The retail commercial mortgage-backed securities (CMBS) market, long seen as a troubled sector due to the pandemic's far-reaching impacts, is now showing signs of stabilization. In July 2024, the amount of delinquent retail CMBS loans fell to its lowest point since delinquencies spiked in response to the COVID-19 shutdowns. This is an encouraging sign for investors, as about $6.3 billion of retail CMBS loans were listed as delinquent in July, representing 5.6% of the nearly $112 billion outstanding that month.
While this delinquency rate is still elevated from a historical perspective, it’s significantly lower than the pandemic-era peak of 15.6%. This sustained decline in retail CMBS loan delinquencies is a sharp contrast to the more troubled office, hospitality, and multifamily sectors. The retail market, bolstered by favorable operating conditions, resilient consumer demand, and low vacancy rates, has allowed many landlords to weather the storm. For investors looking to understand the future trajectory of the retail CMBS market, there are several important factors to consider.
The Driving Forces Behind Retail’s Recovery
The post-pandemic surge in consumer spending has played a key role in bolstering the retail market. While e-commerce saw a significant rise during the height of the pandemic, brick-and-mortar retail has proven to be more resilient than expected. As consumers returned to physical stores, particularly in sectors like grocery, entertainment, and services, landlords found themselves in a stronger operating environment. This shift has allowed many retail properties to improve their cash flow and stay current on their loan payments.
Another critical factor is the limited amount of new retail space coming to market. Low vacancy rates have given landlords more pricing power, increasing rents and boosting revenue. This dynamic has helped offset some of the pressures that retail properties, particularly malls and shopping centers, have faced over the past decade.
In July 2024, just 6.5%, or $410 million, of delinquent retail CMBS loans were less than 90 days late on payments. This means that most delinquencies were not the result of short-term cash flow issues but rather stemmed from longer-term structural challenges. The remaining $5.9 billion of delinquent loans have been overdue for over 90 days, highlighting the divide between properties that are gradually improving and those that are still in distress.
Refinancing Challenges and Maturity Defaults
Despite the overall improvement in the retail CMBS market, there remains a significant number of properties that are still in maturity default. In July, nearly 300 retail properties were backed by loans that were delinquent by more than 90 days. Of these, 214 were in maturity default, meaning their loans had reached the end of their term without being refinanced, while 75 had already been transferred to a receiver to manage value preservation or disposition.
Refinancing retail property debt has become a significant hurdle for many landlords in the current lending environment. The Federal Reserve's rate hikes over the past few years have made it much more expensive for property owners to secure new financing, particularly for those with older, underperforming properties like regional malls. For many of these landlords, the loss of key tenants or department store anchors has further complicated their ability to refinance, leaving them in a precarious financial position.
The Role of Regional and Super Regional Malls
Malls have been one of the hardest-hit sectors of the retail market. Regional and super-regional malls account for slightly more than 70% of the retail space tied to CMBS loans in maturity default. Many of these properties, which once relied heavily on department stores as anchor tenants, have struggled to adapt to changing consumer preferences and the rise of online shopping. The result has been high vacancy rates, declining foot traffic, and, in many cases, the inability to refinance debt as loans come due.
The failure to refinance has left many mall owners with limited options. Some have turned to distressed asset sales, while others have transferred their properties to receivers to preserve value. For investors, this presents both a risk and an opportunity. Distressed mall properties can offer attractive pricing, but they also come with significant challenges, including high capital expenditure needs and uncertain tenant demand.
Looking Ahead: Opportunities and Risks in 2025
As interest rates begin to decline and the retail operating environment remains strong, there is hope that more retail CMBS loans will be able to refinance their debt as we move into 2025. However, this window of opportunity may be too narrow for some borrowers, particularly those with large, underperforming malls. Refinancing options are likely to remain limited for these properties, and further distress may be inevitable.
For investors, the retail CMBS market represents a complex landscape of risks and rewards. While the decline in delinquencies is a positive sign, it’s important to remain cautious, particularly when it comes to assets with long-standing structural challenges. Properties in strong geographic locations with favorable demographic trends will continue to present the best opportunities for growth, while older, poorly located assets may struggle to recover.
In conclusion, the retail CMBS market is at a critical juncture. Investors should closely monitor interest rate movements, refinancing activity, and broader economic trends as they navigate the evolving landscape. Those who are able to identify the right opportunities will be well-positioned to capitalize on the market’s recovery in the coming years.
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