Are You “Kicking Can Down Road” or “Preparing for Rainy Day?”

By Dennis Kaiser

Four leaders with deep expertise in financing retail CRE shared keys to navigating the current triple-net-lease (NNN) environment at Connect Retail West’s panel entitled, “Opportunities in Net Lease: Capitalizing on Current Trends.”

No great retail concept or project can come to fruition without money to finance and sustain it. The search for capital partners in today’s CRE market is increasingly a challenging prospect, and more than ever requires experienced advisors to guide borrowers.

One of the reasons a sophisticated capital advisor is needed today, said BRC Advisors’ Sean O’Shea, are the artificially low interest rates. That has resulted in “an imaginary profit that’s existed for a short period of time,” he said. “Low interest rates have kept balls in the air past the peak of the cycle.” Further, cap rates have been compressed to the lowest level in seven or eight years, he noted.

SRS Real Estate Partners’ Patrick Luther noted that volumes are down, which likely means this market cycle has “run out of gas.” There are fewer bidding wars now, with typically one or two bidders, and it is more difficult to find investors, he said.

Additionally, retailers must figure out what to do with excess big box space, which currently totals “two to three times more than needed.” That’s on top of consumer shifts to e-commerce shopping options, as well as a host of other challenges facing the retail sector.

Further complications could be brewing in some sectors of the retail spectrum, according to Barry Slatt Mortgage’s Michael Kaplan. He said they are starting to “see more problems” with small, single-tenant retail product.

A challenge Marabella Commercial Finance’s Chris Marabella observes is lack of proper deal structure. For him, it is a matter of determining if “you want your cake now or later.” The problem is when a deal wasn’t amortized properly, and the borrower can’t pay off the balance when it comes due.

He noted, for NNN deals, “one size doesn’t fit all,” either. The best debt option, said Marabella, depends on the investment strategy (cash flow or later for heirs), as well as buyer profile, whether that be developer, investor, REIT or flipper. Regardless of the investment objective, he advises investors to “save cash flow for a rainy day,” it may be required to re-tenant a property or pay down a loan.

O’Shea said not paying down principal may be unwise, given the rate uncertainty when a loan comes due. “Most say it [rate] will be higher,” he said. Yet, he finds it “stunning” that people walk themselves into problems simply because they aren’t prepared to deal with future issues.”

Kaplan said, “If they [borrowers] don’t have reserves or the expertise, or if they can’t afford it, they should reconsider the asset they are looking at buying.” Some shrewd borrowers did fully amortize loans, he noted, which removes the balloon risk. But when borrowers “kick the can down the road” it can “reduce options,” including opening them up to personal risk, or an offer of a 25-year term versus a 30.

It takes a savvy advisor to understand the complexities and provide sage counsel. Still, O’Shea believes NNN, though challenging, is the safest route, given its ability to deliver a “predictable income stream.”

The panelists noted that, while there are challenges facing the NNN sector, the advantages it presents, if approached strategically, still offers benefits.

Primarily, NNN has emerged as a highly-efficient process for the asset class, which Luther said is akin to “trading bond paper.” As an investment class today, he views NNN “below bonds, but above equities in terms of yield.”

There are plenty of opportunities to pursue deals in markets across the country too, especially if “credit is equal,” Luther continued. He cited a restaurant deal completed in Green Valley, AZ as an example of how a NNN deal can work to achieve an “acceptable rate of return,” even in markets far from high-profile gateway cities. Green Valley is located roughly 30 minutes outside of Tucson.

Kaplan also noted there’s plenty of “capital available” from life companies, who increased capital allocations by 10%, as well as some banks. It is just a matter of “where to put money to work and make a return.”

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For comments, questions or concerns, please contact Dennis Kaiser