REQUIRED READING: There is no doubt that good information is needed for mortgage lenders and servicers that are dealing with an overload of distressed commercial real estate, including retail assets. In many of these cases, a broker opinion of value (BOV) is designed to provide a better understanding of the marketplace and the asset, and provide enough market knowledge to assess the property in its current condition.
However, there are varying degrees of what passes for a BOV these days. Often, the BOV received is formulaic in nature – a brief summary presented by brokers focused on quantity, not quality.
The fact is, a single-page-style BOV will not provide the level of street-level market knowledge necessary to develop a game plan for handling distressed retail assets. The quality of the BOV becomes even more important when lenders and servicers are evaluating retail properties, simply due to the complex nature of this real estate property type.
Retail is a business that is highly location-driven and completely tenant-driven. For example, consider two hypothetical properties located next door to each other. One is at Main and Main on the corner with a grocery store anchor. The other is just off the hard corner without an anchor.
These two centers will operate in two entirely different ways. The rent structures will be completely different, and the tenant dynamics will be different. Therefore, the value is different.
Another reason that retail properties are particularly complex is that retail leases can be uniquely structured. For instance, they can include exclusivity clauses that prohibit the landlord from leasing space in the center to a business that would directly compete with another tenant's business, or co-tenancy clauses that give a tenant the right to rent abatement or lease termination if certain stores close.
An additional issue unique to retail properties can be reciprocal easement agreements (REAs). Large shopping centers are often divided into separate parcels that are separately owned, and these REAs exist to coordinate operation of the center among the various owners. On a distressed asset, it is important to get an estoppel from the other parties to the REA to be sure that all REA obligations are satisfied.
Essential data points
Overall, when compared to other property types such as office and industrial, retail's specific structures and issues make it a more complex business with numerous options and variables.
For this reason, the BOV for a retail property must include enough data points verified through demographics, market information, tenant information, sale and lease rate comps, in order to get the best picture of that property.
Beyond these basic requirements, the BOV needs to include discussion of strategy. More specifically, it needs to answer the question "What is the sales strategy for this property in this marketplace?"
Too often, the data provided are simply a reflection of the past – similar to an appraisal. If the assessment provides the history of the property and trade area, it falls short. The information needed is whether the property will sell for that price, the strategy needed to execute the sale and an understanding of who is willing to pay that price.
This information comes from a real assessment of the buyer pool. Past performance tells little about buyer pool trends or the type of buyer that fits a property's profile.Â
A BOV should aid in examining buyer pool trends, and better yet, it should provide an understanding of the type of buyer who will buy the asset being evaluated. For instance, is the potential buyer institutional, private or a fund? Does the property buyer need specific expertise due to construction elements that need to be finished?
There can be a range of different buyer pools for the property. The objective is to gain a street-level evaluation that can actually be deployed. In other words, does the BOV explain the property's value, whether it can be sold and what the potential buyer looks like?
The analysis should also be done relative to availability of new or modified financing for the property, which can significantly affect valuation. To provide that complete level of detailed information takes a higher level of expertise and transactional knowledge, and more likely, retail specialization.
Strategies for special situations
Consider the information needed to assess the right strategy for a retail property with a vacant anchor tenant. In many cases, it may be a better decision to sell the property as-is, especially if there is a lack of tenants in the market.
More time may be spent trying to find a tenant and ending up with a lease rate that is less desirable than what could be gained from working with the right buyer profile for the property. The right buyer may seek a different rate, a different tenant and a unique strategy.
If you lease instead of sell, you remove the buyer opportunity and strategy, which ultimately could have driven a higher property price. Another strategy for that same vacant space, especially if there is tenant activity in the market, may be to cut the deal with the tenant or at least determine the interest level.
Another special execution opportunity for retail is the break-up strategy. For example, a break-up strategy that was deployed for a 218,540 square-foot portion of the Plaza at Puente Hills resulted in a total sale price of $50 million, maximizing the value of property – estimated at $43 million as a single asset – by 15%.
In this case, the sales team analyzed the site plan, size and management of the property, and broke it into eight pads and multi-tenant parcels. With the right break-up strategy, the anchor and pads can be sold to separate owners and still realize good cap rates.
There is a clear price differential between selling off the occupied fast-food, bank, and drug pads and the grocery-anchored space – and selling an entire shopping center that is one-fourth empty. With a break-up strategy, the pad sales and anchor sales help to pay the loan down.
The remaining loan is then used against the vacant shop space with the new loan-to-value greatly reduced because of the arbitrage amount used to pay the loan down. However, caution must be taken in dealing with the existing lease and use agreements in place with current tenants. There are many remedies that can be utilized to overcome these issues.
The creativity and complexity in deal structures for retail can be wide-ranging. In the end, the BOV specifically prepared for distressed retail assets needs to provide solid data, along with street-level strategy backed up by the experience and ability to execute that strategy. For real value in a BOV, look for a smart BOV that takes a full-circle approach to evaluating the property to determine the right next step.
Richard J. Walter is president of Faris Lee Investments, a retail-specialized investment sales team. He can be contacted at (949) 221-1800 or rwalter@farislee.com.
