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Investors Aim To Lead Malls Through ‘CMBS Purgatory’ To Retail Paradise

Mall investing in 2022 isn't necessarily the landscape of widespread distress many predicted when billions were raised in opportunistic funds in the hopes of buying assets out of foreclosure for pennies on the dollar.

The outlook for retail is more positive than it has been in years, but a large swath of the national mall inventory is still in financial stagnancy, with owners unable to make full payments or refinance maturing loans and their lenders still playing wait-and-see.  

“A lot have become distressed and remain kind of in what we call CMBS purgatory, which is defaulted but not seized yet. The foreclosure hasn’t finished,” Trepp Senior Managing Director Manus Clancy told Bisnow. “But these things have had really long tails, and they just kind of sit out there.”

Virgil leads Dante through Purgatory

As fundamentals like foot traffic — down just 0.3% at indoor malls last month compared to April 2019, according to — and sales recover to pre-pandemic levels, retailers and landlords alike have been better able to meet their obligations. Retail delinquency during the pandemic peaked at more than 10.5% but now rests at about 3.8%, according to Moody’s Analytics Senior Director of CMBS Research Darrell Wheeler. Trepp and Fitch Ratings reports from April indicate higher rates of 7.4% and 6.8%, respectively.

With values dropping and loans often secured at a relatively high loan-to-value ratio, the more than $40B of retail CMBS loans coming due over the next couple of years offered a compelling reason for mall owners to try to change the terms of their loans or exit altogether. 

Unibail-Rodamco-Westfield plans to sell off its $13.2B U.S. portfolio, but some of its dozens of malls are expected to be handed over to lenders.

"Westfield has already announced it is no longer supporting several assets, and cooperating with a friendly foreclosure process," Fitch Ratings wrote in a report.

URW isn’t alone among large owners that have given up on a portion of their mall holdings, which as an asset class lost a third of its value between 2017 and 2021. Simon Property Group, the largest U.S. mall owner, turned over the keys of nearly a dozen malls within a year of the pandemic's onset.

“[We] hope to make deals in some — if not, then they’ll no longer be part of our portfolio, and we wish that new owner the best of luck," Simon CEO David Simon said during a February 2021 earnings call.

But malls that have been handed to their lenders or reached a point where they might normally be seized by the lender aren't moving. Malls in CMBS purgatory are scattered across the U.S.

The $198.9M CMBS backed by Park Place Mall in Tucson, Arizona, matured in December, but the mall hasn't gone into foreclosure, according to Trepp, nor has Mall St. Matthews in Louisville, Kentucky, with its $186.7M CMBS debt having matured in June 2020. Likewise, White Marsh Mall in Baltimore, with a $190M CMBS note that matured in May 2021, hasn't reached the foreclosure process.  

One reason for the lack of movement may be that lenders are pretty well assured the malls they seize will sell at a loss. Buyers like Kohan Retail Investment Group have made a strategy out of buying failing malls at auction for a fraction of their outstanding debt. Kohan's acquisitions include the auction purchase of half of the Burnsville Center property in Burnsville, Minnesota, for $17M. More than $64M was owed on the property. 

“I’m not trying to be a liquidator,” Mike Kohan told The Real Deal earlier this year. “I’m trying to come in and try to revitalize this mall the best possible way. Sometimes it’s beyond fixing.”

But other investors won’t go near malls that have worked their way into the lender’s possession, which in the real estate debt space is called "going REO," which stands for real estate-owned.

“REO’s the hardest way to get an asset,” Steerpoint Capital Managing Partner ​​Bo Okoroji said. “Just fundamentally, the system is broken. Everybody’s incentivized by fees, so it doesn’t create an environment that’s conducive to transaction. And no one wants to take a haircut or a write-down on the notes, because they’re going to actually realize those losses.”

The Shops at Montebello, Steerpoint Capital's first acquisition.

The deep distress route may not be feasible for all investors, but retail's surprising resilience has made it an attractive target for different kinds of plays.

“Retail centers today are a lot more predictable, and retailers that were struggling pre-Covid or on the fence pre-Covid, they’ve either gone away or adapted fairly quickly, and the centers now are a lot stronger, the retail universe is a lot stronger,” Clarion Partners Managing Director and Head of Retail Asset Management Lauren Holden said. 

Amid that optimism, investors are in a favorable position to land debt financing. 

“There’s as much liquidity for good retail today as there’s been in six or seven years,” said JLL Capital Markets Senior Managing Director Chris Drew, who arranges lending for retail borrowers. 

Tailwinds have even reached the secondary debt market, but volatility may mean the window to capitalize is closing. 

“We’re advising our sell-side clients that if they’re on the fence about potentially selling an opportunity, we are still in what most in our profession, the loan sale space, are saying is pretty much the selling opportunity that’s a once-in-a-decade, once-in-a-generation-type marketplace,” JLL Capital Markets Vice President Kyle Kaminski said. 

“We’re potentially entering a period of potential volatility where that may not be the case for much longer — inflation, geopolitical issues, rising interest rates, etc. — where they may be losing the window to maximize the amount of recovery that they could potentially get.”

As retail investors try to navigate the uncertain mall landscape, Okoroji, a former executive with both Simon and URW, said he sees opportunity in picking up assets whose owners reached their limits amid the pandemic strife. His plan is to reduce the overall retail portion of a property and redevelop the reclaimed space for another use.

“The majority of transactions that you’re seeing are private market owners that are just to the ends, that are kind of fed up,” said Okoroji, whose company, with backing from Bridge Group Investments, paid $91.5M for a 750K SF Los Angeles-area mall in its inaugural transaction last month.

“They don’t want to put the capital that’s required to reposition these venues, and they got their asses handed to them in the pandemic with lease amendments and tenant defaults and outstanding [accounts receivable] balances, so they’re just giving up.”

Drew said a client of his in Chicago is working on a mall transformation, cutting down a portion of the property’s retail space to add new multifamily. But instead of leaving the remaining enclosed mall as is, he said the borrower plans to transform it into an open-air center.

It will likely take years for the mall CMBS purgatory to shake out of the system, but when it does, retail experts said it will result in a vastly reduced national inventory.

“There’s 1,300 malls in the country,” Okoroji said. “Three hundred of them are going to exist as they are today, in our opinion. About 300 are likely going to go away. And then in the middle, where we play, are assets that need to be repositioned."