Before COVID-19 upended the U.S. economy, the capital spigot for retail real estate was more or less open. Today, however, the flow of capital has slowed to a trickle amid heightened uncertainty surrounding the sector. “We’re in a transition period. What’s happened since mid-March is that most retail investment sales transactions above $10 million have come to a pause,” explained Melina Cordero, who leads CBRE’s retail capital markets business for the Americas. Transaction volume, she says, has declined because of uncertainty surrounding rent rolls and greater caution among lenders. “Lenders have really pulled back on retail right now and become very conservative in what they’ll lend on.”

Not surprisingly, smaller centers and triple-net properties leased to grocers and other essential retailers are garnering the most interest. “Properties leased to grocery and drug stores have long been popular with lenders and investors,” said Marcus & Millichap national director of retail Scott Holmes. “They’re seen as more stable and less risky than some of the other retail product types.”

Even so, banks that continue to lend on such properties have adopted stricter underwriting standards over the past few months, according to Joshua Simon, CEO of SimonCRE, which acquires and develops centers and triple-net-lease retail properties. Loan-to-value and loan-to-cost ratios, for instance, are now in the 75 to 80 percent range, down from 80 to 85 percent pre-COVID-19, according to Simon.

“We’re seeing banks raise their equity requirements by at least 5 percent on loan-to-cost and loan-to-value ratios. That’s assuming a project has the right credit tenants,” explains Simon. “For years, we all chased experiential tenants. Now, the focus is on essential tenants.”

Even as many lenders get stricter, there’s growing evidence that capital for retail real estate may flow more freely in the near future, thanks in part to the Federal Reserve’s unprecedented efforts to support the economy through this crisis. The commercial mortgage-backed securities loan market, for instance, is beginning to pick up after contracting sharply at the start of the crisis. In mid-June, the Fed pledged to keep buying about $120 billion a month worth of Treasuries and agency residential and commercial mortgage-backed securities to support the flow of credit to households and businesses. The Fed also has begun buying individual, investment-grade corporate bonds to support market liquidity and the availability of credit for large employers. 

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Interestingly, the CMBS market, which suffered large losses during the 2007-08 financial crisis, has played a relatively modest role in the commercial mortgage debt market in recent years, according to Real Capital Analytics. Banks issued more than 50 percent of the loans on retail, industrial and office properties in 2019, reported RCA. CMBS lenders issued just 21 percent of the loans on such properties last year, down from 64 percent in 2007. “During this downturn, the piece that has dried up dramatically has been the CMBS side,” said Holmes. “Local banks that have client relationships and know the [retail real estate] business have continued to lend; they’ve just pulled back on leverage amounts. But we’re starting to see CMBS lenders issue quotes again for retail and net lease, which is encouraging.” 

Private capital

One key difference between the early days of the 2007-08 financial crisis and the start of this downturn is the amount of private capital sitting on the sidelines. Last year, total private real estate fundraising exceeded $150 billion for the first time ever and, thanks to robust deal-making activity, the amount of dry powder on the sidelines decreased to $319 billion, according to data firm Preqin. That’s still a substantial amount by any measure.

If and when asset prices begin to decline, fund managers are expected to begin deploying that capital, which experts say should help shorten the current distress cycle and blunt price corrections.

“We expect to see an acceleration of what we were seeing before COVID-19, which is a lot more participation from private capital,” said Cordero, noting that funds, family offices and other sources of private capital made nearly 70 percent of retail real estate trades in 2019. Institutions, she notes, already had been reducing their exposure to retail real estate for years now. “Private players have a lot of capital that they’re waiting to deploy when they see the price dislocation they’re waiting for,” she added.

Where will capital go?

How are retail real estate owners and operators expected to deploy capital in the coming months and years? While many invested substantial amounts to redevelop existing properties during the last expansion, such activity is likely to remain muted in the near term, as is ground-up development.

Green Street Advisors senior analyst Vince Tibone says retail REITs are likely to hunker down and preserve capital over the next year or so. “In the next 12 to 18 months, there will be very few projects getting started,” said Tibone, who leads Green Street’s retail research team. “It’s wise to preserve capital and not commit to new development projects in such an uncertain environment.”

Longer term, he expects mall REITs to resume their focus on redeveloping properties and adding new uses. “We’re expecting a lot more department stores to close in the coming years, creating a need to redevelop a lot of dark anchor space,” he said.

Well-positioned heading into this crisis

Thanks to the record-long expansion that preceded the current downturn, many retail real estate firms have been able to leverage their financial strength and access to capital, including pre-approved lines of credit, to help tenants weather the storm, notes Holmes. “Many companies have been able to augment the Paycheck Protection Program by coming up with ways to lend money or help with temporary rent deferrals. They’ve been able to do so because they were in a strong position going into the downturn.”

In late 2019, many community shopping center REITs took advantage of a rebound in their share prices to issue equity to fund acquisitions and redevelopment projects and pay down debt, says Tibone. The timing proved fortuitous, as community center REITs are much better positioned than during the last downturn, he said. “We’re not expecting any of them to experience financial distress or have to issue equity at the wrong time.”

In fact, some REITs find themselves in a position to compete with other types of investors for opportunistic deals. Kimco Realty, for instance, is exploring the idea of sponsoring a separate investment vehicle for opportunities that arise from market disruptions affecting retailers. It intends to invest $50 million to $100 million in the vehicle upon the closing of its initial private-capital raise.

RELATED: The spigot has turned on for opportunistic retail real estate investments

Some are still building 

While development is likely to remain muted for the foreseeable future, some firms, particularly those focused on necessity retail, are soldiering on. SimonCRE, for instance, plans to develop 40 projects this year, mostly neighborhood and community centers leased to grocers and other purveyors of essential goods and services. The firm has shelved only a couple of its planned projects because of the downturn.

In a sign that some retailers already are looking past the current downturn, the company has seen a strong pickup in leasing activity for the four centers it’s building in Phoenix. “There was a lot of pent-up demand on those projects,” said Simon.