CRE Retail: Does This Tenant Make My Butt Look Fat?

Retail CRE Analysis

A couple years ago, I wanted to see what the “New JC Penney” looked like so we took a stroll through one at the local mall. While I was intrigued with the concept of doing away with sale prices, wider aisles and easier to read signs, the wife doubted if not having sales would work – “people love sales,” she said. However, 15 feet into the store the wife declared the chain will go bankrupt.  When I inquired how she came to such a conclusion so fast when many well-paid Wall Street analyst and fund managers thought otherwise, the answer was “The rack size display is huge!” Apparently, JC Penny thought grouping and displaying clothing items by size, instead of a single style, might help make the shopping experience easier.


This is yet another example of where men and woman differ. A man appreciates not having to dig through a clothing rack to find his size. Men also do not spend any time worrying about the size of their pants. In fact right now, the guy in front of me waiting to get on the airline has a pair of jeans with a 50-inch waist and a 28-inch inseam. He might as well have a sign that says “Yes, my butt will require several airplane seats.” The good part about this is that he doesn’t care, and I don’t care. Guys are like that.


Women, and we admit we are generalizing here, seem to feel differently about displaying their size.  It shouldn’t make a difference because most men have no numerical feel for what a size “8” or “6” is - clearly a woman came up with that sizing. For the record, male sizing is firmly rooted in English measure. For that matter, it is rare to meet a man that can explain what the heck a “Size 0” is. I am not sure what women feel about sizes, but judging from the wife’s reaction, she sure did not want to stand next to a carousel rack that displayed her size in the form of a small billboard.  As a result, she determined that any store that dumb, wasn’t likely to make it.


As usual, the wife was partially right. The retailer stopped the size grouping and display practice shortly after its introduction and yet still the store struggles.


When it comes to loans on retail properties, JC Penny, like several other retailers, are making property cash flows look too skinny in the future. What you want, of course are retailers that make your future cash flow look fat.


Having a major tenant in a shopping center to provide a concentration of cash flow is both good and bad. The good is obviously that it provides a stable source of lease revenue for the property, and the bad is that there is concentration risk. As we go into the holiday season, we have our eye on four retailers whose credit is currently deteriorating to the point of impacting the underlying loan’s probability of default. Lower cash flow from these tenants and the chance that they may not be able to honor their lease has increased the expected probability of default in more than 300 loans that we track. These retailers are: JC Penney, Sears, Radio Shack and Best Buy (in order of highest risk to lowest).


Each of these retailers faces declining revenue and margins, the combination of which could prove terminally fatal. At a minimum, we look for almost all of these retailers to close stores in 2014 and 2015, thereby directly impacting the cash flow of properties with active loans.


On average, each of these tenants composes about 5% of the revenue flow into a property. In approximately 68 loans, both Sears and JC Penny are in a retail center together making up almost 12% of the cash flow. Here, the risk is exacerbated as declining traffic, higher potential vacancy rates and the reputational stigma of having a major retailer “go dark,” puts the whole center at risk.

While in all probability your bank doesn’t have exposure to these loans, understanding your tenant mix in each of your investor-owned CRE properties is important.


One of the best ways to manage this risk is also one of the best ways to gather new customers. For every investor-owned CRE loan, get the OK from the owner as part of the loan documentation to assist the bank in marketing cash management and lending services. Providing a special promotion or small in-building “banking center” (maybe a kiosk?) potentially creates value to the property’s owner to attract tenants. Developing a concentration of clients in one spot, while it comes with risk, also comes with reward as customer visits, advertising and monitoring become easier.


The classic example is the medical office building. Given the competition, a new medical office building is priced dat about a 3.90% fixed rate for seven years. This is about a 12% risk-adjusted probability of default.  Not bad, but not great. Now, if there are 40 tenants and 200 employees and you can get 10% over time, that likely brings the related relationship profitability for that first loan, into the 50% plus range - Not bad business.


Package a checking, medical savings and loan promotion together; drop a couple remote deposit teller scanners and give the tenants some customized banking love and you have the makings of a solid promotion. Better yet, the more commercial tenants you bank, the better data and the better insight you have into the quality of the tenant.


All this adds up to putting extra care into the tenants of an investor-owned property so that you can gain customers and insight into property level cash flow. Hopefully, you can ensure the collateral’s cash flow is as big as a size 20 – if that is even a size. 

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