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COVER STORY, DECEMBER 2008
NAVIGATING THE RETAIL SECTOR
NYC retail experts speculate on what is ahead for the retail sector in our annual New York City Retail Roundtable.
Moderated by Jerry France and Randall Shearin. Edited by Stephanie Mayhew.
As developers, retailers and brokers grapple with the current economy, it is clear that even deals that used to be no brainers have become questionable. Northeast Real Estate Business invited several retail experts to discuss the current climate and much more at its annual New York City Retail Roundtable.
Held this year on October 14, 2008, at Greenberg Traurig’s office in Manhattan, New York City, attendees included: Damon Hemmerdinger of A&Co., Andrew Pittel of Andrew Pittel & Co., Daniel Biederman of Bryant Park Corp./34th Street Partnership, Andrew Fawer of CIBC Capital Markets, Aaron Fleishaker of Fairway, Marshall Felenstein of Felenstein Was & Associates, David Cohen of GE North America Lending, Gary Schwartzman of Grubb & Ellis, Patrick Breslin of Grubb & Ellis, Daniel Lisser of Johnson Capital, Matthew Harding of Levin Management Corp., Edward Jordan of Marcus & Millichap, Richard Brunelli of R.J. Brunelli & Co., Ariel Schuster of Robert K. Futterman & Associates, Franklin Zuckerbrot of Sholom Zuckerbrot Realty, Lynn DeMarco of Holliday, Fenoglio, Fowler, John Orrico of National Realty & Development Corp., Richard Hodos of CB Richard Ellis, Craig Estream of Black Rock, Virginia Pittarelli of Madison HGCD, and Warren Karp of Greenberg Traurig. Turn to page 26 to see what retail in the Northeast is really headed for.
NREB: Lynn [DeMarco], can you address the investment climate in the Northeast?
DeMarco: There is a staring contest between buyers and sellers, and on a secondary level, there is a disconnect between lenders and borrowers. Some of that has to do with underwriting risk profile and how deals are being structured. Recourse and reserve are things that people have been hearing about, and low loan to values are driving investors to stand back. However, this is really more of a global problem as opposed to something here in New York because Manhattan tends to function a little bit differently.
NREB: What differences do you see in Manhattan and in the Northeast versus elsewhere?
DeMarco: There has been activity in New Jersey, New York City and on Long Island. People are looking at quality of credit, tenancy, and quality of sponsorship from the lender’s perspective, as well as good locations and demographics. Good real estate will continue to trade, but there might not be 20 bidders, there will be five.
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Edward Jordan and Craig Estream
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Jordan: The good news is that for mid-market and smaller sized deals, there is more velocity than the deals that are running north of $100 million. In the mid-market, mostly individual investors as opposed to institutions are the ones that are doing deals. None the less, there has been a shift in buyers’ expectations, which is now driving the market for most individual investors. You take the prospect of capital appreciation over the short term out of the equation, which for the past few years has been the result of compressing cap rates, and all you are left with is the NOI, the income side of the equation. Going in, values need to meet year-one yield expectations for the first time in a long time. If you were to re-price most of the assets that had been listed in this market over the last couple of years to get a year-one 8 percent cash-on-cash on real numbers, you would be knocking 20 percent off the top of most of their list prices.
NREB: Are investors that are ready to buy sitting on the sidelines? And are those that are ready to sell waiting because they don’t know how to price their properties?
Jordan: There is no doubt that buyers perceive that time is on their side with regards to pricing. Buyers’ going into contract or closing right now feel that they are buying value that compensates for the remaining downside in pressure on rents and vacancies. Sellers’ sell for many reasons, but there is also the sense that being in an all-cash position 6 or 9 months from now may be a unique opportunity, and so, we are seeing that motivator driving seller activity right now.
Zuckerbrot: What about triple-net properties versus shopping centers?
Jordan: In Manhattan, the focus has been on commercial condominiums, net lease, and nationally, it has been on our single-tenant net lease practice. It is a capital solution for those that are selling. If banks are not lending, an owner can tap into the equity in their real estate whether it is a convenience store chain or a restaurant franchise or a chain of independently owned gas stations. You can recapitalize your business by sale/leaseback of the property. In some cases, investors are buying 20-year credit tenant leases at sub-7 cap depending on the quality of the tenants, which is a relative bright spot.
Zuckerbrot: Cap rates came closer together for a while, but are we going to see a widening?
Jordan: Net leased properties with good credit tenants should probably trade more aggressively on cap rates than a multi-tenanted center.
Breslin: In the last 3 weeks, landlords are not asking, they are demanding security deposits from a credit tenant. But, a tenant that has done 25 deals this year, just in that landlord’s market alone, is not going to tie up $25 to $30 million for security to help this landlord ease his pain a bit. It is an illusion because the landlord is not doing anything with the money; he just likes the idea that he has it.
Zuckerbrot: Could that be lender imposed?
Breslin: I don’t care who imposes it. I can understand if you have one or two stores in a center and the landlord needs some security, but I have one customer that has more than 3,000 stores and is a multi-billion dollar company and the landlord was adamant about it. And he is a big landlord too.
NREB: Matt [Harding], you manage several suburban properties. Are you seeing more vacancies or retail bankruptcies?
Harding: We have not seen that. We have about 80 shopping centers in New York, New Jersey and Pennsylvania, and we have not seen a real uptick in overnight vacancies. We will have to see what happens coming into the holiday season. We are working with some good quality tenants that we are trying to help out. New deals are still happening. It is slower than it has been, but there are still tenants out there looking for stores and trying to take advantage of this market. If it is a strong tenant, they are trying to lock in great rates for a long time.
NREB: When you say ‘helping out,’ what does that encompass?
Harding: It encompasses spreading out a CAM that comes in one big lump — spreading that out over time for tenants. But also keeping a tight leash on some tenants so they don’t get far behind. We take a very aggressive approach to keeping things tight.
NREB: Have you had a lot of tenants come to you for rent relief?
Harding: Some categories have come to us a little bit more than others. Some of the food users and so forth that may not just be tied to the economy, but they have their issues.
Zuckerbrot: We have taken the same approach — trying to keep on top of our tenants, understanding their business, as well as understanding who is really suffering and who is not suffering, but trying to ride along on the bandwagon. In good times and in bad times we deal with that. At times, we also try to spread a lump sum payment. In some cases, the local government will drive taxes up and the tax impact can be difficult for some tenants, especially on some of the smaller businesses. Even our franchise businesses are struggling with their lenders. You have to look at each situation.
NREB: What kind of tenants are you taking a closer look at? Local, regional or national tenants?
Zuckerbrot: Today, some of the landlords, who in the past may have chosen not bring a broker on, are now deciding that for some of their smaller inside vacancies that they need brokers to go out there and canvas the area for new franchise business that are doing well. Owners typically want to hire brokers, but they want you to work. They don’t want you to just hang a sign. So, we are circling back to a more traditional model a little bit and it is not easy.
NREB: You have a center and a game plan based on the kind of retailers you want. However, now, many retailers have fallen by the wayside and owners are left with more empty space. Are you now looking at retailers that you would not have normally put in a certain space?
Zuckerbrot: Today, some of our strong landlords, and even REITs, are willing to deal with the lower-tier tenants provided that they have business models that make sense for that space and they are economically viable. Many owners just want the cash flow.
NREB: Are landlords getting feedback from other retailers saying, ‘this is not what you said was going to be in the center when I leased space?’
Zuckerbrot: Actually that is a question they will probably be asking 12 months from now, especially in the boroughs with so much large-box development going on. A developer constructing a large project envisions filling 75 to 80 percent of it with larger tenants, however, now they have to re-evaluate that plan. I have not heard of any tenants that committed based on the initial game plan, but it is a possibility. I give a lot of credit to the landlords that are building right now because they are being adaptive. Landlords that initially planned to have only one or two units on a floor are now breaking the space up into smaller units. They are trying to go with the times and address the marketplace. And, owners are doing the right things with the rent up front. If they are making a 10-, 15- or 20-year deal, many owners are giving a little bit of a teaser rate up front to help on the short end because we all know that this is not going to be forever. And if a good company wants to open a store, yes times may be tough for a year or two, but to get position and good properties in the next 10, 15 or 20 years, it is still a great proposition for a lot of businesses that want to open in new properties.
Harding: You have to careful to focus on tenant mix. We are working on a center in which we have a junior anchor space that is coming up in another year or so, and there is a beauty school that wants to take 40,000 square feet. It is tempting, but that school will set a tone because the last tenant, to a certain degree, drives the types of tenants that are looking at the other space. In some instances, you have to keep in mind that this is not going to last forever and it is still important to focus on the long term.
Fleishaker: Years ago in property management, people said, ‘We are not property managers, we are asset managers.’ If you are an asset manager, are you managing your asset for today or are you managing your asset for the future? You don’t want to take your shopping center and put it in a downward spiral.
Breslin: The short-term relief that you can get, can really affect your property long-term if you go the wrong way with tenants.
Orrico: Those that are making short-term decisions are those that did not put enough cash away in the bank to take care of the bad times. You are going to see some of these early decisions and it is going to hurt some of them.
Breslin: Are you seeing those types of decisions from some of the new developers?
Orrico: Our company has been around for a long time, and we are never going to move away from our fundamentals. I don’t know of any new developers who want to jump into the business right now, plus, they can’t jump in unless they have a lot of strong partners. But, you are going to see pressure on those that are not capitalized, and they are going to make some silly decisions. What people have given away in co-tenancy restrictions over the past 5 years is now coming back to haunt them because of the value of their real estate and their ability to sell it.
NREB: Are you finding a legal side when you are structuring a deal for your client and this is coming into play?
Karp: Absolutely. The key is the long-term deal. The tenants that we represent are quality tenants, they have big names, they are national, big-boxes, etc. They are able to make the appeal today, close long-term deals and get real estate that they might have been fighting over 2 years ago. The ones that are smart are actually looking at this as an opportunity. On the landlord side, many are saying, ‘Just do the deal. As long as he is paying rent I don’t want to hear about condemnation. I want them in.’
Orrico: It is the long-term deal for those eight pads that make the rest of your center. We have considered things that I would not have considered in the past, but they add value to the center and they add value to the future. I will do deals today that I would not have even considered a few years ago, a year ago or maybe even 6 months ago, but that is just the market right now.
Hemmerdinger: Going back to what Frank [Zuckerbrot] said earlier, part of the challenge is to find the new tenants. There are national tenants that were at the top of the competition a year ago, but since then their sales have plummeted. We are going out to find growing retailers that are not in this market yet and bringing them in. At Atlas Park, we are finding that as the project matures we are actually moving more of the new nationals into the center. Most recently it was Mango, which is the kind of tenant that will allow some of the other A tenants to feel comfortable moving forward. I agree with what people are saying — looking in a wider and deeper way to make an A deal.
NREB: The tenant reps have been very quiet.
Pittarelli: Obviously the news has been pretty depressing. We are very fortunate to work with some strong names that have a solid and mature expansion program, so if we have to walk away from a transaction, other than a branding opportunity such as on Fifth Avenue, it is fine because we have six other buildings that are lined up to take us in. We are looking for TI (tenant improvement allowances) in areas that we would never even think about asking for before and we are getting it. Quite frankly, we have been asked by our clients to go back to the table to re-trade. It is sort of a wait and see climate with respect to the retail that is coming into the market. Clearly, landlords are as concerned as tenants are. We are approaching a holiday season that, right now, does not look like it is going to be very good. In January and February, we are going to see a lot of new spaces come on the market. Retailers that are currently holding on with white knuckles are either going to let go or be able to continue, but it is clear that everyone is holding on for the holidays. We are lucky because our clients have not put the brakes on their expansion plans, but they are reducing the number of stores and locations that they are looking at. Many that had been looking in the boroughs for expansion sites have scaled back. We are seeing 10 percent to 25 percent reductions in total store penetration and they are being much more selective in regards to the markets they are choosing. The due diligence that we have to do has increased because everybody wants a guarantee, which is impossible to do. The days of just doing a store for a brand and it not being as profitable are over and will be over for quite some time.
NREB: Is this in shopping centers or on street retail or both?
Pittarelli: For me, the bulk of it is in street retail and some of the lifestyle centers.
Felenstein: I see a lot of this in shopping centers as well. We work with a fairly significant number of retailers, but we are also doing a considerable amount of shopping centers. In the shopping center work in particular, we are watching things go to what I would not exactly say is a halt, but is about the closest thing to it. Almost every retailer is waiting to see what the holidays bring and then in January they will figure out exactly what they need to do. There is a psychology out there that has changed considerably in the last year. Previously, many retailers were driven by delivering a certain number of stores in order to meet management projections. But now, much of that is gone. The psychology that you see now is more of ‘let’s wait and see.’ There is no great urgency. We have clients that have 10 or 15 stores on the drawing boards for 2009, but I have heard over and over again that if they can’t deliver the 10 or 15, they will deal with as little as one or two stores. They want to make sure that they are going into the right places and demands for tenant allowances have greatly increased. They want to be absolutely certain. We have leases virtually on the verge of being signed and the board of directors decides to wait 3 months or even 6 months before they actually do it.
Pittarelli: Frank [Zuckerbrot] already touched on it. Even the very strong retailers today that were viewed as recession proof are taking this as an opportunity to restructure. Tenants are using this as an opportunity to create an even better transaction even though their sales have not suffered.
Fleishaker: The tight credit market has made it much more difficult to borrow, so every dollar of capital is going to be measured on what kind of return it provides. Companies have said they want a profitable store in 3 years, but CFOs don’t want to wait 3 years, they want a profitable store in 18 months. They don’t want to go 10 years with a weak store and they want the ability to get out. They want to conserve capital as much as possible and they want to see ROIs. Everyone is looking for bottom line earnings. If it is not going to generate earnings, there is no cache in opening up a bunch of C stores.
Orrico: Retailers and developers are looking to conserve cash. Tenants want more TI. Owners are saying, ‘We want more money.’ What is going to wind up happening, and I remember seeing it before in the early ‘90s, is that real estate is going to turn because there is not enough capital. Residential is ahead of us, but commercial is heading toward the perfect storm right now. There will be more vacancies, owners that can’t make their mortgage payments, and tenants demanding more, which could result in a collapse of the business. It is going to be very interesting because cash is going to control more real estate. We have been there before as an industry and we keep coming back.
Pittarelli: The developers never lost track. In the last 4 years, developers have been extremely strong.
Orrico: If Target wants to slug it out with me, they are going to beat me up because you need those kinds of tenants to make your project successful. We should make sure that the deal works for each of us, so that we are all successful. The retailers I deal with don’t hesitate to pick up the phone and ask me to help them out. If we have been good to one another throughout the years, I will say ok. Conversely, there are those deals where there is just blood all over the wall. There are those tenants and landlords that just want blood all of the time. They are going to have a difficult time throughout this process.
Cohen: Historically, the only deals GE would lend on are those with a TI package. So, it goes back to the basic fundamentals of who your tenants are, the location, and what kind of package are you looking for because all we are looking for is an increase in value. The problem today is that most of the value losses are driven by the cap rate adjustments. From a lender’s standpoint, it is about the value losses and what is happening in the macro economy picture. The macro economy picture is showing less disposable income, inflation, credit card problems, and a decrease in home prices. All of this combined points to negative retail sales growth. There is a certain type of product that is in favor — the grocery store. Everybody likes the grocery stores because less people are eating out. When you see a great shopping center bringing in a Stop & Shop, it is a good story because you have a big package that can create a greater giant that is going to prosper in this type of recession in which we are going into in 2009 and maybe 2010. The one thing that I am hearing here that is very appealing is the long-term strategy. As lenders, when that recovery is happening, we want to see rent growth and declining vacancies. Right now, the major issues for lenders are a lack of liquidity, volatility and having to price deals in today’s market. On the other side, as retail sales decline, how is that going to be handled for particular locations and tenant mixes and the retail market?
Brunelli: In some areas, the perfect storm that John [Orrico] mentioned a moment ago won’t occur. My focus is on Northern and Central New Jersey. We have had retail vacancies rates less than 4 percent in Northern New Jersey and less then 5 percent in Central New Jersey for years. Certain properties might be negatively affected by what is going on, and some landlords in Northern New Jersey and Central New Jersey may see their vacancy rates go from 2 percent to 5 percent. If you represent a tenant, however, that difference from 2 percent to 5 percent could mean that you have a whole new variety of choice to look at. We represent 25 tenants that want to be in great shopping centers, what we call power centers, that are well anchored, but the never have any vacancies. Now we are starting to see some small vacancies pop up. I don’t see that perfect storm in the area I work in every day.
Schuster: There is no doubt that tenants are going to go back and get better deals and there will be less competition for space. I also do a lot of landlord rep in New York City, and it is important to differentiate New York City from the rest of the country. We are talking to retailers and we are educating them. Every body is scared, but my angle is to tell people you are signing a 10- or 15-year marriage. The rents have come down a little bit, so now is the time to take advantage of that and do some business in New York City. Some of these malls are struggling and some lifestyle centers are not hitting their sales volume. A lot of high profile malls are just not getting built because of financing. Retailers still need to grow despite capital conservation. Retail by definition still needs to grow and this is the place to grow. The sales volume for New York has not been affected. We talk to nationals all the time. The chains on 34th Street and in Soho for example, are doing the highest volumes and the sales are growing. And it is not just the Europeans shopping; this is still the place to shop for everyone. We are talking to tenants who are skittish about opening their doors, but we are saying now is the time to take the plunge.
Pittel: When you are talking about Manhattan, the retail is a little bit more diverse. The landlords here have no noose around their neck. They have deep pockets, they have made a lot of money in the past few years and now they can still sit back and wait for the right tenant. However, just like in the past, this is a time when the locals can come in. Nationals may slow down a little bit and the landlord may want to take that deal. The locals become the regionals and the regionals are all of a sudden growing and are going to become the nationals and the cycle continues.
Hemmerdinger: That is happening in the malls as well.
Hodos: I agree largely with what Ariel [Schuster] has to say. Generally when you look at Manhattan you have to look at the submarkets. There are neighborhoods such as Third Avenue and the Upper East Side that I think will experience rent declines. Rents at $400 per square foot on Third Avenue cannot be sustained by the sales volumes that are achieved there. Look at Fifth Avenue and the Flatiron district — there are six or eight vacancies now that are all priced at about $400 per square foot, and they are not being filled. And maybe the real rent there, depending on the size of the space, is $160 to $250 per square foot. If you are looking at Broadway, Soho, Times Square, 34th Street, Fifth Avenue and certain sections of Madison Avenue, rents have not been declining. They may have plateaued and they may decline a little bit over time, but it is still a good opportunity for these retailers.
Pittarelli: Ultimately, there will be some softening even in those primary submarkets.
Cohen: You have to remember that many of those centers or parcels were financed at the high rents, so what happens when these rents can’t be paid? That is when we are going to see the increase in vacancies because once the debt service coverage falls, the landlord, depending on the deep pockets, will make a decision as to what his strategy is with that particular property.
NREB: Is this the time for the international retailers to pounce or are they staying away?
Pittarelli: No, they are not staying away, but they are being more cautious than they were a year ago. We have some international clients that are looking at opportunities on avenues that for 2 or 3 years we haven’t been able to get space in, and we are getting benefits such as higher TI as well.
Schwartzman: The diversity of Manhattan will increase. Specifically, you have a lot of tenants, especially in the higher end districts like Madison and Fifth, that are reshuffling and they are moving from perhaps a corner to a mid block to take advantage of what is happening. I think there is a benefit to the entire environment of Manhattan given these opportunities that will allow retailers to either reposition or get a better deal.
Hodos: There are retailers like Abercrombie & Fitch on Fifth Avenue that are hitting record sales volume. It is the same situation for H&M. Topshop, when it opens, will undoubtedly also be very successful. I represent a retailer on 34th Street that projected sales to be X plus 10 percent this year and X plus 20 percent next year. So far we have not seen an impact, but it may very well decline because of the economic problems around the world.
Breslin: In the outer boroughs, the driving force behind the retail is people. On Fulton Street and Fordham Road in the Bronx, you still have more people in the borough of Brooklyn than you have in most major cities around the world. There may be a little drop, but those retailers are the ones that have been there for 30 years and they are going to be there for another 30 years. It is just a matter of getting the balance between a landlord and a tenant.
Biederman: It has to do with the environment as opposed to the business environment. All of the incredibly hard work that all of us did — Giuliani, Bloomberg, BIDs and neighborhood groups — in the ‘80s, ‘90s and 2000s to bring down crime and turn around residential neighborhoods. Crime is really not an issue now at all. As a result, there are so many kids coming from college that want to live here and will work in other industries other than finance, meaning there will still be a demand for retail. Despite what is happening on Wall Street, people will still move to New York City. The suburbs are another phenomenon. Families from the suburbs are coming to New York City on the weekends, and I don’t think all of that is going to change during the economic crisis.
Lisser: To pick up on your point about young people. Before young people just wanted to be in Manhattan and now we are seeing them move to Brooklyn. Between the price points and the atmosphere of Brooklyn, and the amount of people moving there is going to drive more retail.
Fleishaker: You can’t ignore the success of Manhattan. There is real estate going for $400 to $500 per square foot and even $2,000 per square foot. But, those types of tenants are not being frequented by the 22-year-old from Iowa that is coming here to get a job in graphic design. These retailers are supported by the investment bankers who were making multi-million dollar bonuses, living in very expensive places, going to the Hamptons and driving Bentleys. And there are thousands and thousands of these people who have hit the end of the road and are out of work. In addition to that, there are a lot of back office people that are out of work. The mind set of the affluent New York consumer has changed dramatically. There is a lot of supply and not a lot of demand.
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Andrew Pittel, and Damon Hemmerdinger
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Hemmerdinger: Are you changing what you are putting on your shelves?
Fleishaker: We are not changing what we are putting on our shelves because in our business at Fairway, we are benefiting from the people that would rather come to my store and buy some beautiful food for $50 and invite a couple over and have dinner for four at home rather than go to a restaurant and spend $200. In the real world, there has been a tremendous economic hiccup. People who were living very high on the hog and have now taken a hit will get back on their feet because the world does operate in cycles. Some people think a recovery will take 5 years or even 10 years, but my personal belief is 2 years and we will see things come back to normal. In the short term, people are afraid.
NREB: Is there any impact on the Wall Street and Downtown area on the retail that was becoming a bigger buzz in the last few years? Is there less of an interest?
Pittel: Local retailers. Local delis made their money during lunch and now they are not making money during lunch. Most of them did not have dinner to begin with or they were just starting to get dinner because residential was just starting to fill up down there.
Hodos: Yes, restaurants are affected and some of the higher end retail undoubtedly has to be affected. The uncertainty surrounding Merrill Lynch along with the delay of the World Trade Center and other projects certainly does not breed confidence. And when there is a lack of confidence, sales are just not there.
Pittarelli: That happens to be one of the areas where retailers have had to put the brakes on. It is very bad for us in New York because we all worked very hard to win back the Downtown area after 9/11. There were a lot of high-end retailers that went there and there was a new sense of energy. The residential market was building up and now that is on hold. There are also going to be a lot of office vacancies and once you have commercial vacancies, it hits the retail. There has been a break on retailers continuing their search for space there.
Hodos: The other thing is that the investment banking model has changed, so nobody is quite sure what to expect. The era of the $10 to $30 million bonuses is over and new compensation is going to be implemented on Wall Street as a result of the investment banks becoming commercial banks.
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Andrew Fawer and Daniel Lisser
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Fawer: The essential theme that keeps coming back in everyone’s comments is uncertainty, uncertainty, uncertainty. No one is doing anything. Everyone is waiting for the next person to figure out what they want to do, so there is a total lack of activity. When you have an environment of uncertainty and volatility, it is just a recipe for people to sit back and not do anything, which just exacerbates the problem. Previously, capital providers, especially on the debt side, drove much of the investment sales. The era of financial engineering is over at least for the foreseeable future. For the next 2 or 3 years, whether you are getting something on LIBOR plus 350 or 700, it doesn’t make a difference. What I am hearing today is: Pick where you want to be, but even the best spots are going to be down. More importantly, you have to have capital. We look to the borrowers that have deep relationships with their tenants. Those that don’t have deep relationships and did not squirrel away capital for a rainy day are going to suffer. And, yes, vacancies are going too inch up a little bit. Over the last few years, deals were not leveraged to 70 percent, they were leveraged to 80 or 90 percent; thus, you only need one small tenant to go away and things will start to crescendo. So, it is the perfect storm right now. You have to pick professional owners that are well capitalized and have a viable business plan. This is business 101.
Breslin: The relationships are a huge factor in this kind of market.
Fawer: It is going to be the haves and the have nots. The good areas are going to get through it as long as they have capital and relationships. I have heard, ‘time is on our side,’ from tenants. Yes, but time is also on the side of the buyers and the lenders. We have still been putting money out into the market, but we have also been saying since January that we know things are going to get worse, not better. The mindset today seems to be: Why should I put money out there because if I wait 3 months I can get an even a higher spread and a better deal?
Fleishaker: Aren’t you concerned about loans that were done with 6 cap rates and 95 percent financing? A 25,000-square-foot big-box that might file after Christmas is going to be so under water that they can’t survive. You are going to get back these properties at 70 percent the value of your loan.
Fawer: Yes, that is a very good question. There is about $80 to $100 billion worth of loans coming due through 2011, on the CMBS market anyway. If these rents were written at performing at $400 on Third Avenue, obviously we are going to be under water. There is clearly a lot of devaluation going on and there will be more defaults. However, there have actually been some very large recoveries on those default rates because there are banks in there to take them out. So, we have not really seen it yet, but it remains to be seen how that is going to affect capital markets in the long term in terms of default rates.
Zuckerbrot: Many of these loans were long loans. At least we weren’t on 3-, 4-, 5-year loans for the most part.
Lisser: It was 2004 when we started seeing all of these 5-year interest only loans.
Orrico: The question is: How are they going to value those leases today? Some of these leases are above market today, so are they going to start writing them down? If you have a $100 million loan and the value is now $80 million and you can only loan 65 to 75 percent loan value, you better be able to reach deep into your pocket to hold onto that asset. If you don’t believe there is a perfect storm coming in Northern New Jersey, it is not just about the occupancy levels. You have to be able to look at the whole picture. It is what is happening on the lending side, it is the liquidity in the marketplace and the valuation. You have to start looking at everything. The whole conversation started around net leases. What is the value of that net lease today and is it over valued in today’s market?
Fawer: I was surprised about the net lease comment before because I don’t know what is considered a great tenant today, number one, and, number two, is a 7 cap rate a good return in today’s market when you could decline maybe at 9, 10, 15 percent? The fact is there just isn’t enough capital in the system right now to take care of too much debt, even on good properties.
Orrico: Where is the small tenant going to get a bank loan to start and fund their business? This is the concern I have in my business right now. Sometimes we take a myopic view of our business, but we have to look at the broader scope of what is going on here. For example, Quizno’s operators aren’t expanding because they can’t get a loan and they can’t open the next two franchises that they have the market for. You are seeing more and more of this. Even Lord & Taylor and Hudson’s Bay. Some retailers are not going to make it through the holidays. And you have the next set of problems coming after the holidays because some will get through January, February and then there are some real tough decisions to make.
Cohen: For the short-term, the focus is on financing, the prudence of the underwriting, and the role of the CMBS. The bigger problem goes back to what we were saying before about operators. You have to remember when there is rental growth; the investor thinks that they are going to make a quick hit. They want a quick hit, they want to buy a building, get some short-term debt, pay a little more yield and then they figure that with the rent growth they are going to turn over this building. That is where I think the problem is going to come up simultaneously with the CMBS issue. There must be hundreds of millions of dollars of debt rolling that were on 6 to 18 month LIBOR, short-term bridge loans. It goes back to quality of sponsorship. I don’t think that is in the mindset of a quality operator. A quality operator thinks of their long-term strategy in terms of value creation, holding onto a center, tenant improvements and cash flow. The short term speculator or investor is where we are going to see problems.
Schwartzman: Great retailers and operators succeed in times like these because they are doing certain things to increase their margins, lower their costs, and change around their merchandising. These are lessons to be learned going forward in regards to who you should bring into your properties. The consumer and who is buying what.
Fleishaker: As a retailer, if you are going to be successful, your number one concern has to be your customer. You are constantly thinking about your customer. In my business, I get into heated debates with landlords and I always say to them, ‘The way you are talking is surprising. I would never talk to a customer that way and if you have space why are you not treating me like a customer? I am the one using your commodity.’ Successful landlords think about who the best tenants are. All of a sudden, it sounds like the world is waking up and you are not just looking at tenants as commodities, but instead they are customers. A transaction that takes place between a landlord and a tenant should be done in a way that helps the relationship in both directions. At the end of the day, if you are taking care of your customers, it is going to take care of your shopping center and that is something that has truly not been part of the equation.
Zuckerbrot: We talk about operators and investors and capital stack and what is your position in your property, but truth be told, there are just different types of property owners out there. More so now than 10, 15, 20 years ago. There are a lot of property owners that in the near future are going to be difficult on issues because their lenders are forcing them and they have to answer to the lender versus some of the older school operators that want to meet the needs of their lenders, but don’t have to listen to them given their basis in the property or given their lenders. Operators that aren’t under an enormous pressure are going to be able to do the right thing.
Hemmerdinger: Just like there are different types of landlords under different types of pressure, there are different types of tenants. These kinds of things all come back around, and as landlords and tenants know, whenever it does come back around, the tone is set from the first volleyball.
Fleishaker: It does go around. And for every story of a tenant going back and re-trading, there are stories of six drafts of leases going back and forth, and finding out that your competitor has just gone in and made a $4 per square foot more deal and the landlord took it.
Hemmerdinger: That is not going to change just because the economy has changed.
Zuckerbrot: You had a good point with the length of the leasing process. Landlords and representatives of landlords need to work on ensuring that their process goes as quickly as possible because as time goes on, there is a greater probability of a re-trade or a re-tenant. The process has gotten so long, especially in the last 12 to 18 months.
Fleishaker: One of the things that has made the leasing process so difficult is that the process has become impersonal. A draft goes out by email and 2 weeks later comes back in another email and another email. You can get 10 times more done with one face-to-face meeting.
Schuster: As an adviser to a landlord, you still need to hold on and not give into certain issues. As much as the broker wants to get the deal done, you have to protect the best interest of your landlord and in a 15-year deal you can’t rush it. You can’t advise your landlord to just get it done and sign the lease just because you are worried that the tenant may walk away. You have to look at it on a case-by-case basis and you still have to protect the landlord. It is important to realize that it might be an A tenant now, but it may not be down the road.
Pittarelli: Everyone agrees with that, but what we are saying is just to shorten the practice with more face-to-face meetings and talk through the issues rather than just sending emails back and forth with comments, so that it doesn’t take 3 months before they even get on the phone for the first time.
Felenstein: We just completed a deal with a very good tenant and a terrific landlord. And that deal was as dead as dead can be. We put the two senior people for the tenant and the landlord in a room with four or five people 2 weeks ago and the deal is now signed.
Karp: The deal making process has gotten worse in the last 10 years. There were a lot of strong relationships amongst the landlords and the tenants that you don’t see today. When I get a new deal, the first thing I do is call the attorney and establish some form of a relationship. I ask say what is important to their client and tell them what is important to my client, and we discuss how we can get them to that point. It is a question of counseling your client. I am hearing the landlord say, ‘Just get it done because I need that space leased.’ And I am hearing tenants say, ‘We are almost there, but we need a little bit more time.’
Fleishaker: As an experienced tenant, you get a first draft of the lease and you just know that there are 52 things that we are going to ask for that are retail 101. Please don’t make me ask for this. Give me a lease that is somewhat negotiated to start with. The process just has become impossible. We are going to stop asking for TI and ask for legal fees because it is going to be more expensive.
Hemmerdinger: Will the fact that tenants will have more sites to choose from change how they will make site selection decisions?
Breslin: If deals are being made strictly on economics and not on location then the process is going to get even worse.
Hemmerdinger: If it includes the landlord’s process and the tenant’s process in regards to deal making and conducting business versus just an offer to pay rent. All of these things should start to play a bigger role.
Pittel: It is about both sides being more creative. Thinking creatively on how to get the deal done successfully for both parties.
Pittarelli: People are themselves in negotiations in a good market or a bad market. Only what you ask for may change. For the most part, if they really want to get the deal done, both sides are willing to meet. It is inexperience that really causes the problem.
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