Shopping Center loan process explained

This article is a summary view of the underwriting process for a shopping center loan, and should be helpful as an introduction to the subject. If you have experience in it, you might find it too superficial.

What is a shopping center?

A shopping center is a property built and used to house several retail tenants. It is the present day representation of the old marketplace. By visiting a place with a diversity of stores, customers can benefit from the variety of offerings, and businesses are able to share parking and other amenities.

What types of shopping centers are there?

For the purposes of this article, we are going to concentrate on the two types that most small to medium sized investors look at (strip malls, and neighborhood centers). We are not going to talk about the Community, Regional or Super Regional shopping centers. So forget about anything over 150,000 Square Feet. Although the underwriting for large shopping centers is similar to what bank lenders do for smaller properties, once you start dealing with properties of those sizes and corresponding large loan amounts other options such as getting loans from pension funds or conduit financing become available. My employer (a commercial bank) has done loans for large shopping centers recently, but it has been due mostly because the other lending channels have been beat up due to the recession. I suspect that once those channels come back in force, they will once again beat us more times that we beat them on pricing.

Strip malls: These are the smallest version of a shopping center, and get their name for being built parallel to the street thereby providing maximum street frontage (visibility in retail is very important). They range from 5,000 Square Feet to 80,000 square feet in size. Strip malls serve a small residential area, and by definition have the type of tenants that provide services to those residents. Think Laundromat, convenience store, grocery store, hair salons, etc.

Neighborhood centers: The larger brother to the strip, it could very well be built parallel to the street, but the most common layout involves an open ended plaza with lots of parking in the middle called a “U shape” or an “L Shape” in order to take advantage of a corner location, and maximize visibility. They are usually anchored with a supermarket, and cater to a variety of tenants. It is not uncommon to see restaurants, bank branches, and gas stations as part of the neighborhood shopping center or as outparcels managed/owned independently. They range in size from 30,000 Sq. Ft. to 150,000 Sq. Ft.

So how is the bank going to look at a shopping center loan request?

Well, the bank is going to assess the different risks in order to come up with its decision. There is a well defined set of parameters that must be tested, and is pretty standard on all of the analysis that I have seen at different banks during my career.

Market Conditions

The first thing assessed by the lender is the market. I have seen low end analysis accomplish market assessments by getting demographic data from a one mile radius circle centered in the shopping center. But good market analysis involves digging into the trends within those demographics, as well as looking at the competitive landscape for the subject property. The chosen property needs to be measured against the market rental rates and vacancy rates of comparable properties that would be considered direct competitors for similar tenants. If the property is outperforming the immediate market, the risk of losing tenants to the competition offering better rates, and the downward pressure on performance cannot be dismissed. It needs to be mitigated. At the same time, should the subject property be underperforming the market, there is an argument to be made for future improvement as long as a reasonable roadmap to stabilization is laid out.

The lender has or should have access to many resources to double check market conditions. For example, my Department gets market reports from at least three different firms on a quarterly basis (CB Richard Ellis, Cushman Wakefield, and Marcus & Millichap). In addition to that, we have a CoStar subscription that allows us to research comparable sales and listings, and up to date market information. The bank lender uses those resources for underwriting and approval. Furthermore, the loan is usually committed subject to a third-party professional (the commercial real estate appraiser) confirming the underwriting assumptions.

Within the market analysis, the analyst would make some comments about the layout and location of the subject property mentioning the advantages and disadvantages of the property.  Visibility and signage is key, so are the traffic patterns that allow access to the property. Just as important is the parking situation with more parking being definitely better.

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