A recent report by http://www.morningstar.com/ demonstrates that retail malls across the country continue declining in sales as the retail landscape permanently changes. Among the property types backing securitized commercial mortgages, retail is the second-most common after multifamily (very healthy), and in that retail category, some $48.60 billion in loans are backed by regional malls, from well-known behemoths such as the Mall of America to smaller counterparts in out-of-the-way markets.
As online shopping, the diminishing importance of department stores, and store closures all contribute to the changing retail landscape, commercial mortgage-backed securities loans backed by malls have suffered. Since 2010, liquidations amounting to $3.89 billion led to $2.88 billion in CMBS losses, a 74.0% loss severity. Even with these liquidations, another $3.81 billion, or 7.8% of the balance of loans backed by malls, are in special servicing. Furthermore, $2.82 billion in mall-backed CMBS loans are scheduled to mature through next year.
The underwriting of loans to regional malls is a complex subject with location, competition, and the terms of the underwriting being the most influential. Special servicers are companies that step in to handle the debt obligations for troubled or potentially problematic commercial loans. A mall’s loss of customers to nearby competitors and the poor perception from the departure of an anchor store can trigger a downward spiral in performance that in some cases has led to massive losses on loans.
Properties in secondary and tertiary markets, anchored by department-store chains that have shuttered locations, such as Macy’s, Sears, and JCPenney, are particularly susceptible to dramatic devaluation. The closure of an anchor tenant often triggers co-tenancy clauses that allow other mall tenants to exercise the right to terminate their leases or renegotiate the terms, typically with a period of lower rents, until the co-tenancy issue is resolved.
In its recent report Mall Monitor—Examining the State of U.S. Malls with Attention to Retail, Morningstar projects about $1.88 billion in losses on 53 specially serviced mall-backed loans with an unpaid principal balance of $3.40 billion. This suggests a 55.3% loss severity. Many of these properties are lesser quality Class B or C malls in markets lacking a sufficient customer base to support ongoing operations. Other loans are backed by properties underwritten at the peak of the market with high debt leverage and little to no amortization. Of these loans, Morningstar forecasts that three will incur losses of more than $100 million.
In general, loans that have been in special servicing for a longer period run the risk of higher loss severities. Loans with three or more years in special servicing are likely to incur a 22% higher expected loss severity compared with more recently transferred loans because some servicers, not foreseeing such a swift devaluation, may have a harder time disposing of poorly performing properties.
Morningstar's largest forecast loss is $146.6 million on the $240 million Westfield Centro Portfolio, which represents 43.3% of the balance of JPMCC 2006-LDP7. The collateral, five properties with about 2.4 million combined square feet in secondary and tertiary markets in five states, never achieved the issuer’s underwritten net cash flow, as the portfolio lost multiple anchors at four different properties. The struggling Midway Mall in suburban Cleveland, representing about one third of the allocated loan balance, has been the primary strain on the portfolio, as it was unable to keep up with nearby competing properties SouthPark Mall and Crocker Park.
Morningstar's next highest projected loss, $125.5 million, equating to a severity of 94.4%, is on the Galleria at Pittsburgh Mills. The $133.0 million mortgage, which is 10.9% of MSC 2007-HQ11, was transferred to the special servicer for the second time more than a year ago after Sears closed. The collateral, nearly 890,000 square feet of a 1.1-million-square-foot mall northeast of Pittsburgh, has seen net operating income tumble, as occupancy dropped to 60% as of April 2016 from 83% at year-end 2014. After the loan failed to pay off at maturity in 2012, the servicer extended the maturity date and lowered the interest rate. However, the loan missed its new April 2015 maturity date, prompting the servicer to initiate foreclosure proceedings.
For information about the declining situation with regional malls, see Morningstar's detailed report at Mall Monitor—Examining the State of U.S. Malls with Attention to Retail.
Please leave a comment if this article was helpful or if you have a question.