Jun 28

Analysis: Bringing retail back into the lending fold

Goldman Sachs’ newly originated loan on the retail component of 680 Madison Avenue in New York demonstrates the changing opportunity set for the sector.

The fortunes of the retail sector appear to be rising, with lenders including Goldman Sachs and Deutsche Bank originating substantial financings on high-quality properties.

Earlier this month, New York-based manager Goldman Sachs funded a $120 million loan on the retail component of New York’s 680 Madison Avenue while Deutsche Bank in late May originated a $120 million loan to refinance debt on the Miami Worldcenter retail mixed-use project, according to PERE Credit’s weekly lending barometer.

This activity comes against a backdrop of positive metrics for the sector, which demonstrated strong performance in the first quarter, according to Ryan Severino, chief economist at manager BGO.

The sector saw a vacancy rate of 4.1 percent in the first quarter, which Severino said is just above its historical low.

“Although asking rent growth has slowed a bit, down to 3.3 percent yearly, it remains strong by historical standards. The combination of low vacancy and healthy rent growth are quietly producing strong performance from the sector,” Severino said. “While this is not uniform across subtypes, it marks a dramatic reversal of fortune for the sector since the 2008-09 global financial crisis when many left the retail sector for dead.”

X Team Retail Advisors, a retail-focused advisory, is seeing the impact of these positive metrics on the ground via an increase in institutional demand for retail assets. It is also seeing more lenders seeking to finance activity in the sector, said Jason Baker, co-founder of Houston-based Baker Katz and an executive director of Phoenix-based X Team Retail Advisors.

With ongoing inflationary pressures and the elevated cost of borrowing capital, investors have been more disciplined with adding retail exposure to their portfolio, but institutional appetite is strong, added Baker.

“There’s certainly a growing appetite among some of the big institutional players for retail in a way that we haven’t seen in the past,” Baker said. “Our population is continuing to grow, but the amount of retail has really flattened out, or may even be on the decline compared to historical levels.”

This means the sector is not yet in balance. “But we’re becoming more balanced per capita and that is a good thing,” Baker added.

Evaluating retail transactions is complex, with Baker noting that investors and lenders need to balance metrics which include the resiliency of the consumer with the day-to-day risks of owning and lending on real estate.

“With increased financing, leasing and construction risks, as well as these rising rates that we’ve experienced, there seems to be a shift toward buying stabilized deals amongst both institutional and non-institutional owners,” Baker said.

He continued: “There are several things that have to be considered – we continue to see crazy inflationary pressures which makes developing ground-up retail and other product types [difficult],”

The retail allocation

Kim Hourihan, chief investment officer for New York-based CBRE Investment Management, said the firm believes the fundamentals are generally solid for the retail sector. This is an important factor in portfolio construction for the firm and for its clients. While there is an interest in and willingness to invest across sectors that include real estate, there are also larger concerns.

“Everyone wants to know where the bottom is. My response to that is you cannot perfectly time the bottom. We are long-term investors and are not day-trading buildings and I believe 2024 will prove to be an excellent vintage year for real estate,” she said.

While the fundamentals of the office sector continue to be a challenge, Hourihan believes there are parts of the sector that will perform well going forward.

“Office is not ideal, but the other three asset classes are seeing good fundamentals,” Hourihan said. “If I think about the GFC, the main asset classes — office, retail, multifamily and industrial — all had negatively challenged fundamentals. With retail, we haven’t seen retail rents grow in a very long time and starting to see that now.”

Data from Crexi supports this thesis, with a Q1 2024 report citing a situation in which store openings were significantly higher than closings in 2023 and leasing and rent growth were robust. The data provider tracked a nearly 30 percent increase in rent growth, the report stated.

“Landlords are optimistic, reassured by the retail sector’s survival and growth post-pandemic, limited new retail development and a favorable supply-demand balance,” the report said.


In the current credit environment, Baker said having strong lender relationships is more important than ever.

“If we were to build a project today, we would go to more of a traditional lending source. We have relationships that are in some cases, 15 and 20 years old and they still have an appetite to do deals,” Baker said. “It is hard to foster those kinds of new relationships.”

Part of that can be put down to limitations with what lenders have been willing to do, added Baker.

“That has a lot to do with how retailers view coming into a market and how many units they really need, given our population size,” he said. “But the cost of getting these deals done continues to be high. The equity required now on any deal is going to be higher than it’s been historically, at probably 35-40 percent equity. You used to be able to do a lot better than that. But there is capital available. It’s just more expensive than in the past.”

While at the Federal Reserve’s latest policy meeting on June 11 rates were left unchanged, with the central bank opting to keep its target rate at 5-5.5 percent, Baker said he is optimistic there will be some cuts down the road.

“The overwhelming expectation in between now and the election is that we would definitely see at least one, possibly two, but it sounds like that will probably happen some time in September. Not that investors are bracing for impact.”

by Anna-Marie Beal
PERE Credit
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