Lenders Are Adapting Their Retail Underwriting

Orange County’s Credit Union has watched the retail market evolve in the last several years, and is adjusting its retail underwriting in response to the changes. Tenant mix and credit have become more important factors, and they are performing more due diligence on potential opportunities. Additionally, the lender has begun to diversify into more multifamily opportunities as a way to mitigate the risk of retail properties. We sat down with Art Armas, VP of business services at Orange County’s Credit Union, to talk about the changes in the retail space and how they are adapting in response.

GlobeSt.com: How have you seen retail assets change this cycle?

Art Armas: Retail assets have changed considerably this last cycle, especially with power retail centers. Tenants are shrinking store foot print size and vacant box spaces are being repurposed. Power centers that have survived have done an excellent job at mixing in more fast food and restaurants to the centers in order to create a full-service experience for the customer. In Orange County, this change hasn’t had a huge impact on retail properties. We’re seeing vacant retail space convert to fast food and experience-based restaurants or more service-based tenants.

GlobeSt.com: How have lending practices or the capital markets responded to retail property changes?

Armas: I can’t speak for how other lenders have changed their practices, but for Orange County’s Credit Union, we aren’t players in big power center financing, but instead we do more of local neighborhood retail centers, “out-pads” strips, and single tenant properties. The biggest change to our underwriting centers around performing extra due diligence on shadow anchor tenants and making sure we understand how it positively or negatively impacts the property we’re financing. In the past, if you had a shadow anchor tenant and it was a major retailer with a long lease, you were considered “good to go”.

GlobeSt.com: How do you think lending practices need to continue to adapt to these changes, and where is retail lending heading?

Armas: As a lender, we’ll need to continue to make sure there is a diverse mix of tenants, good credit strength amongst those tenants, and income streams coming from many tenants instead of just one or two. The need for service-based retail tenants will be in great demand and when underwritten well, should reduce the risk for many.

GlobeSt.com: You have been following this trend closely. What changes do you expect to come in the retail space over the next five years?

Armas: Over the next five years we should continue to see more big-box retail vacancy and a continued push towards online purchases. With more retail sales moving online, the need for warehouse space will thrive, especially in Orange County as Amazon and other retailers try to fulfill the “last mile” delivery problem.

GlobeSt.com: How have these changes impacted Orange County Credit Union’s business and lending strategy?

Armas: Since Orange County’s Credit Union doesn’t necessarily finance big-box retail properties or power centers, the impact will be small. Orange County’s Credit Union is already financing more multifamily to diversify the current core portfolio make up.