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The Biggest Challenge for Retail Investors Comes With an Amortization Schedule

Picture this: You have an opportunity to buy a stock that has been thoroughly thrashed for almost a year now. The price is low and lots of people are looking to get rid of their shares. You’ve been following this stock for a while, and you know that prices won’t be this low forever. Instead, things are going to pick back up for this company, despite broad changes in the industry. Wouldn’t you want to be there? 

This is the situation currently facing real estate investors considering buying retail properties. There is no doubt that the retail world has taken a thrashing over the last year thanks to the almost apocalyptic impacts of COVID-19 on consumer shopping habits. Recent months have seen a wave of bankruptcies from individual retailers like Lord & Taylor, Brooks Brothers, and Stein Mart. Retail investors have also struggled with bankruptcy, with big players like Pennsylvania Real Estate Investment Trust submitting their own filings recently.

It isn’t even just the pandemic that is causing headaches and heartache at retailers. Internet-enabled retailers like Amazon and giants like Walmart have sucked much of the air out of the room. The accelerating efficiency of these players vis-a-vis curbside pickup, delivery, and flexible logistics networks due to COVID-19 will make competing even tougher in the long run for everyone else. 

But beyond those disruptions, there have been some good indicators for the sector as well. Retailers in niches like grocery and hardware sales have been performing well through the pandemic. There is now the first sign of relief to the outbreak on the horizon, thanks to vaccine progress at several different companies. And in the single-net world, new opportunities are hitting the market, like NetSTREIT, a REIT that went public in August, and is insulated from experiential retailers, instead focusing on resilient ones like Lowe’s and Walmart.

For some investors, now would seem like the perfect time to make a retail play, while prices are uniquely low and many operators are facing tremendous amounts of distress. So what’s holding the typical retail real estate investor back?

In a word, lending. Finding a debt partner who is comfortable putting money up for a field as embattled as retail is now a very challenging proposition. The typical commercial bank, even one with the most experienced staff imaginable, is writing notes on all sorts of real assets: office, retail, multifamily, and industrial. Between that and the typically conservative nature of the lending world, retail real estate does not present an attractive picture for the typical financial institution.

According to Greg Matus, senior vice president of investment sales for the Florida-based Franklin Street, loans on retail properties have had their LTVs slashed down to around 50 percent, up from a typical pre-pandemic figure of 60 or 70 percent. “A lot of owners are trying to refinance properties that have problems, so banks are running scared. It’s just a really tricky market when it comes to debt.” Unfortunately, this puts pressure on even talented investors who have their eyes on really great deals.

Think about it from the lender’s perspective. According to senior director Stuart Plesser’s team at Standard & Poor’s, “Commercial real estate (CRE), in our view, tops the list of sectors that are most at risk of declining asset quality amid the coronavirus pandemic—which would lead to losses for U.S. banks.” Indeed, their data shows that banks own about half of all the debt on commercial real estate across the country. Such large existing exposure would likely put pressure on investment committees within banks to avoid overplaying their hands with marginal properties. 

Here’s the other side of the problem for investors looking to capitalize on the ups and downs of retail. Distressed opportunities might be what the savviest growth-oriented investors are looking for in the retail space, but lender’s aren’t having it. According to Jeff Enck, who is a capital investments associate director at Stan Johnson Company, lenders are passing on properties experiencing high vacancy or less attractive tenants. “The entire market is chasing quality right now. People are afraid of any property with a blemish on it,” he added. 

The numbers back this up. According to data from Bank of America Global, only one to two percent of commercial transactions in the second and third quarters have been distressed. “Until distressed asset sales increase in a significant way, we anticipate that asset pricing metrics will remain relatively idiosyncratic,” they said. This type of environment could reward investors with strong lender connections and demonstrated skill in turning distressed retail assets around, but for the vast majority of firms looking to dive into distressed retail before a vaccine hits, it might be too late to make something happen. 

It is easy to look at a big market swing and think that being there with a mission and a willingness to get creative is all it takes to strike it big. But simply seeing the trend isn’t enough. Unless investors can come to the table with a ton of cash in their pocket, as many of the biggest REITs have done recently, things will likely come down to lending. Above just being a “good borrower” there is a relational element to the lending side of the business. Trust has once again become one of the most valuable commodities. Without trust in the outlook for retail overall, lenders need to be able to trust their borrowers to justify their investments. Investing in distressed retail assets right now is a known strategy, as long as you have the money and the relationships to make it work.

Associate Publisher, Propmodo Research
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