As asset-based lending continues to evolve, one thing remains abundantly clear: ABLs are no longer competing solely against their peers. All types of lenders – from hedge funds and business development companies to private equity players – have gotten into the debt business. As a result of this ever-changing dynamic, ABLs need to be both astute and aware of current trends in terms of the way they look at a substantial component of the collateral pool –- real estate.
ABL Advisor took the time to speak with Hilco Real Estate’s Navin Nagrani and Joel Schneider to gain insight into the overall conditions of today’s commercial real estate market as well as to shed light on the ways asset-based lenders should approach their assets in this class.
ABL Advisor: If you consider the U.S. commercial real estate market from a geographic standpoint, which regions are thriving and which are experiencing distress? As a follow up, which property types are faring well and which are faltering?
Joel Schneider: Let me begin by addressing both. From a geographic standpoint, there’s fairly good news in terms of industrial properties and that’s true for just about everywhere in the U.S. Most markets are very healthy and we’re seeing pricing levels that are either meeting or surpassing the previous peak in 2008 prior to the recession. Of course, there are some variations. We’re starting to see some softening in the oil patch in the southwestern U.S. stemming from repercussions from the low price of oil. On the other hand, we’re continuing to see very strong markets in and around all of the major transportation hubs and ports throughout the U.S.
Navin Nagrani: There are some dark clouds in this picture. As Joel mentioned, there is some definite softening the in the oil and gas industry and that is pretty obvious at this point. Real estate is generally tied to the health of the economy so we have to look at one with the other. But we are seeing a ripple effect on other property types in oil and gas markets. For example, if you look at the hospitality (hotels, lodging, etc.) in the oil patch, there’s a slowdown among business travelers. As a result, hotels are having a difficult time maintaining occupancy rates and restaurants in these markets aren’t turning their tables as frequently. These underlying economic ultimately lower the valuation of the underlying real estate.
Beyond oil and gas, there are some cracks in the retail sector amongst the big box retailers as well as others in traditional enclosed malls. If you look at some of the specialty apparel retailers whose public debt is trading at a discount, you can detect these signs of stress. These retailers are generally mall-based and national in scope.
ABL Advisor: News of distress in the retail sector has dominated the headlines for quite some time now. From your perspective as it relates to store closings and the like, have we seen the worst of it or is there more to come?
Schneider: As traffic patterns at malls decrease and these malls begin to lose some of their bigger tenants, it’s a bit of a death knell for some of these B&C-class malls. These malls typically don’t enjoy the premier locations in their respective metropolitan areas and they may never have the high-end tenancy and retailer mix that the best malls in those markets have. These B&C malls are under pressure and there’s a sea change going on. Many of these malls are going to be redeveloped or re-purposed either partially or completely. We are already seeing some atypical uses like entertainment type venues -- for example wall climbing. Some enclosed malls are being torn down or partially torn down and retro-fitted into open-air, lifestyle retail spaces with the rest of the property being used for other purposes.
ABL Advisor: How accommodating are landlords being with regard to lease negotiations and/or terminations in the current environment?
Nagrani: Typically when you are negotiating a lease with a landlord, you’re trying to understand what you can do from a leverage perspective. You either need a really big stick or a really big carrot and what I mean is you have to provide the landlord with a reason to negotiate … something that is sensible for the landlord as well as for the tenant.
If you take a healthy retailer, a landlord is motivated to keep that user in their space because that tenant draws traffic and helps with the overall economics of their real estate. If the landlord is seeking financing, it’s easier to obtain if Starbucks is a tenant rather than an unknown entity opening a coffee shop. On the other end of the spectrum with troubled retailers, we find that landlords are often open to negotiations as well. For example, we’re currently serving as real estate advisor to the largest restaurant chain in bankruptcy. In a situation such as this, the landlords typically don't want to be in a position of having to deal with a vacant restaurant. There’s going to be downtime while they hire a broker to find a new tenant; they’ll have to incentivize that broker by paying a commission and once they obtain a new tenant, the landlord will likely have to give the new some initial capital contribution -- tenant improvement dollars to rehab the space as part of signing the new lease. All of that is very expensive and time consuming.
The landlord has to figure out what they need to do to maximize the value of the real estate, period. That could mean keeping a healthy tenant happy or working with a struggling one. But it has to be balanced; you can’t go out there simply to arm wrestle with your landlord expecting some sort of concession. You have to have to have a solid rationale and thesis as to why you’re seeking to re-negotiate the current lease terms.
The smartest asset-based lenders that we work with take the time to be proactive when they have a retailer in their book of business that is struggling. They take the time to evaluate that retailer’s real estate portfolio to see where opportunities may exist within those leases before an event like a bankruptcy.
Continued on Page 2...