Retail properties are expected to have the most challenging road forward due to the acute effects that the coronavirus pandemic is having on the sector. Shelter-in-place orders, which began in mid-March in the San Francisco Bay Area, have been extended through the end of May, placing significant pressure on retail property incomes.
In the most recent March retail sales report from the U.S. Census Bureau, total retail sales retreated 8.7% across the United States, the worst monthly decline since the data became available in 1992. The hardest hit retail sector was clothing stores, which saw sales decline by 50%, according to the report. And furniture, bars and restaurants, and sporting goods all saw sales declines of over 20%.
Given the stress that retail property financials are undergoing, it is worth looking at leverage levels in some of the larger retail property sales in recent years compared to the levels seen prior to the Great Recession of 2008.
The loan-to-value analysis takes a broad, high-level look at the 40 largest transactions across the San Francisco, South Bay/San Jose and East Bay/Oakland metropolitan areas, where CoStar has data on loan amounts. Despite the broad view, it does give insight into the comparative lending trends for retail properties, and the relative risk for property loans compared to recent history.
Comparing the relative ratio of loan-to-value figures — the ratio of a property’s sales value to the amount the buyer financed on the deal — shows that there were significantly higher leverage levels undertaken in retail asset purchases during 2006-2007 compared to 2018-2019.
In 2006-2007 over 10% of the 40 largest retail transactions in which CoStar captured loan financing with LTV ratio’s over 80%, compared to 0 from 2018-2019. Properties with LTVs between 60% and 80% represented 45% of the sales in 2006-2007 compared to just 20% in 2018-2019. And while sales with LTVs lower than 60% accounted for 45% of retail sales from 2006-2007, 80% of the sales in 2018-2019 had LTVs 60% or below.
Clearly, retail investors and lenders have been far more conservative in recent years compared to the years leading into the Great Recession. And landlords appear to have more sustainable mortgage payments relative to their property’s net operating incomes.
This is to be expected, given changes in the financial industry stemming from the financial crisis and changes in consumer behavior as e-commerce has risen significantly in popularity. Retail properties will need all the help they can get to avoid a wave of distressed selling, which would further damage a sector already facing a number of major headwinds moving forward.