COX, CASTLE & NICHOLSON - RETAIL & COMMERCIAL DEVELOPMENT GROUP 2022 FORECAST

COX, CASTLE & NICHOLSON

RETAIL & COMMERCIAL DEVELOPMENT GROUP
            2022 FORECAST

LIVING WITH COVID: CAPITAL MARKETS FOR RETAIL IN
     2022 WILL CONTINUE TO BE RESURGENT (MUCH LIKE 2021)
     By: Gary Glick

2021 was a year in which businesses and the public moved from lockdowns to an understanding
that COVID-19 will likely continue in some form for the foreseeable future. As a result, the
public is beginning to learn to coexist with the virus, and the ability of the business community
to manage its effects has improved considerably. In part, this is due to the availability of highly
effective vaccines and the emergence of antibody and antiviral therapeutics. Nevertheless,
as more mutations like the Omicron variant appear in the U.S., business activity may continue
to be blindsided from time to time. However, most experts do not expect governmentally
imposed broad lockdowns again to stop the spread of COVID-19.

2021 was also a year in which a strong economic recovery began in the U.S., despite some
hiccups relating to inflation, higher oil prices, supply chain issues, a tight labor market and the
Delta and Omicron variants. The shopping center industry had a very robust year compared
to 2020 as interest rates remained close to zero, treasury yields remained at historic lows,
consumers (in many cases buoyed by funds received from the close to $6 trillion of stimulus
funds pumped into the economy by the Federal Government) ventured out to restaurants
and shopping centers, and consumers also continued to favor on-line purchases and home
deliveries. Retail sales (including e-commerce) recovered to pre-COVID levels in 2021.

Most real estate experts are maintaining a positive outlook for the economy and commercial
real estate into 2022, despite uncertainty over the potential impacts of the Omicron variant

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and other risks. As noted in the 2022 U.S. Real Estate Market Outlook (published by CBRE)
(“Real Estate Market Outlook”): “While the new variant will impact the timing of a large-scale
return to the office, fiscal and monetary policy remains highly supportive of economic growth.
There may be other bumps along the way, notably from the ripple effects of an economic
slowdown in China and rising oil prices, but the factors that held back growth in 2021—
labor shortages, supply disruptions, inflation and other COVID variants—will ease. Monetary
policy will tighten to keep longer-term inflation pressures in check, which may trigger some
short-run volatility in the stock market, but it will not be enough to dampen investor demand
for real estate.”

Investment activity in retail projects substantially increased in 2021 due to plentiful capital
flows and strong demand from investors. With equity capital targeting U.S. real estate near
all-time highs and low-cost financing readily available, capital likely will continue to support
investor demand for retail projects in 2022. Foreign capital is also likely to increase for the
acquisition of retail assets in 2022, as long as restrictions on international travel eventually
ease.

Although investors still favor industrial and multifamily projects, neighborhood shopping
centers and well-located and well-conceived regional malls and lifestyle centers will continue
to be attractive assets to investors, especially as cap rates for industrial and multifamily
projects continue to be significantly lower as compared to retail projects. Institutional
investors consider real estate returns on these types of retail projects attractive in relation to
alternatives when comparing the risk level.

Age demographics in the U.S. are also driving investment in commercial real estate. Numerous
individuals in the U.S. possess a significant amount of wealth, and wealth generally needs to
find a place for investment. Much has recently been invested in the stock market. However,
as the U.S population has aged, there has been a need for slightly lower-risk, lower-return
alternatives to reflect an older population’s investment appetites. Many of these investors are
transitioning monies into U.S. commercial property markets.

Also notable in 2021 was the growth in single-asset, single-borrower retail property transactions.
Many investors are still cautious about investing in shopping centers and prefer the security
of evaluating a single property and sponsor (such as creditworthy tenants like Starbucks,
McDonalds, In ‘N Out and Chick-fil-A).

As stated in the 2022 U.S. Real Estate Market Outlook, “Putting the pieces together, 2022 is
set for a record level of investment activity, fueled by ample liquidity and stable cap rates.
Improving economic conditions will support both asset value appreciation and NOI growth,
boosting returns. The largest risks to this outlook are from a COVID-19-caused disruption, an
unforeseen spike in interest rates or elevated inflation that proves more durable than currently
anticipated. At this point, these factors do not appear to be major threats to the outlook.”

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Perhaps even more surprising than the liquidity of capital during the pandemic has been the
limited number of shopping center defaults and lender foreclosures. Commercial lenders
learned in the global financial crisis that “pray and delay” and “extend and pretend” were
excellent strategies then, and even better strategies now. It also helped that investors and
lenders were more disciplined in this cycle, respecting market fundamentals, limiting leverage,
and (generally) not overbuilding.

For the most part, the debt markets are even more liquid than the equity side, with lenders
extremely eager to accommodate borrower needs. Mortgage originations soared during
2021, nearly reaching 2019’s record levels.

Though industry experts believe that underwriting standards remain at prudent levels, one
concern is inflation. If inflation causes interest rates to go up, a wealth transfer is going
to occur. Retail developers that are currently borrowing at low rates are going to be the
beneficiaries. The losers will be investors in mortgage-backed securities and CMBS and
investors buying into any kind of long-term fixed-rate deal.

Loan origination volumes should remain elevated through 2022 - building on the marked
increase in 2021 - as borrowers seek to lock in lower rates ahead of the Fed’s tightening of
monetary policy. 2021 saw a surge in activity from alternative lenders, particularly debt funds
making use of collateralized loan obligations (CLO). This shift reflects a growing risk appetite
from both borrowers seeking bridge loans and other transitional financing and investors who
are seeking higher yields, especially given current corporate and government bond spreads.
CLO and traditional commercial mortgage-backed securities (CMBS) issuance should remain
high in 2022 assuming the Federal Reserve reduces its asset purchases in a manner that
does not unsettle credit markets.

Life insurance companies and banks were also very active in 2021, finding good value in
lending on well-located stabilized retail projects. At the same time, private equity firms have
demonstrated interest in purchasing loan portfolios from life companies and banks, as their
investment parameters can be more aggressive than risk averse life companies and banks.

In search of higher yields and less competition, debt funds were very active in 2021, especially
in connection with construction lending. These debt funds are providing retail developers
with higher leverage than has typically been available from banks and life companies with
less restrictive underwriting standards relating to sponsorship, project business plans and
geographic location. As a result, such lenders have permitted a larger number of retail
developments to proceed than in prior years.

As the availability of capital and competition increases for fixed-rate, bridge and construction
loans, there has been a loosening of underwriting criteria by lenders. For fixed-rate loans,
that has resulted in an increase of interest-only loans in addition to lower debt yields. On
bridge and construction loans, some lenders are increasing leverage levels to 80 percent of

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cost, as compared to the 65 percent or 70 percent of cost levels generally offered in 2019.

Even though the Federal Reserve has indicated that it will increase the federal funds
borrowing rate in 2022 up to three times to the extent necessary to combat inflation, interest
rates for borrowing will still remain historically low, which should lead to the continuation of
loan originations for retail projects in 2022. As a result, despite some continued headwinds
in 2022, mostly from supply chain issues, inflation, and the continuation of the impacts of
COVID-19, the retail real estate industry should have no shortage of capital as it continues
the recovery that began in 2021.

                                  GARY A. GLICK, PARTNER
                                  Gary specializes in shopping center and commercial development and
                                  retail, office and industrial leasing, generally representing developers and
                                  property owners, as well as major retailers. Gary has also represented
                                  retail and commercial developers in the acquisition and disposition of both
                                  undeveloped land and commercial projects.

                                  Retail and Commercial Development, Commercial Leasing, REAs and
                                  Purchase and Sale Experience
                                  Gary has represented major shopping center developers in the negotiation
of leases with almost every national, regional and local retailer in the Western United States. As a result,
he has negotiated reciprocal easements agreements (REAs) and development agreements with nearly
every “big box” retailer in the United States (e.g., Target, Wal-Mart, Costco, Sam’s Club, Kohl’s, Home
Depot and Lowe’s). In addition, Gary’s practice involves the representation of clients in connection with
the acquisition of land for development and the acquisition and disposition of major shopping center and
commercial developments. He is skilled at the negotiation and drafting of every agreement necessary in
connection with the acquisition, development, leasing, and disposition of a shopping center or commercial
development. He has also represented major retailers in connection with virtually every facet of leasing or
purchasing land for retail operations. Gary has also represented office developers and major office tenants
in the negotiation of significant office leases.

Nationally Recognized In The Retail Industry
Gary is nationally recognized as one of the premier retail transactional attorneys by his clients and peers.
For many years, he has been named one of the country’s best attorneys by The Best Lawyers in America, as
well as one of the top real estate lawyers in Southern California by Super Lawyers. Gary is a frequent lecturer
on the subject of retail development, commercial leasing, REAs and purchase and sale agreements, and
has spoken at numerous seminars and conferences, including conferences sponsored by the International
Conference of Shopping Centers (ICSC) (the retail industry’s most prominent trade group) and the California
Continuing Education of the Bar. Gary is also frequently interviewed by the media on issues related to
retail and commercial development. In June 2013, ICSC honored Gary with the prestigious 2013 Trustees
Distinguished Service Award for his commitment to the retail industry.

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