post record-setting loan
origination figures. This has been a
banner year and property owners
shouldn’t be discouraged, but they
should also be mindful that the first
half of the year is generally the best
Michael
Salzman
Vice president, loan
production, Essex
Financial Group,
Denver
Lending Market