The 2 investment retail property types addressed in this financing guide include:              

• Single Tenant Retail (Credit and Local)
• Retail Multi-Tenant (Anchored /Unanchored)

A single tenant property is just like it sounds, a commercial property that is leased to 1 tenant. A single tenant property can be occupied by a local tenant (Kevin’s Gun Shop) or a national credit tenant (Walgreen’s store). A national credit tenant, also known as a brand name tenant, is defined as a tenant with an investment-grade rating based on size and financial strength from a major credit rating agency such as Moody's and Standard & Poor's. For CCB’s underwriting purposes, an acceptable rating to qualify as a credit tenant is: 

• Moody’s Baa3 or better or 
• S & P BBB or better 

A reputable website for a lender to visit to obtain detailed information on national credit tenants is Net Lease Advisor. The site provides tenant ratings, current cap rates, a brief description of the business, earnings information, and detail on the retailer’s typical lease structure. An example is detailed below:

Leases executed by national credit tenants typically have initial lease terms of 10 years or more, are most oftentimes corporately guaranteed, and are triple net. Loans secured by building’s occupied by credit tenants are desirable loans for the Bank to originate, however, oftentimes these loans are priced very aggressively and generate lower loan fee income for the Bank.

A multi-tenant property is a commercial property occupied by multiple tenants. The most common multi-tenant retail properties are retail strip centers, neighborhood shopping centers, and power centers. For the readers' purpose, we are going to address single tenant retail and multi-tenant from  a broad perspective.

When originating loans to businesses on leased commercial properties, a tenant may execute one of 4 types of leases. Below is a description of each type for review.

• Gross Lease - A gross lease is an agreement that requires the tenant to pay the property owner a flat rental fee in exchange for the exclusive use of the property. The fee includes all the costs associated with property ownership, including taxes, insurance, utilities, and building maintenance. A gross lease is oftentimes used when leasing office space or retail space.
• Modified Gross Lease - A modified gross lease is an agreement where the tenant pays base rent at the lease's inception, but the tenant takes on a proportional share of some of the other costs associated with the property, such as property taxes, insurance, utilities, and maintenance. This type of lease is oftentimes used in multi-tenant office and retail.
• Net Leases (3 types) - A net lease refers to a contractual agreement where a lessee pays a portion or all the taxes, insurance fees, and building maintenance costs. Oftentimes used in single and multi-tenant retail when national credit tenants occupy space within a commercial investment property.
  • Single (N) - In addition to rent and utilities, the tenant pays property taxes. All other expenses are paid by the landlord.
  • Double (NN) - In addition to rent and utilities, a NN lease requires the tenant to pay property taxes and insurance. The building maintenance is the responsibility of the landlord.
  • Triple (NNN) - in addition to rent and utilities, a NNN lease requires the tenant to pay all expenses associated with the property including property taxes, insurance, and building maintenance.
• Percentage Lease - A percentage lease is an agreement that requires the tenant to pay a base rent plus a percentage of any revenue (business) earned while doing business on the rental premises.

A fifth lease type that a lender may encounter when financing commercial real estate is a ground lease. The simplest way to define a ground lease ownership structure, is one party retains ownership of the ground (lessor) and an investor/developer owns all of the improvements built and situated on the site (lessee). When the ground lease expires, the lessor not only retains ownership of the land but also the improvements. For example: Publix is a large retailer (grocer) who oftentimes chooses to lease (ground) a site versus acquire fee simple ownership of the land. Ground leases will have longer terms (25 years plus). A lender should include the expense associated with the ground lease when calculating the properties debt coverage ratio. In addition, the remaining term of the ground lease should exceed the maturity date of the Bank’s loan.

• Anchored Tenant -A retail anchor is a strong investment grade national or regional brand name tenant that drives traffic to a retail center or area. The most common type of shopping center is the Neighborhood Shopping Center (NSC- typically 30,000 –150,000 sq. ft.). The anchor tenant in most cases is a national or regional grocer. The grocer will occupy roughly 50% or more of the building space and is the primary driver of most of the traffic to the center. When one thinks of a NSC, a Publix, Piggly Wiggly, or Safeway may come to mind. The other tenants occupying the remaining square footage in the center are smaller anchor or unanchored (local tenants) such as restaurants, nail salons, dry cleaners, game shops, and small clothing and gift shops.
  
  Anchored tenants are accustomed to signing longer term NNN leases or modified gross leases with initial terms of 7 years or greater. Although the tenant can be a publicly traded company or a private retailer, the leases are usually corporately guaranteed by the parent company. Conversely, unanchored tenants typically have lease terms of less than 7 years and the leases are guaranteed by the business owner.
  
  A name brand drug store can be the anchor tenant who drives most of the traffic to a center. Walgreens is a name brand, publicly traded company that is a good example of a drug store anchored center.
  
  From time to time a lender may hear the term shadow anchored center. Many smaller shopping centers or strip centers are shadow anchored which means that an anchor store is present, but it is not a part of the center. A good example of this would be a strip center built next to a Target store.
   
• Power Center - For a shopping center to be considered a power center at least 75% to 90% of the available retail space must be dedicated to anchor stores. Power centers range in size from 250,000 to 600,000 square feet and draw customers from a primary trade area of 5 to 10 miles. Power centers can be entirely made up of anchored space or include a few small retail unanchored storefronts. Power center anchors are typically home improvement stores, discount department stores, or warehouse clubs.

For CCB’s underwriting purposes, the Bank will consider a retail center to be anchored if 60% or more of the retail space is occupied by anchored tenants.

Proximity to residential subdivisions and major highways, heavily traveled with high traffic counts is critical to the success of a retail site. A lender should visit Costar to identify the traffic counts on roads and highways providing access to the site. With new construction, a borrower, prior to acquiring the land, will oftentimes obtain analytical data that scores the site based on the intended use as retail. Placer AI is a reputable company providing analytical data to developers, appraisers, retailers, financing sources and brokers who are trying to determine the trade potential of a site. CCB lenders should request to review this information if obtained by the client and reference the information in the credit memo to add support to the loan request. If the data is not available, and the project is new construction, a feasibility study is required.

Retail site and store frontage and easily readable signage from roads and highways supporting your site is paramount. The walkability to your site and access to public transportation will have an impact on property performance especially if the property is located within a central business district or a planned unit development.

A lender needs to evaluate the ease of getting to the site. This is very important especially in areas experiencing major growth. Highly congested areas can be detrimental to the success of a retail property. Traffic lights will help with the congestion and are preferred over curb cuts.

When evaluating the site, the lender is encouraged to review the permitting reports published by the county and city to determine if any new road construction has been permitted near the site. The Department of Transportation (DOT) and other public authorities are continuously upgrading the road systems. A major road expansion or detour can have a negative impact on a property’s performance for an extended period causing significant cash flow problems. Inversely, road expansions or changes to traffic patterns can enhance a property’s location. Examples of this may be the addition of a service road or a traffic light.

Verify legal access to the property through the following:

• Visual inspection
• Review of a survey
• Review of title work

The availability of public utilities to the site to include water, sewer, and electric.

A level site is more likely to provide for a higher amount of commercial density, lower costs related to stormwater management, and less drainage and flood concerns.

Evaluate the site for potential environmental constraints or contamination.

• Lender’s on-site inspection should look for potential wetlands (for example: standing water, low areas, types of tree growth), dead vegetation, unidentifiable debris or abandoned equipment/ autos/tractors/fuel tank (operable or inoperable), homes or buildings, endangered species (for example: gopher turtles), indications of past use related to farming, dry-cleaning, manufacturing, railroads and processing facilities, waste dump sites, defense or military operations, and mines. 
• Review the Environmental Risk Management Policy for documentation requirements. 

Drive around to identify any off-site properties within a 1-mile radius that could have the potential to contaminate or could have already contaminated the site you are considering financing. It is quite common for a property to become contaminated through the migration of contaminants from offsite properties. 

Obtaining a Phase I Site Assessment performed by a qualified engineer will identify any potential Recognizable Environmental Conditions (REC’s).

If the property is located within a designated special flood area, evaluate the impacts that a weather event could have on your property’s cash flow, borrower, and collateral. Identify ways the Bank can mitigate its credit risk and decision the loan accordingly.

Within the state of Florida, our business clients are challenged by the constant turnover in insurance providers and rising insurance costs. A lender needs to understand what impacts there may be to a property’s cash flow if CCB has to place forced-placed insurance on the loan.

Confirm that your site has the appropriate zoning and future land use designation for the intended use. In addition, review the local permitting reports to determine if any new retail sites have been permitted within your property’s defined market area which is typically a 3-mile radius or a 10 –15 minute drive.

A lender should understand who the retail project is targeting demographically and verify through CoStar that the submarket supports the borrower’s projections. Key demographic trends that a lender should review include:

• Median Household Income
• Number of households
• Population trends and forecasts (increasing or declining)
• Housing Prices and housing permits
• Age
• Educational level

Below, is an example of the information available in Costar when evaluating the demographics at a specific propert location.

A lender will want to evaluate the current and forecasted economic conditions that will have the greatest impact on the profitability of retailers. The key economic factors that are especially important include:

• The unemployment rate - Higher unemployment rates will reduce the amount of discretionary spending.
• Wages - When wages are rising consumers have more discretionary income.
• Prices - Higher inflation rates erode purchasing power deterring consumers from spending.
• Interest Rates - Higher interest rates make purchases more expensive, so the consumer postpones major purchases. 
• Consumer Confidence Index (CCI) - When consumers are optimistic, they will spend more money and stimulate the economy.

Deteriorating economic conditions could result in delayed absorption of leasable space, higher tenant turnover, payment delinquency, and lease defaults, which in turn, will impact the repayment of the bank’s loan negatively.

Identify the supply of retail, and your possible competitors, within a 3-mile trade area. A lender can obtain this information from CoStar or Loop Net, or simply perform a visual survey of the retail properties within the defined trade area. 

Below is information obtained through Costar that identifies all neighborhood shopping centers located within a 3-mile radius of the Bank’s Metropolitan Blvd office in Tallahassee. Costar drills down to identify what tenants occupy each center along with the lease terms. Costar also has available, a retail submarket report which provides the lender with the current trends within the retail sector.

If professionally managed, review the terms and conditions of the Management Agreement and integrate the related expenses in your cashflow projections. 

Research the management company, read client reviews online, and note the company’s experience in managing retail properties. 

The ability for the company to effectively manage the relationship with the tenants, rental rates, occupancy, and employ sound property maintenance practices are critical to the property sustaining cash flow performance during the life of the loan.

If new construction, obtain a feasibility study to:

• Identify the competition;
• Validate your borrower’s forecast for costs, rents, occupancy, operating expenses, and net operating income; and
• Determine the stabilization period.

If the project is stabilized, review CoStar and obtain a retail market report for the trade area or submarket to validate that the borrower’s rental, occupancy, and operating expenses are consistent with market conditions.

In reviewing the rent roll, the lender should confirm that none of the tenants are on month-to-month lease terms. If so, the space will be considered vacant when underwriting the net operating income (NOI).

An acceptable rent roll should include:

• The tenant’s name, 
• Unit or bay number, 
• Amount of leased space, 
• Date of tenancy, 
• Lease maturity date, 
• Renewal options, 
• Rental rate, and 
• The common area expense maintenance requirements (CAM). Oftentimes CAM, property tax, and insurance expenses are stated on a per sq. ft. basis when leasing retail space.

Lease rates will vary. Naturally, the lease rate for storage space or unconditioned space is going to be very different then the lease rate for store front space.  However, the lease rate for similar typed space should be consistent throughout the center assuming the lease maturity dates are similar.

A lender will want to pay special attention to the initial date of tenancy and the maturity date of the leases. The Bank minimizes its credit risk when its collateral has a stable tenant base with longer termed leases in place. If a large percentage of the leases have a short-term expiration, the cash flow position of the property in the near future could change considerably. A rent roll with staggered maturity dates is more desirable.

The tenant mix is very important when reviewing a rent roll. A property with a good tenant mix works well for the retailers because it can drive higher sales and popularity and it works well for property owners because it drives higher rental income and allows them to re-lease vacant space faster. The lender will want to address the following when evaluating tenant mix:

• Is there too much space occupied by one tenant type who sells the same merchandise?
• What is the impact of the tenant mix on parking? Consider the consumer peak time for your larger retailers.
• Do the tenants complement each other’s businesses. For example: Does a juice bar compliment a yoga studio or a bookstore a coffee shop?
• Is a drug store or liquor store a strong tenant, in a shopping center that houses a Publix with a pharmacy and liquor store?

 A lender should review each of the leases to confirm that there is no lease condition included that could negatively impact the rentability/marketability of the property. Also, confirm that the lease terms are consistent with what has been provided in the rent roll, paying particular attention to the lease rate(s), maturity dates, options to renew, and CAM requirements.

When financing shopping centers with anchor tenants, it is very common for the lease to include an exclusive use provision. An exclusive use provision essentially allows a tenant to use its premises for an intended specific use, for example, sell coffee, and restricts the landlord from leasing to other tenants who specialize in coffee sales. For a lender, you will want to make sure that the language isn’t so far reaching that it greatly diminishes the size of your tenant pool.

If financing a property older than 15 years, require a property inspection report especially if deferred maintenance items are noted by the lender while conducting a site visit.

Typically you do not find other income on an operating statement when analyzing retail properties unless the lease calls for percentage rents. When percentage rents are required per the lease, a lender will likely see a line item for base rent and a line item for percentage rent.

• On an existing property, the borrower’s annual financial statements and tax returns for the last 3 years give a lender the most insight into the operating expenses associated with a stabilized retail property. For new construction, the Bank relies on industry standards, the borrower’s proforma, the feasibility study, and the appraisal in estimating the operating expenses.
• The OER is the total operating expense divided by EGI. In the Quick Reference Guide for Non-Owner-Occupied Properties located in Help U, the reader will note that the typical operating expense ratio for retail properties is as follows:
  • Single tenant retail (local) - 35-40%
  • Single tenant retail (credit) - 3-6%
  • Multi-tenant (unanchored) - 28-38%
  • Multi-tenant (anchored) - 22-32%

A newer property will likely scale toward the lower end of the range once stabilized and an older property, the higher end.

Evaluating the Lease Hangout Risk (LHR) is critically important in underwriting single credit tenant occupied properties. The LHR is the relationship between the outstanding loan balance and the value of the property at lease expiration. To minimize its risk, the Bank calculates the LTV ratio based on a fee simple valuation versus leased fee.

The lender is required to perform a cash flow analysis prior to presenting a retail financing request to Preflight or Credit Administration for confirmation that the requested loan amount is supportable based on the Bank’s underwriting criteria. Templates for cash flow analysis are posted on HelpU in the Quick Reference Guide for Non-Owner-Occupied Properties. 

Below are detailed examples of a cash flow analysis on a single tenant retail property and a multi-tenant retail property.

For CCB underwriting purposes, the reimbursements (property taxes, insurance, and common area maintenance expenses) paid by the tenants to the property owner should be reflected on the revenue side in aggregate followed up by an itemization of the operating expenses as depicted above.

• Assess the site contractor’s experience in building similar property types of the same scale
• Obtain an active contractor’s license
• Determine if the contractor is bondable
• Obtain financial information if required as a condition of the loan approval
• Review contractor’s website and request a resume of projects
• Collect and review GC’s liability insurance policy

From time to time the lender or Credit Administration requires the borrower to fund an interest reserve at closing. An interest reserve account is a credit enhancement considering the construction project is not income producing while under construction or in lease up.

Interest costs during construction will be funded from the Bank controlled interest reserve account as the interest comes due. Interest Reserves are non-interest-bearing accounts. Underwriting conditions that typically trigger an interest reserve requirement are: 

• Low liquidity levels of the borrower,
• An extended timeline for project completion,
• Project size or type, or 
• Volatile conditions within the economy.