The biggest challenge for retail investors comes with an amortization schedule

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Imagine this: you have the opportunity to buy a stock that has been completely beaten for almost a year now. The price is low and a lot of people are looking to get rid of their stocks. You’ve been following this stock for a while and you know the prices won’t be this low forever. Instead, things will pick up for this company, despite big changes in the industry. Wouldn’t you like to be there?

This is the situation currently facing real estate investors who are considering buying commercial properties. There’s no doubt that the retail world has taken a beating over the past year thanks to the near 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 been battling bankruptcy, with big players like Pennsylvania Real Estate Investment Trust recently submitting their own filings.

It’s not even just the pandemic that’s causing retailers headaches and heartaches. Internet-connected retailers like Amazon and giants like Walmart sucked much of the air out of the room. These players’ increasing efficiency with curbside pickup, delivery, and flexible logistics networks due to COVID-19 will make it even harder to compete in the long run for everyone else.

But beyond these disruptions, there were also good indicators for the sector. Retailers in niches like grocery and hardware sales have performed well during the pandemic. There is now the first sign of relief from the epidemic on the horizon, thanks to advances in vaccines at several different companies. And in the single network world, new opportunities are coming to market, like NetSTREIT, a REIT that went public in August and is isolated from experiential retailersinstead focusing on resilient businesses like Lowe’s and Walmart.

For some investors, now would appear to be the perfect time to play retail, as prices are particularly low and many traders are facing huge difficulties. So what’s holding the typical commercial real estate investor back?

In a word, lend. Finding a debt partner who is comfortable putting up money for such a beleaguered field as retail is now a very difficult proposition. The typical commercial bank, even one with the most experienced staff imaginable, writes notes on all kinds of real estate assets: offices, retail, multi-family and industrial. Between this and the typically conservative nature of the lending world, commercial real estate does not present an attractive image for the typical financial institution.

Commercial property loans have had their LTV, according to Greg Matus, senior vice president of investment sales for Florida-based Franklin Street. reduced to about 50%, compared to a typical pre-pandemic figure of 60 or 70%. “Many landlords are trying to refinance properties that are in trouble, so the banks are scared. It’s just a very tricky debt market. Unfortunately, this puts pressure even on talented investors who have their eyes set on some really good 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, is at the top of the list of sectors most exposed to the risk of a decline in asset quality in the context of the coronavirus pandemic, which would lead to losses for US banks”. Indeed, their data shows that banks hold about half of all 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.

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

The numbers confirm this. According to data from Bank of America Global, only one to two percent of business transactions in the second and third quarters were in trouble. “Until sales of distressed assets increase significantly, we expect asset pricing metrics to remain relatively idiosyncratic,” they said. This type of environment might reward investors with strong lender relationships and a demonstrated ability to turn distressed retail assets, but for the vast majority of companies looking to dive into distressed retail before until a vaccine arrives, it may be too late to make things happen.

It’s easy to watch a big swing in the market and think that being there with a mission and a willingness to get creative is all it takes to be successful. But it is not enough to see the trend. Unless investors can come to the table with a ton of cash in their pockets, as many of the larger REITs have recently done, things will likely come down to loans. Beyond 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 assets. Without confidence in the general retail outlook, lenders must 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 connections to make it work.

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