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Cash Registers Are Ringing For CRE Retail Investors

May 06, 2022

The properties have to be the right type though, and lenders are tighter than they once were.

It’s been almost two years since the pandemic rolled in and many wondered whether retail could survive shutdowns, fear of contagion, and an explosion of e-commerce.

Now, after online buying hit a peak of 15.7% of all retail in the second quarter of 2020, it’s now back down to 12.9% with a continuation of its older growth rates.

“Not all consumer activity is online,” says Jim Costello, senior vice president of Real Capital Analytics. “It’s a very upper-middle-class thing.”

Reality has set in; retail survived. CBRE’s 2021 look at real estate volume showed a record year at $746 billion with retail accounting for almost 10%.

However, experts say that it’s specific areas of retail that are hot, with some older standbys cooling heels off in the corner. And lenders, while active, still show some signs of wariness.


“Early on in COVID, retail was totally persona non grata,” Tom Fish, managing director of CRE financing firm Walker & Dunlop, tells “Every tenant that could, asked for—and most of them got—deferral of rent. This probably went on for nine months to a year until the stability showed. When it came to shadow anchor, power center, neighborhood strip retail or whatever, there wasn’t much capital to be had because you didn’t know who was paying the rent and who wasn’t.”

“Going into the pandemic, everyone took a pause to figure how things were going to shake out,” says Cap Putt, Atlanta managing director of private lender Trez Capital, which primarily focuses on construction lending but has branched into bridge loans. “I’d say 2020 was a slow year in all asset classes as people were trying to figure out what was happening.”

By the end of 2020, however, developers, owners and lenders began to see retail doing better than many had expected. Things started slowly.

“When we started in 2021, the capital markets around retail were fragmented at best,” Chris Drew, a senior managing director and co-head of JLL’s Miami office, says. “There was probably tepid interest in demand for grocery, for shopping centers. There was relatively no interest in power centers and limited interest in open shopping centers. There was very limited demand from capital markets to finance any of those.”

Trez Capital began to get interest in “internet-resistant retail,” including experiential, such as movie theaters and restaurants in neighborhood and town center developments.

Initially, regional banks and insurance companies financed local projects anchored with essential businesses like grocery stores and pharmacies. Once things stabilized, “the market came around a little bit for large centers,” Drew says. Financing was more broadly available in the Sun Belt, where the influx of a major demographic shift ensured a better risk profile. “The Heitmans, the BlackStones, larger groups could underwrite the risk with those centers. And these lenders were able to finance their positions through secondary markets or their warehouse lines.”

Move to the end of 2021 and into 2022 and the appetite for retail significantly returned.

“Starting with space market data, vacancy rates finished 2021 at 10.3%, which is down 0.2% over the year,” says Moody’s senior economist Tom LaSalvia.


Lenders generally think that the worst has already happened and “any business that was going to fail has failed and most of the remaining businesses will succeed,” says Steve Bram, co-founder and principal of George Smith Partners. “Any retail that exists today has weathered the storm and tenants are now expected to be paying back any deferral they received in 2020 and 2021 in addition to their current rent payments. In most locations, retail is now very strong; there is pent-up demand.”

Call it a period of heightened Darwinian selection. That has affected the projects that not only developers will consider, but that lenders will fund.

“Prior to COVID, the general retail business model needed to evolve, adapt and change,” says JLL’s Drew. “Retailers as a whole were still trying to figure out what their business plan was. That was probably the first pillar they had to work through. COVID basically helped expedite that. If you didn’t have a sound business plan, you probably got wiped out at this point.” Plus, there was PPP money to help tide things over, giving many retailers a chance to breathe.

Unfortunately, some structural weaknesses have continued. Look at big-box stores. “Certainly, the outlet malls seem to be doing fine, but conventional retail with big box doesn’t seem to be doing well,” Bram says. “Many retailers find they can’t afford the rents they agreed to pay. Some big boxes will survive but the landlords have to get realistic about the rents they can pay.”

This has a major and immediate effect on the market—fear over the sustainability of big-box stores, because they take up a lot of space with specific needs that don’t translate to other sorts of businesses.

“Big-box retail stores don’t make any sense for the current environment,” says Aviva Sonenreich, a senior broker at Sonenreich & Co. “There are so many retail uses that just can’t be replaced [by virtual commerce]. Like the restaurants, salons, dry cleaners. We expected there to be a fire sale on retail, but in [our area of] Denver, it’s still top of the market, five caps on retail. The big-box single-tenant properties don’t get those numbers. We overbuilt them.”

Turning them into something like a warehouse, which is the largest investment Sonenreich’s firm makes, is difficult. They typically lack the physical layout, facilities, and features industrial properties need. The few retail chains that can use a big-box layout are few, far between, and not typically on the hunt for leftovers.

“One of my clients said they’re really wary of the single big-box sites and single tenants because the re-tenanting of the space is tough,” says Peter David Ballance, a real estate partner at Stroock & Stroock & Lavan LLP. “The folks I work with see the retail repositioning and adapting it to an additional use is probably one of the more complicated.”

“Reconfiguring space for a new user for retail gets very expensive,” Jarred Elmar, managing partner, the Geneva Group, adds. “We bought a former LA Fitness shopping center. Now we have a 40,000-square-foot box. It cost us a million dollars to split that box in half and change the façade.” Then Geneva had to provide a lot of construction to build out each side of the space for incoming tenants. An expensive undertaking and the firm was lucky to find replacements at that.

“You don’t know how long it’s going to take and how much it’s going to cost,” Elmar says. “Who would take a 40,000-square-foot gym with no loading dock? There aren’t many tenants who would.” Lenders have to ask if operators and owners might take a broken relationship on their financial chins, minimizing rental revenue and, in the process, increasing risk.

That points to a big reason Geneva likes “the smaller units, the neighborhood shops in a heavily trafficked area with good foot traffic, good parking, good fundamentals [with] viability for the long term,” Elmar adds. “When we buy, we’re looking at 10 years out. Neighborhood areas with two to five thousand square feet are easy to backfill. There aren’t as many users out there that need 10,000 feet, 20,000 feet anymore.

The firm also looks for specific physical layouts of space. “I like the one with all shop spaces with frontage along a major road,” Elmar says. “It’s plug and play. If you lose a tenant, you can get another. We have some spaces that are like a revolving door.” It’s not the best model but can work. Geneva also looks for types of businesses that can work together, like putting a gym, chiropractor, and pre-packaged meal provider all in the same strip. “They’re working out and then they get their meals for the week.” Or seeing the chiropractor when they overdo the stair climb machine.

Part of making the approach work is to say no and protect small business owners from themselves. “A lot of time, they’re good at their craft but they’re not good at business,” Elmar notes. “We’re really looking at the demographics of where the center is [to ensure a business is a fit]. I don’t want to see these guys fail for self-serving reasons, but for them, too.”


Part of getting a lender to sign on is finding the right location, which includes the right city. “If you’re in a one-horse town in Michigan where the auto company has pulled out, you don’t have income to spend. That’s a problem,” Costello says. “But if you’re in a high growth and income area, the tech markets, coastal markets, there’s still a lot of disposable income around.”

There’s also looking into the financials and business realities not only of the project but of the tenants. “The labor issue impacts the retailers,” John Johannson, managing director of retail services at Transwestern, says. “The retailers are the ones that lease your space and provide security or the loan. If the retailers are struggling with a component of their operation, it has a dramatic impact on real estate and then my ability to provide an asset. In the old days, you could borrow 90% of your costs. Today, I think they start to get the heebie jeebies at 65%.”

But aim there and you can get a good response. “We’re looking to get a conservative loan amount like 65% of cost on purchase and we’ve got lenders fighting over each other to do that deal,” says Bram. We’re getting pricing as low as 1.65% over the 10-year swap and the 10-year today is 1.75%. That would be 3.40% interest only for 10 years. That’s the easiest deal that can be done.”

Then consider the best type of lender. “Most of the lenders we’re dealing with are state chartered banks,” says Elmar. “Banks that really know their client, know their market, and don’t deviate from the state they’re in. With national banks, they check the box and if they can’t check the boxes, they don’t go in.” Choosing projects with many smaller spaces outside of the anchor also helps. “The lenders know the 1,000-square-foot units, 2,000-square-foot units, 3,000-square-foot units, they know they can always get tenants.” Plus, a business owner doesn’t want to go under. “Frankly, someone will default on their home mortgage rather than their retail space.”

Plus, lenders and investors need some retail in their diets, according to Drew. “You can get a sensational return on what you can get in retail compared to what you see in multifamily and industrial,” he says. “The market views those assets as high growth and low risk based on the fundamentals you’ve seen on those two asset classes. But in retail, if you have the right operator with a good relationship with tenants, that will be a good investment piece of your overall portfolio.”

“We get a deal in the marketplace. We’ll get 20 different CMBS shops fighting for it, we’ll get multiple banks, and there are a lot of debt funds that will be aggressive in trying to pursue it,” Fish says. “We can get 30 different bids on any one particular asset.”

“Cap rates have increased a little bit [to between 6.5 and 8.5], which tells me there is a slight bit more long-term risk with retail that is being priced into some of these deals, but only in the 50 to 80 basis point range,” LaSalvia says. “That’s not far off what we were seeing pre-pandemic. It’s relatively flat and boring, but I’d say boring’s good for retail given what the sentiment was 20 months or so ago.”

He adds that the transaction count for 2021 was likely to finish at 80% to 89% of 2019 levels, “but 2019 levels were extraordinarily high.” Overall, things have been steady.

Those looking for a lender, plan on showing lower leverage and a few years of a solid P&L, because they are “on a search for yield,” says Mark Perkowski, vice president of the commercial finance group at Chicago-based Draper and Kramer. “Retail gives them the ability to get as much 50 to 100 basis points more on a property than an industrial or multifamily property.”

Remember, too, that “lenders lend against retail collateral,” Harold Bordwin, principal and managing director of Keen-Summit Capital Partners LLC, says. “The valuation is the valuation of the inventory, the stuff on shelves. As a company is getting more financially distressed, those appraisals are really focused on what is the value of that inventory in a [going out of business] sale.”

Just don’t necessarily plan on getting terms you’d love. “What I’m hearing from clients is that there’s a disconnect between what sponsors want and what lenders are willing to do,” says Jonathan Kurry, a partner in Reed Smith LLP’s finance industry group. “Sponsors want to get 70% loan to value, non-recourse. They’re not finding it from traditional lenders. I think the lenders are still a little bit shy. They’re looking at it as the same way as multifamily—strong but not rushing out to do super-high leveraged loans. Lenders are only offering a 65% LTV at most; rates are not aggressive.”

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