Depressed Values and Heavy Debt Lead to More Malls Trading

Soon after the nation’s largest retail REIT, Simon Property Group, returned Montgomery Mall in suburban Philadelphia to its creditors in late 2021, Kohan Retail Investment Group acquired 1.1 million square feet. for 55 million dollars.

Montgomery Mall is located on 105 acres in North Wales, Pennsylvania, and is anchored by Wegman’s, Macy’s, JCPenney and Dick’s Sporting Goods. The regional mall, which originally opened in 1977 and was last renovated in 2014, is leased 73 percent at the time of sale to well-known retailers, including H&M, Forever 21, American Eagle, Bath and Body Works, and Outback Steakhouse. , among others.

The Montgomery Mall has attracted interest from more than 100 investors and secured more than 15 bids, according to JLL senior managing director David Monahan. He and his team (including Jim Galbally, Chris Munley, Cameron Pittman, Colin Behr, and Akhil Patel) marketed the property on behalf of CMBS Trust.

“There is a perception that there is no interest in mall investors and that none of them have traded for the past five years, but that could not be further from the truth,” Monahan says. “It’s been a fairly active market for regional malls with about 30-40 malls trading annually.”

Creditors drive shopping mall deals

In 2021, investment in mall sales was $7.42 billion, close to a six-year high of $7.48 billion in 2016, according to JLL analysis of data from New York City-based Real Capital Analytics (RCA) its headquarters. Unsurprisingly, the lowest investment volume in shopping centers was recorded in 2020, at just over $4.5 billion.

The vast majority of regional malls that have traded hands over the past several years have been debt-indebted Class B and Class C malls, which carry either outstanding debt that cannot be refinanced due to a lender’s lack of interest or debt that has exceeded the value of the property.

“The lender world has certainly become more conservative in the mall space in general,” Monahan notes.

The most recent peak in regional mall acquisitions by institutional investors occurred around 2010. At that time, a number of private equity firms, including Cypress Equities, KKR and Starwood Capital Group, were acquiring regional malls for their opportunity funds. And they put 10-year debt on the property.

Experts estimate that between $30 billion and $40 billion of mall-related debt is due to be repaid over the next five years. At the same time, there is an imbalance in the market between current valuations and historical LTVs.

According to Monahan, many of the regional mall loans that originated 10 years ago had an LTV of 70 percent to 75 percent prior. Now, long-term vehicles are closer to 50 percent. Making the situation even more complicated, mall values ​​have fallen dramatically over the same period. While regional malls may have been trading at cap rates of 7.0 percent a decade ago, they are now trading in average double digits.

Many lenders prefer to extend the loan if the borrower wants to keep the mall, but if that borrower has no interest in continuing to own and operate the asset, the lender will have no choice but to move the property to market. According to Monahan, lender-driven deals, including short sales and receivership sales, made up more than 70 percent of regional mall deal volume in 2019.

“Lenders don’t really want to get these assets back because they understand what happens if and when they do,” Monahan says. “No one can run a regional mall as well as mall REITs, and it’s very difficult to operate them at that level.”

Monahan compares malls to “living, breathing” organisms that need constant reinvestment to stay healthy. Many owners who end up selling don’t want to make this continued investment because they don’t see any upside in the future.

Real estate investment trusts in the mall: sellers, not buyers

Most of the regional mall assets belonging to the lenders were formerly owned by publicly traded mall REITs or former mall REITs that were taken private. “Enterprise owners are still committed to the space, but not all of their assets are committed to the same level,” Monahan notes. “The Mall REITs will reinvest in assets that they see as better prospects for a better return on that investment.”

For example, the Washington Prime Group handed over Rushmore Mall in Rapid City, SD to creditors in 2018. It worked in receivership until Rockstep Capital purchased 823,816 square feet. A regional mall in late 2021. This 100-acre property was built out of a large four-state business district and was erected by JC Penney, At Home, Trader’s Market, and Planet Fitness.

Houston-based Rockstep, whose strategy is to acquire “quality real estate with attractive cash flow and future growth potential,” has rebranded the mall as Uptown Rapid. This acquisition marks the company’s second acquisition in South Dakota – it also owns Uptown Aberdeen in Aberdeen, SD.

Similarly, Brookfield Asset Management sold three Michigan regional malls totaling 1.3 million square feet in early 2021 to Kohan Retail Investment Group for $14 per sixth, according to real estate data firm CoStar. Over the past 12 months, the investment firm has negotiated “mortgage foreclosures” for several additional malls.

Three categories of mall buyers

As mall REITs and large institutional investors wash their hands of non-functioning malls or those that don’t fit into their strategic plan anymore, private investors have emerged as buyers of these assets.

These private investors can be divided into three main categories: opportunistic buyers of malls, operators of private value-added malls, and non-mall local developers. Over the past two years, opportunistic buyers of shopping malls accounted for 70 percent of the deal volume in this segment, while developers accounted for 25 percent of deals, and operators made up the rest.

“The hardest type of mall to trade today is the very stable kind because there’s no real upside,” Monahan says. “Capital looking to invest in this type of real estate today is not primary, it is an opportunity and an added value.”

Opportunistic mall buyers are looking for assets with stable cash flow. Using their own money, this class of buyers has amassed individual portfolios of 120 or more properties over the past several years. This group is ready to take over shopping centers in smaller markets that other groups of buyers avoid.

The goal of these opportunistic shopping mall buyers is to maintain your existing tenant base and cash flow for as long as possible without making any additional investment. Simply put, they will squeeze every last drop of juice from the lemon, and once the juice is all gone, they will toss out the remnants of the bitter pulp and rind and move on to the next lemon and put the juice on it.

Meanwhile, private mall operators typically invest with equity partners, whether they are individuals or institutions. They plan to improve the malls through a variety of strategies, including reimagining and redeveloping parts of the property to bring in new tenants or ramping up the property by separating excess parking spaces into cushion locations. These buyers are more selective with the markets and assets they seek, which makes them less active than other buyers today.

Distressed malls – those that are often vacant and have no hope of salvaging them – are attracting investment from local developers who have no interest or intention in the buildings themselves. These buyers are only interested in the land on which these malls are located, and once they take possession of the property, they demolish the malls and build something else, usually industrial or multi-family projects.

Lenders slowly warm up to shopping malls

Many mall buyers today are focused on eliminating the shattered property found in most malls, according to George Good, executive vice president at National Retail Group with real estate services firm CBRE. This fragmented ownership structure, where department stores own their space and another entity owns the remaining space, creates a very complex problem for buyers looking to redevelop or demolish mall properties.

“Fragmentary ownership means different entities and different motives,” says Judd. “This, and a lack of funding, have been the two biggest obstacles to the mall trade.”

However, Judd adds that lenders are slowly becoming more willing to offer debt to regional business centers across the quality spectrum. Although the CMBS market is still hesitant about the financing of Class B malls, strong sponsors can still access the channel market. Buyers looking to acquire Class C malls can take out bank debt, albeit with recourse, or pursue financing from higher coupon debt funds.

Looking ahead, Good expects several A-class malls to go on sale in 2022. “Property prices in malls are improving across the board, and talks about A malls are happening,” he says. “We are going to see some activity there, and I think everyone will be pleasantly surprised by the rates. Even in the area of ​​Mall B, the double-digit cap rates have gone down, and the better B people are back at the single-digit cap rates.”

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