Retail Lending Rolls On
The retail lending market continues to gain strength, with little change expected for 2007.
Lara Fuller

The retail market has been relatively robust over the past several years and is expected to remain so throughout 2007. Interest rates and cap rates have also remained steady for a while now, creating a sense of security for those involved in the retail market. Developers are continuing to build across the country and are finding a range of funding options available for new projects.

Though much of the same is expected for 2007, there is one area of retail lending that is seeing some change. Fewer and fewer new developments are being considered ‘pure’ retail projects. Most are morphing into mixed-use developments, with additional elements being added to the mix. This is changing the way that lenders look at risk and structure loans. Shopping Center Business recently spoke with several lenders to find out their take on the market and to see how they are handling the shift from retail to mixed-use.

Current Market Conditions

Interest rates and cap rates have remained relatively stable over the past year, keeping the retail lending market stable as well. “Retail markets are generally sound across the country,” says Marty Lanigan, president and chief executive officer with Mezz Cap in Short Hills, New Jersey. “We only see a few pockets of weakness, and those are only slightly softer than the norm.”

Naturally, changes in interest and cap rates are a significant factor in determining the health of the retail lending market. Most lenders agree that as long as the rates remain within the range they are in currently, there will be more of the same for the coming year.

Leslie Lundin, Inland Mortgage Capital Corp.

“Long term rates, to everyone’s surprise, have gone down in 2006 and most people believe that they will stay down or not increase dramatically in 2007,” says Leslie Lundin, senior vice president and national director of originations with Inland Mortgage Capital Corp. in Walnut Creek, California. “The low long term rates and low fear of big rate shifts has added strength and confidence to the equity markets, keeping cap rates down and propping up values.”

Thomas Peacock, senior vice president, and Jacqueline Patterson, assistant vice president with Huntington Capital Markets in Indianapolis, also believe that rates will remain steady. “Long term rates will not change,” say Peacock and Patterson. “We will continue to see business as usual until we start experiencing greater vacancies or issues associated with the consumer.”

“We do not anticipate any severe changes in rates this year,” says EJ Burke, executive vice president and group head with KeyBank Real Estate Capital in Kansas City, Missouri. “The overall strength of the economy, the housing market and the emergence of the newly popular financial products like collateralized debt obligations will have more influence on the commercial real estate lending market than changes in interest rates.”

The large amount of capital currently available in the market will also keep the retail lending market busy throughout 2007. Most lenders believe that there is more than enough capital available, and some believe that there might actually be too much.

“Capital is available and then some,” say Peacock and Patterson. “There is plenty of capital in today’s economic environment.”

“Capital continues to be readily available to credit-worthy developers and investors,” says Burke. “Retail developers and investors are seeking solutions where they can take the fullest advantage possible of the immense amount of capital in the market. Where once a developer might have adhered to an 80/20 loan-to-value ratio, borrowers with high quality credit can now combine mezzanine equity with more traditional loans, to achieve, in some cases, a nearly 100 percent loan to cost.”

Karen Case, LaSalle Bank.

“The enormous supply of capital has driven down loan spreads significantly,” says Karen Case, executive vice president and head of Illinois commercial real estate with LaSalle Bank in Chicago. “Loans which 24 months ago may have been quoted at spreads of 225 to 275 basis points over Libor are now being quoted in the mid-100s.”

At Legacy Capital Partners, David St. Pierre also believes that while capital isn’t a problem, there is a lack of equity in the market at the moment. “There is plenty of equity capital available, but there is not a lot of long term equity in the market,” says St. Pierre, president of Lyndhurst, Ohio-based Legacy. “As a long term investor, we are looking for projects that are irreplaceable and are in markets with significant barriers to entry. Developers of these projects typically share our long-term investment approach and are not interested in a merchant build strategy.”

Lundin believes that there is actually too much capital available at the moment. “Is capital readily available? That is an understatement,” she says. “It’s too available. The market is flush with the stuff. Leverage is at an all-time high. Spreads are at all-time lows.”

Market Vs. Project

While there are always certain areas of the country where retail development is more prevalent, most lenders are shifting their focus away from particular markets and looking more at the project itself. For many lenders, the market is no longer the most significant factor in considering a loan.

David St. Pierre, Legacy Capital Partners.

“There are good opportunities in every market and there are bad opportunities in ‘hot’ markets,” says St. Pierre. “In retail, as opposed to multifamily or office, it has more to do with the overall project concept and execution of the strategy rather than overall conditions in a market in general.”

“Huntington Capital Markets evaluates all projects on an individual basis,” say Peacock and Patterson. “Because the mezzanine business tends to take a higher risk, it truly does differentiate amongst properties relative to the quality of the return.”

One of the major reasons for the shift from market to individual project is because most retail projects being developed now are actually mixed-use projects. More and more, retail does not stand alone. There are usually office, multifamily, hospitality and entertainment components to projects, which changes the lending game.

“We rarely see today a new retail project of any great significance that does not incorporate some elements of mixed-use lifestyle/town center discipline,” says St. Pierre. “Mixed-use projects are retail projects at their core, but when you add in the additional uses such as residential, entertainment, restaurants, hotel and office, you begin to diversify the risk profile of the project.”

The residential market has always had an influence on retail, but because so many of the new mixed-use projects now include residential elements, the state of the residential market is more influential than ever. “Because retail follows residential, the market for new retail development corresponds more or less directly with the markets where the housing market has maintained its strength,” says Burke. “So as long as there is continuing residential growth, you will continue to see demand for new retail centers — and the capital to fund them.”

Popular Loan Products

Because there are so many different types of products available in the lending market, the popularity of certain products varies from lender to lender. The popularity of a product is also dependent on the size and type of project being financed.

At Torreón Capital in Austin, Texas, the most popular products are preferred equity and mezzanine equity. “We are mainly seeing preferred equity deals from $3 million and up and mezzanine equity deals from $10 million and up,” says Rex Paine, partner with Torreón Capital.

At Inland Mortgage Capital, 100 percent bridge loans and construction loans are completed the most often. “More construction loans are being written in Phoenix, Las Vegas, Florida and Texas, where there is more construction,” says Lundin. “We tend to do more bridge loans for retenanting of vacant boxes in other markets where there is less new construction.”

KeyBank offers a range of lending options, but there are several that seem to be used more often than others. “Syndicated interim loans, CMBS loans, mezzanine debt, private equity and structured finance solutions are rising in popularity right now,” says Burke.

Mezzanine loans continue to be popular in many markets and they are currently the most popular loan type at both Huntington Capital Markets and Mezz Cap.

“Mezzanine financing is very popular with retail properties,” say Peacock and Patterson.

Adds Mezz Cap’s Lanigan, “Our core program products have been exceptionally popular for retail transactions, and we have funded over 100 mezzanine loans since our inception.”

The Coming Months

According to most lenders, interest rates are the most significant factor in the health of the lending market in 2007. Rates have remained steady over the past year and there is no immediate fear of big changes in the immediate future. Retail is expected to remain at the top of the ‘hot’ property list in most areas of the country. While some see changes coming, most believe that it won’t be for a while. “We saw a steady deal flow in 2006 and anticipate the same for 2007,” says Paine.

“So far so good for those who predicted a soft landing of the economy,” says Lanigan. “Interest rates and inflation will really be the key drivers as to whether we feel a few bumps or not. That being said, real estate has been very good for an awful long time, and an enormous amount of good news has been packaged into cap rates and lending terms. The market feels ripe for correction, and it’s usually only obvious as to what started one when you look in the rearview mirror.”

Retail will continue to remain the most popular property type and development is expected to continue all over the country. Though some predict a slight slowdown, there are no major changes expected for 2007.

“Locally, in Chicago, the marketplace has been frothy for retail development and sales in the last year, and we see that trend continuing through 2007,” says Case. “We have also seen significant activity in suburban development.”

“Retail is our product of choice today,” says Lundin. “We could easily put half of our loans in retail transactions and probably will in 2007. However, being an opportunistic lender, we have to temper our appetite for retail with its relative market strength. If the market softens and we are not able to get our required yields, we will re-allocate to other product types. I don’t see that happening in 2007.”

Due to changes in the residential market, Burke sees a slight drop in retail activity in the coming year, but no major or drastic changes. “In 2007, because the market for single-family homes and condominiums has slowed down, we foresee a slightly smaller market for the financing of new retail development in the coming year,” says Burke. “While we continue to dedicate capital to new retail developments and acquisitions, we believe that the 2007 market will not be quite as strong as it was in 2006.”

Overall, 2007 is expected to be a good year in the world of retail lending. With steady interest rates and lots of available capital, retail development is not expected to slow down any time soon.

LENDERS CLOSE NEW RETAIL LOANS Torreón Capital recently provided financing to Allegiance Development for the land assemblage of a 412-acre mixed-use development site for Rayzor Ranch in Denton, Texas. As the retail market grows, so do retail developments. Many of the newest projects combine multiple uses into one large-scale project, offering consumers a variety of options when it comes to shopping, eating, living and working. Lenders across the country are seeing a surge in the creation of mixed-use developments and are working fast to finance these popular projects. LaSalle Bank of Chicago is currently financing several significant projects. In DuPage County, Illinois, LaSalle is financing the 200,000-square-foot Willowbrook Town Center. Harlem Irving Cos. is developing the project, which will feature The Sports Authority, Staples, Panera Bread and Starbucks. In Naperville, LaSalle is also financing the Freedom Commons project. The 140,000-square-foot development, a joint venture of The Harp Group and Wm. Krug Inc., will feature a mix of retail, restaurants, entertainment and recreation venues, as well as facilities offering health, fitness and spa services. In Baton Rouge, Louisiana, KeyBank Real Estate Capital recently closed a $170 million construction loan with JTS Interests. “Proceeds from the loan will be used to construct Phase I of Perkins Rowe, an 833,000-square-foot urban, mixed-use, open-air lifestyle center consisting of retail, restaurant, office and residential components,” says Burke. Tenants at the center will include Barnes & Noble, The Fresh Market, Z Gallerie, Guess and Anthropologie. KeyBank Real Estate Capital recently closed a $170 million construction loan with JTS Interests to construct Phase I of Perkins Rowe, an 833,000-square-foot urban, mixed-use, open-air lifestyle center in Baton Rouge, Louisiana. Legacy Capital Partners recently handled financing for The Launch at Hingham Shipyard, part of a 1.2 million-square-foot mixed-use waterfront district on Boston Harbor’s south shore. The Launch at Hingham Shipyard will feature 240,000 square feet of commercial and retail space. “Our company was chosen to service the loan because of our long term investment strategy,” says St. Pierre. “Our partner had no interest in working with a short term equity partner.” In Denton, Texas, Torreón Capital recently provided financing for the land assemblage of a 412-acre mixed-use development site for Allegiance Development. The $800 million Rayzor Ranch development will be constructed on the site. When complete, the project will feature a 1 million-square-foot department store-anchored center, a 700,000-square-foot power center, office and medical uses, and single, multifamily and senior living residential components. “We were invited to partner with Allegiance on this highly visible project because of their positive experience with us on two previous projects and also because we have the financial strength, flexibility and the ability to move very quickly,” says Paine. — Lara Fuller

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