By Tom Hoban Realty Markets
When the Everett Mall’s lender announced it was starting a foreclosure action against the owner in July, it made front-page news. TV news crews converged asking what was wrong in Everett.
The reality is, Everett Mall’s owners are facing nothing particularly unusual and most of us drive by dozens of commercial and retail properties going through the same thing. In fact, the U.S. commercial real estate market still has $1.3 trillion in loans like it coming due on commercial properties over the next few years.
Called loan-sizing in the boardrooms of banks, the borrower must pay down some of the principal amount of the loan when the value of the property he pledged as collateral drops. That usually forces the borrower to refinance the loan with another lender or extend the existing loan’s term after they pay down the loan to get comfortably under the current appraised value.
Everett Mall’s owner is in that very situation. But so are many other investors and borrowers around the nation. This is happening in Everett at the mall today because many loans are just now hitting the five-year due dates on loans issued in 2007, the peak of the market, and those are the ones seeing the most value adjustment. Everett Mall’s owners refinanced the mall about that time in order to make the improvements mall customers enjoy today. Based on the current value of the property, the current loan size of $98 million far exceeds the current appraised value.
It all sounds very simple, if painful. Unfortunately, few borrowers anticipated such a precipitous drop in values and didn’t reserve enough cash to pay down loan balances. Cash strapped, they try to work out some sort of arrangement with the lender if they can. Those who don’t often face foreclosure as the means by which the bank gets the deed and keys back in order to market the property and try to reduce their losses.
Understanding the cause and effect of how values dropped so much can tell us when and how they might recover. Commercial and retail properties saw rent rates decline in most parts of the country starting in 2009 as businesses began to lay off, shrink or go out of business, leaving vacancies and less revenue coming into the landlord’s pocket. Add up the rents post-recession and the same office or retail property simply produced less cash flow that would interest a potential buyer, thereby driving down value. It all catches up with the current owner when a loan due date hits, sometimes several years after the reduction in value has actually settled in.
Blake Stedman, a commercial realtor in Everett, explains it in practical terms.
“Once a loan hits its due date, that’s D-Day,” he said. “The value adjustment becomes real and real money has to pay down those loans unless the lender and borrower can work something out. It’s like eating a big bite of mashed potatoes. There’s simply no avoiding the reality that there’s pain involved and someone will have to swallow it.”
Stedman sees positive signs, though, even for properties like the Everett Mall.
“What changes things is strengthening of the businesses that pay rent,” he said. “As the building’s tenants see improvements in their revenues, they will be able to pay more rent, and eventually that will push values of the buildings they are in back up.”
Confidence is a factor as well. Watching how small business owners behave and the moves they make is more than an anecdotal element in forecasting where investment grade commercial and retail properties will go. Stedman is cautiously optimistic.
“A year ago, the mashed potatoes were halfway down our throats and all we saw on our plate was more mashed potatoes,” he said. “Today, it’s a plate with some fruits, vegetables and in some cases a nice slice of steak on it. That, to me, is a sign that there are deals out there, buyers can make moves, and stabilization of values is imminent.”
Tom Hoban is CEO of The Coast Group of companies in Everett. Contact him at 425-339-3638, firstname.lastname@example.org or www.coastsvn.com.