The beleaguered retail sector of the commercial real estate market has enjoyed some quiet time away from the negative headlines recently as the office sector has taken its place at the whipping post. The recent liquidation of the Crossgates Mall in Albany, NY provides an opportunity to check in on the retail sector after it was the subject of the commercial mortgage-backed securities (CMBS) version of the “Big Short” during the pandemic.
Before we get into the recent liquidation a short history of Crossgates is in order. The mall came into this world on March 4, 1984, amidst strong opposition from residents, environmentalists, and at least one resignation by town officials after the Town Board approved the developer’s plans. Pyramid Management Group began purchasing the land on which it was to build Crossgates in the 1970s, but it wasn’t until 1978 that it revealed its plans to the public. Crossgates was Pyramid’s 7th mall and was completed during the nationwide boom in enclosed shopping center openings in the mid-1980s. Pyramid almost doubled the size of the mall from 975,00 square-feet to nearly 1.7 million square-feet in 1994 and attempted to double the footprint once again in 1998, by razing a nearby residential neighborhood but was rebuffed by the Guilderland Town Board.
It wasn’t until July 2005 that Crossgates came into financial markets via the JPMCC 2006-FL1 floating-rate CMBS deal. The $200 million loan was advanced against an appraised value of $484 million and underwritten net operating income (NOI) and occupancy of $36.3 million and 89% respectively. The loan was set to mature in June 2007, but Pyramid had five 1-year extension options which it fully utilized as it was not able to refinance the loan during the height of the Global Financial Crisis. Macy’s bought Filene’s basement during this period which put further pressure on the mall’s revenues as both Macy’s and Filene’s were tenants and Macy’s vacated their space after the acquisition. Despite this downward pressure on earnings the mall always sported a healthy debt-service coverage ratio since LIBOR was pegged near 0% during that period and the loan’s interest rate was based on LIBOR.
When the CMBS market began to re-open in the 2010-2012 period most of the deals brought to market had heavy concentrations of retail properties. While this may seem odd today given the pressure bricks-and-mortar retailers have been under, back then Amazon had only just crossed the $100bln market capitalization threshold and the inevitability of retail’s demise was not widely appreciated. In fact, retail was sought after as a port in the storm of the housing crisis from which we were only just beginning to emerge. It was during this time that Pyramid was able to secure a $300 million loan from the CMBS lending unit of Deutsche Bank. Deutsche and the new lending unit of Cantor Fitzgerald, CCRE, bought this loan to market in the first three deals of their new CR shelf in 2012. In each deal Crossgates was prominently featured in the top 10 loans. The deals fared well in the market even as the winds were changing in the market for retail properties.
It wasn’t until the CMBS bull market subsided in 2013 in the wake of the Taper Tantrum that the problems in retail started to be appreciated by the market. There were several cycles during this period which were triggered by exogenous events like the Chinese revaluation of their currency in 2015 and the oil market crash of ’15-’16 that led to changing lending conditions in the CRE market. As economic growth and inflation stayed stubbornly low, the Fed kept rates low which helped keep lending markets open but weak consumer spending and a shift to online purchases made lenders increasingly skeptical of retail properties and favored the office sector. A furious debate ensued in the marketplace between hedge funds who were shorting CMBS securities tied to enclosed malls like Crossgates, and money managers and insurance companies who were buying the debt as they search for yield in a ZIRP world. Lengthy “white papers” were shared in the market arguing both sides of the trade, but as the shorts carried a high cost of carry and took too long to pay off the hedge funds struggled to hold onto their trades. Their forced buying as they covered shorts kept spreads for retail properties artificially low, masking the deteriorating fundamentals. It wasn’t until COVID hit that the market decisively changed in the favor of the retail shorts and kicked of the current default cycle. The Crossgates Mall loan was a large exposure in the CMBX 6 index which was the instrument of choice for the shorts given its high exposure to enclosed, regional malls like Crossgates. In fact, many of Pyramid’s malls were targets of the CMBX shorts given their prominence in CMBX 6 and being in weaker suburban areas.
After securing a forbearance deal in the midst of the pandemic Pyramid was able to get NOI back up to the pre-COVID levels in 2021 but with sentiment souring towards enclosed malls in the wake of the pandemic and rapidly rising interest rates, Pyramid once again found itself in a position where the mall was performing well but the capital markets were not receptive to making a new loan which would enable them to refinance. With 2021 NOI just above the underwritten NOI from 2012 and the loan having paid down over $50 million giving it a debt yield of over 10%, Pyramid was apparently not ready to hand over the keys to the property but was also not able to pay off the loan. The servicer then proceeded to sell the loan at approximately 70 cents on the dollar to a partnership of Cannae Advisors and Morgan Stanley. The reported purchase price of $173.9 million represents a 15.2% cap rate on the last reported annualized NOI of $26.3 million for the six-months ended in June 2022.
Despite Pyramid’s troubles and controversy, they have been able to maintain NOI at stable levels for over a decade despite a pandemic and secular downturn in retail. As CRED iQ’s own Harry Blanchard recently pointed out mall properties are showing signs of resiliency and as Pyramid has shown, there is a path for sophisticated sponsors to prosper amidst the challenges in the market. COVID not only changed attitudes towards working from home, but it also changed attitudes for urban living with many people fleeing cities to the suburbs which has removed a major headwind for regional malls that was present prior to the pandemic. While Pyramid might not have the financial wherewithal to complete a discounted payoff, they have proven to be adept operators of mall properties and their apparent unwillingness to hand over the keys to their properties carries important information for investors. It is likely that the new owners of the Crossgates loan will seek to restructure the debt while keeping Pyramid as the owner operator, as it would be difficult to bring in a more experienced and proven operator and Pyramid is unlikely to walk away without a fight.
The Crossgates liquidation is just one of many troubled retail loans that are currently being worked out from the last default cycle. However, just like the market was already turning down amidst the prevailing bullish sentiment when Crossgates came to market, the market today may be emerging from its long winter just as the negative headlines from the last default cycle seem to never end.
About the Author
Joshua J. Myers, CFA
After a successful 20+ year investing career, Joshua Myers, CFA launched Cedars Hill Group to bring large market expertise to broader audiences. He primarily serves as an outsourced CIO/CFO for family offices, RIAs, and small-to-medium sized businesses. He started as an assistant trader at Susquehanna Investment Group during the Russian default and LTCM failure in 1998. Afterwards, he was Head of Fixed Income at Penn Mutual Life Insurance during the Global Financial Crisis of 2008-2009. He traded distressed CMBS securities in the aftermath of the GFC at Cantor Fitzgerald and most recently was Chairman of the Board for an oil production company during the COVID pandemic. He is a lifelong student of financial markets and writes about current events with a focus on the art of decision making and cognitive psychology.
About CRED iQ
CRED iQ is a commercial real estate data, analytics, and valuation platform providing actionable intelligence to CRE and capital markets investors. Subscribers use the platform to identify valuable leads for leasing, lending, refinancing, distressed debt, and acquisition opportunities.
The platform also offers a highly efficient valuation engine which can be leveraged across all property types and geographies. Our data platform is powered by over $2.0 trillion in transactions and data covering CRE, CMBS, CRE CLO, Single Asset Single Borrower (SASB), and all of GSE / Agency.