CREJ

As uncertainty looms, retail investors seek to lock more than just interest rate W e’ve entered this year’s second half, and 2020 is right around the corner. As a fresh decade approaches and we reflect on the for- mer, two major themes stand out. First, the current economic expan- sion, which our industry continues to enjoy, has now lasted over a decade. Second, retail is far from dead, but it has undergone substan- tial change. Despite the fact that the word “apocalypse” has been used so many times to describe the retail sector, there are notable bright spots in the retail space. There are a wide variety of retailers posting healthy growth and the same online retail- ers and direct-to-consumer brands that were supposed to be a threat to our industry are now opening brick- and-mortar stores. Amazon, Warby Parker, Casper Mattress, Untuckit, Mizzen & Main, Ministry of Supply, Bonobos, Allbirds, Everlane, Away and Indochino are just of a few of the successful companies that have opened physical stores and now make up the growing “clicks-to- bricks” category. Another bright spot within the retail sector has been the success of infill neighborhood retail centers, many of which have proven that with a strong lineup of service- based tenants, a grocery store is not necessarily needed to drive traffic. Despite all of the aforementioned “good news” in the retail sector, retail real estate inves- tors are presented with two signifi- cant challenges as we embark on a new decade. First, the retail space will continue to evolve in ways we cannot predict. Second, the economic environment is uncertain, and while interest-rate movements are a significant wild card, they are only one of many economic factors that we cannot predict. With this confluence of industry- specific uncertainty and overall economic uncertainty, we’re notic- ing that our borrowers who intend to hold retail assets long-term are often opting to secure long-term financing for reasons besides lock- ing a long-term fixed interest-rate. Many of our borrowers are focused on securing a long-term loan amount with no structuring (leasing capital reserves or cash flow sweeps) that lenders would not be allowed to modify during an economic downturn. Further, these borrowers also are careful to secure a term that matches up with their lease expi- ration schedule and with enough term to get past the next economic downturn. In many cases, this deci- sion has meant pivoting away from bank financing, and toward nonrecourse permanent lending sources, like life insur- ance companies and commercial mortgage-backed securities lenders. While these capital sources usually don’t offer the same level of pre- payment flexibility as banks, their loan documents also don’t typically contain “negative covenants” often required by banks, whereby banks reserve the right to order a new appraisal of loan collateral at any time during a loan term and can demand loan pay-downs (“re-mar- gining”) in the event that a prop- erty’s value has decreased. As borrowers have shifted toward lending sources that do not require “negative covenants” in their loan documents, they have found a vari- ety of capital sources attractive for distinct reasons: • Life insurance companies. Aside from offering the lowest interest rates available in the market, life insurance companies continue to offer the longest-term fixed-rate loans available (up to 30 years for retail properties). Our borrower cli- ents have consistently been locking 10-year fixed-rate loans in the high 3% to low 4% range, and longer- term deals are pricing in the mid-4% area. Further, while 18 to 24 months ago life insurance companies were extremely focused on grocery- anchored shopping centers, they are now also actively lending on infill neighborhood centers with strong occupancy history and robust line- ups of service-based tenants (with offerings/experiences that consum- ers cannot buy on the internet). In many cases, depending on lever- age, 30-year amortizations also are attainable from life company lend- ers. • CMBS lenders. While CMBS lenders have historically excelled at providing high-leverage loans (up to 75% loan to value), they are now actively competing for lower- leverage loans by offering significant interest-only payment periods. For example, in many cases, 10-year, full-term, interest-only payment periods are attainable at 65% LTVs or Please see Essex, Page 24 August 2019 Michael Salzman Principal, Essex Financial Group Peter Keepper Principal, Essex Financial Group