Retail Property Sellers Opt to Offer Financing to Get Deals Done (6/11)
Jun 11, 2009 7:41 PM, By Hortense Leon
In today's troubled financial climate, it isn't easy to sell shopping centers. But some property owners—because conventional financing is scarce—have gotten creative and begun to finance sales themselves.
For example in April, Jim Glabman, owner of an empty retail building in Costa Mesa, Calif., offered a $5.5 million, seven-year mortgage to prospective sellers in an attempt to move a 40,000-square-foot, two-story property. That's not the ideal scenario for Glabman. In good times, he would lease the property and up and collect the rental stream, according to Philip Voorhees, senior vice president at CB Richard Ellis in Costa Mesa, who is trying to broker a deal for Glabman. But finding tenants—especially for a fully empty center—is extremely difficult.
But by offering a mortgage, Glabman may be able to replace that income stream. If he sold the property for cash, he could get as much as $7.5 million in a best-case scenario and then earn 2.0 percent to 2.5 percent interest by investing the proceeds of the sale in government or corporate securities, says Voorhees. "By carrying paper, he will earn 6.5 percent," he says.
Glabman's situation is typical of how seller financing is functioning in today's market. In most cases, the deals are on properties selling for $10 million or less. However, there are exceptions. In recent months, 47 percent of the total transactions are being financed through assumed debt and another 7 percent through seller financing, according to New York-based real estate research firm Real Capital Analytics. (See a chart published in mid-May on how the sources of acquisitions financing have evolved.) At the market's peak, just 10 percent of transactions were financed through assumed debt and less than 1 percent through seller financing. However, seller-financing is not completely transparent because not all deals are recorded, says Dan Fasulo, managing director at Real Capital. Moreover, many sellers don't have enough equity in their properties to be in a position to offer a mortgage, says Voorhees. This is one reason why—despite its rise—its overall use is limited.
This rise in seller financing is coming at a time when investment sales volumes on retail real estate have virtually collapsed. For the first three months of 2009, sales transaction volume for retail properties worth $5 million or more amounted to $1.9 billion—off 75 percent compared to the $7.2 billion in the first quarter of 2008 and 90 percent off the $18.8 billion in the first quarter of 2007, according to Real Capital. In some markets, volume has fallen off even more than that. For example, in the Chicago area, just two retail properties for a combined $12.5 million traded in the first quarter.
That's a wrap
Seller-financing may be done in a number of ways. If a seller can't finance a buyer directly, for example, they may be able to do a "loan wrap" or loan assumption. In this kind of deal, the seller retains its mortgage on a property with a bank and acts as a funnel—taking payments from the seller and passing them along. Of course, a seller can't just do this on their own, says Tim Neal, owner of Neal Realty & Investments in Ft. Lauderdale, Fla. They must get their lender to sign onto this arrangement.
This is because when a sale occurs, a borrower technically defaults on their loan. "Normally, the bank won't allow a borrower to keep the same loan, once the property is transferred," says Rob McCracken, senior vice president, American National Bank, a community bank in Oakland Park, Fla. What is more common is for the bank to give the buyer a new loan and, if there isn't enough equity, the seller will give the buyer a second mortgage. However, in the current climate, banks are being more flexible.
Duane Stiller, president of Woolbright Development, a retail property owner and developer based in Boca Raton, Fla., has come across deals in which the borrower sells their property, with permission from their lender, and the new owner makes payments on the old loan. In these cases there are often certain stipulations. For example, the lender may ask the new or former owner to pay down a portion of the principal. The loan might also be altered with a new interest rate or additional fees. Stiller recently had a transaction like this approved by a lender, but ultimately decided not to go through with the deal because he was unsatisfied with the sales price for the property.
In another deal, however, Stiller is currently negotiating a seller-financed deal on an outparcel at one of Woolbright's shopping centers in North Miami Beach, Fla. The plan is for the buyer to borrow $1.5 million to $2 million to build an 8,000-square-foot restaurant on the one-acre property. Woolbright will then carry second mortgage worth between a $2 million and $3 million on the land at a 6 percent interest rate. Normally, the buyer would have paid cash for the land, says Stiller.
Although most seller financing is done for small deals, there are exceptions, says Sam Alison, senior vice president for Capital Markets at CB Richard Ellis in Los Angeles. Alison is marketing two properties, both of which could be sold using seller financing. The first has an asking price of $30 million and the other has an asking price of $19 million. In both cases, the sellers are willing to finance provide mortgages at 50 percent loan-to-value ratios, but they might offer more for the right buyers, he says.
The $30 million property is in Inglewood, Calif. near the Los Angeles International Airport. The approximately six-month old, 101,000-square-foot center, which is 100 percent leased, is anchored by Burlington Coat Factory. The center's owners, whose name Alison declined to reveal, are merchant builders. The sellers can carry the note, because they built the center for cash, he says.
The second property is a 107,000-square-foot retail center in the San Fernando Valley area of Los Angeles. The roughly 10-year-old property, anchored by El Super, a Mexican supermarket chain, is 97 percent leased, says Alison. The owner, a publicly traded U.S. REIT which he declined to name, can finance a sale, because it doesn't have a mortgage on the property.
The second deal is a bit unusual because of the involvement of a REIT, which typically are not involved in seller financing. "REITs typically buy and hold their properties for up to 20 years and, in the normal course of business, they sell a small percentage of their assets at a time to raise capital for other investments, especially when stock prices are low," Alison says. Furthermore, REITs that are highly leveraged may not have the flexibility to provide seller financing, says Alison. In many cases, lenders require that 100 percent of the proceeds from asset sales be used to pay down existing debt. That leaves no maneuvering room.
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