Is CMBS lending becoming mezzanine financing at low rates?

The real estate finance community, from media thought-leaders to industry innovators, has been vocally dismayed over continually aggressive underwriting tactics often utilized by today's lenders. One such example seems to be Macerich's recent $751 million acquisition financing of the Kings Plaza in Brooklyn from Vornado Realty Trust, its third latest N.Y.C. area acquisition. The previous two include Green Acres Mall in Nassau County (for $500 million) and the Shops at Atlas Park in Queens County (for $54 million), a configuration-challenged "lifestyle center" which according to the New York Daily News, sold for less than half of what the foreclosing lenders were hoping to receive. In February, Morningstar issued its pre-sale report of "GS Mortgage Securities Corp. Trust 2013-KING," the CMBS trust that has Kings Plaza as collateral. The property's $500 million loan amount equates to $573 per s/f and its interest rate which, on the date of loan origination was priced at approximately 180 basis points over the 10-year treasury, is 3.44% (and amortized over a 30-year schedule). The report lists the property as 1.2 million s/f and anchored by Macy's, Sears, and Lowe's Home Center. The collateral for the loan is just under 873,000 s/f, in addition to the ground under an adjacent Lowe's Home Center and some marina buildings. It is clear that the originating lender (Goldman Sachs) has very different views on the asset than Morningstar. This excerpt from the report encapsulates it perfectly: "Morningstar conducted an evaluation of the tenancy, market rent, and operating expenses and estimated a net cash flow of approximately $36.94 million which is 5.1% lower than that estimated by the issuer. Morningstar valued the property using the direct capitalization method; our final aggregate value of approximately $527.8 million was calculated using a 7% capitalization rate. The Morningstar value, which equates to approximately $605 per s/f, is 30.6% lower than the appraised value of $760 million. The Morningstar valuation resulted in a beginning weighted-average loan-to-value ratio of 94.5% and a weighted-average ending loan to value of 80.8%." Professionals who routinely work out distressed loans that were seemingly solid at the time of origination aren't likely to disregard Morningstar's valuation and assessment. Kings Plaza is a unique property: it caters to an underserved trade area and has weathered challenges over the years, the likes of which many other malls likely could not withstand. Here credit must be given not only to its trade area but to its previous owner Vornado as well. A vacant theater was replaced with a stunning Best Buy build out. The tired mall interior was replaced with inviting finishes and the mall exterior, long neglected, is now sprouting street level retail. However, as noted in the pre-sale report the job is far from complete. The parking garage, entranceways, and elevators still require refurbishment and more capital must be infused to continue the Vornado-initiated modernization. This modernization and revival trend must continue. While Macerich is a first class operator and the property has much going for it, it is still a complex asset recovering from an economic downturn and imminent competition in its trade area. Just three-and-a-half miles away, the Related Cos.-owned and developed Gateway Center is transforming from a power center into a super-regional shopping destination. This 630,000 s/f property - presently anchored by big boxes such as Home Depot, BJ's, Target, Marshall's, Best Buy, Bed Bath & Beyond, and Babies 'R Us - is about to expand with a phase two that appears to be substantially pre-leased. Upon completion the Gateway Center's sheer size (1.23 million s/f) and tenant additions JC Penney, TJ Maxx, Michael's, Raymour & Flanigan, and Shop-Rite will draw more of Kings Plaza's shoppers. This is not to imply that the properties can't thrive with their trade areas significantly overlapping - but Kings Plaza will be competing for shoppers like it's never had to before. As per the Morningstar report, this is yet another case of aggressive loan proceeds and terms. Lending has once again taken an aggressive turn - in this case as a result of lax underwriting, lack of common industry knowledge, and the need to "do deals." Free market beliefs aside, the outcome of Dodd-Frank becomes more intriguing by the day. Shlomo Chopp is a managing partner at Case Property Services, New York, N.Y.