The following is a guest column from Bob Harrington, vice president at Northmarq. The views expressed are the authors' own.

Retail remains a vital and dynamic commercial real estate asset class, demonstrating resilience in the post-COVID environment. While 2023 was marked by a sluggishness in transactions due to factors such as treasury volatility and rising expense costs, there's been a notable uptick in retail financing requests in the early months of 2024. However, this increase in activity has been primarily driven by "forced" refinances due to loan maturities rather than new acquisition financing. Elevated interest rates continue to hamper investment sales volume despite many lender categories offering financing for most retail property types.

Interest Rate Impact

Elevated interest rates created an atmosphere of caution among borrowers over the last several quarters. Current owners facing imminent loan maturities are often opting for shorter-term refinance options, betting on future rate declines. Meanwhile, many would-be buyers are on the sidelines, hopeful for a drop in rates sometime this year. A gap remains between buyer and seller expectations evidenced by a disconnect between property bid/ask prices, and the lack of property trades has impacted the 1031 exchange market. Despite these challenges, retail cap rates — often trending higher than other sectors such as multifamily and industrial – are creating opportunities for positive leverage.

Lenders Remain Active and Interested in Retail

Despite the reduction in overall levels of investment activity, retail interest is comparatively vibrant across geographical markets with strong population growth, thriving tourism, and solid economic drivers. Most lenders are willing to fund new retail development projects and purchases of existing properties, as well as refinance both single- and multi-tenant retail assets.

Lenders active in the retail sector range from life insurance companies to banks, credit unions, CMBS lenders, and even debt funds. Each lender group exhibits a preference for different retail subtypes, driven by a mix of yield prospects and perceived risk. For example, life insurance companies are traditionally more conservative but, in addition to banks and debt funds, have shown a willingness to increase their exposure to retail, particularly given the current hesitancy towards office properties. Here are some examples of property types specific lenders are exploring:

  • Single-tenant net lease: banks, credit unions, and some of the smaller life companies continue to actively lend in this sector
  • Unanchored strip centers: CMBS, life insurance companies, banks and credit unions see the value and performance in well-located unanchored strip centers
  • Anchored shopping centers & neighborhood centers: with a strong anchor in place, life insurance companies and many of the larger banks continue to offer the most aggressive spreads, while CMBS, life companies and banks are the most likely lenders to partner with for properties with lesser credit anchor tenants
  • Power centers: CMBS and banks are continuing to lend on this property type, although they are generally viewed with some caution as this subset of multi-tenant retail has been impacted by e-commerce

Of course, retail lending terms have changed to reflect the current economic landscape. By examining recent debt quotes, trends reveal a noticeable shift from the previous year. For instance, rates on the 10-year US Treasury – a benchmark for many loans – has increased, impacting the attractiveness and accessibility of financing. Even with some headwinds, the sector's overall performance has fueled a vibrant lending environment. While lenders are more closely scrutinizing metrics such as tenant rollover and sales performance, the strength in retail is its resiliency and adaptability in a changing economic landscape.

What Does the Future Hold?

Looking ahead to the latter half of 2024, expectations lean toward an escalation in lending activity, spurred by competitive interest rate spreads and potential market adjustments. A critical factor for this positive trajectory will be the alignment of sellers' expectations with buyers' capacity given the prevailing cost of capital. Even a slight drop in interest rates is expected to catalyze new transactions, while loan maturation should continue driving healthy refinancing activity. 

The coming months will likely see further evolution in lending practices as the market adjusts to a new normal, although strength in investment sales and financing activity could be contingent upon broader economic trends, political influences, and other factors that may challenge the retail sector's attractiveness.

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