How the Brick & Mortar Meltdown works for Commercial Mortgage-Backed Securities after America’s largest mall landlord defaults on a mortgage and walks away from the mall.
The dust has settled and the numbers have emerged: A $200-million commercial real estate mortgage on an indoor mall of over 1 million square feet in a suburb of Kansas City, MO, generated a $149.7 million loss for commercial mortgage-backed securities investors, for a loss ratio of 74.9%, when the mall was sold in a foreclosure sale. On Thursday, Trepp, which provides analysis on CMBS, reported that it was “the largest loss ever incurred by a retail CMBS loan.”
The mall had been owned by Simon Properties Group (SPG), the largest mall landlord in America. It was not a shuttered zombie mall, but a live super-regional mall, the Independence Center, built in 1974, with 88 stores anchored by Sears, Macy’s, Dillard’s, and Dick’s Sporting Goods. The debacle shows how far the brick-and-mortar meltdown has eaten into the values of mall properties.
According to a special servicer commentary quoted by Trepp in August 2017, SPG defaulted on the mortgage in May 2017 when it came due because it was “unable to repay the loan at maturity due to the size of the loan compared to the net operating income that the property generates and the tenants inability to increase sales due to the economic challenges.”
Instead of paying off the mortgage, which was backed by 39% of the mall, SPG walked away from the entire mall in 2017 and washed its hands off it, knowing that the entire mall wasn’t worth anywhere near the $200 million required to pay off the mortgage. It then removed the name of the mall from its website. And it was up to CMBS investors to eat the loss.
Senior Managing Director of Trepp, Manus Clancy, told KSHB in February 2018 that Independence Mall had been valued at $250 million in 2007, when the mortgage was packaged into the CMBS. By May of 2017, the value had dropped to $136 million.
Compare that to the $63.3 million that the mall fetched at the foreclosure sale in February 2019, when it was acquired by International Growth Properties (IPG).
IPG will have to do some creative thinking about what to do with the mall. But whatever it will do with it, and however it may repurpose it, its cost base is a lot lower.
The mortgage had been packaged into CMBS (WBCMT 2007-C33) in August 2007 by Wachovia, just about moments before it all collapsed, including Wachovia. By the time the write-off occurred, the mortgage represented 52.4% of the CMBS’s remaining collateral, according to Trepp.
Last month, after the sale of Independence Center, Moody’s further downgraded three of the seven tranches of these CMBS, including the highest-rated tranche to Caa1.
As rationale for the downgrade, Moody’s cited “higher anticipated losses from the specially serviced loans… driven by the deterioration in performance of the Independence Mall Loan and the high expected loss severity from the reported sale of the asset.”
Moody’s said that the downgrade “reflects a base expected loss of 67.5% of the current pooled balance, compared to 56.2% at Moody’s last review. Moody’s base expected loss plus realized losses is now 14.0% of the original pooled balance, compared to 12.9% at the last review.”
In its monthly CMBS delinquency report, Trepp reported that the retail-sector delinquency rate rose 13 basis points in March to 4.9%. Over the past 12 months, this delinquency rate has been running between 4.7% and 6%. The report notes:
- For retail-sector CMBS issued after the Financial Crisis (“CMBS 2.0”), the delinquency rate rose 16 basis points to 0.92%.
- But for retail sector CMBS issued before the Financial Crisis (“CMBS 1.0”), such as our infamous WBCMT 2007-C33, the delinquency rate soared 249 basis points in March to 63.0%. This is where the descriptor “toxic” comes from.
In its Kansas City Retail Report for 2018, Lane4 Property Group said that the “setback” for Independence Center “is part of a larger trend” that had already “claimed such former major Kansas City shopping destinations as Metcalf South Mall, Metro North Mall, Mission Mall, Antioch Center, Bannister Mall, Indian Springs Mall and the Great Mall of the Great Plains.” And Independence Center is one of only “two remaining true indoor malls” in the Kansas City metro area.
Simon Properties Group CEO David Simon had a special word about how the brick-and-mortar meltdown is impacting his firm: “I prefer not to scare you at this point, okay,” he said during the earnings call. “But it’s something that we’ve been able to withstand.” Read… What the CEO of America’s Largest Mall REIT, Simon Property Group, Just Said about the Brick & Mortar Meltdown and How it’s Trying to Manage It
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This collapse has been on the cards for a while now. Wolf has written about it before.
The chickens have finally come home to roost.
It’s taken quite a while but the inevitable has now happened.
The chickens are roosting in the abandoned Boot Barn or Pacific Sunwear. They are still chickens but at least they are now fashionably dressed.
IPG likely still paid too much for this albatross.
Still not sure how Simon can wash its hands of this though. Was Simon simply the property manager as opposed to the owner?
How many more pre-GFC time bombs are still ticking out there?
Re “How many more pre-GFC time bombs are still ticking out there?”
Looks like this mall exemplifies the tail end of the GFC CMBS debacle. The pre-GFC share of retail CMBS is small (and aging out). The overall delinquency rate is stated in article at 4.9%, while the rate for post-GFC is 0.9%, and for pre-GFC is 63%. Assuming the overall rate is the weighted average from those underlying data, the pre-GFC outstanding is 6.4% of total retail CMBS.
Yes, Simon owned the mall, but similar to a homeowner “owning” their home, it’s the financing company that became the bagholder when the payments stopped coming. Simon is shedding their dead wood, and keeping their performing assets, while the bagholders get burned. Simon has been focusing on outlet malls and other projects. Rest assured, the Simon family will not be going to the poorhouse, but the REIT holders will be taught a lesson.
The question is, who are the bagholders, for this and other cmbs?
It is this fact which will determine whether a retail mall meltdown triggers a wider recession.
Many are Pension Funds.
Since most are not allowed to play in the equities markets, which are considered “too risky”, their search for yield has them pockets deep, in the residential and commercial real estate backed paper.
Another one of those ‘pesky’ fundamentals that will have far reaching consequences, as more and more people apply for their pensions.
What happens when Old Mother Hubbard, goes to the cupboard?
I suspected this. It means the pensions timebomb will go off with a louder bang when it detonates.
I have my pension funds in cash deposits.
I am not sure I understand but it sounds like SPG decided to voluntarily default on a montage on one property they own. But you don’t say that SPG declared bankruptcy. Can’t the mortgage holders go after SPG for the difference between what was recovered and the value of the mortgage? The banks have done that to homeowners who walked away from their mortgages on homes that were no longer worth the mortgage value. Or barring that, don’t they owe income tax on the income? The IRS also goes after homeowners who default for the difference as a “income”.
Something smells here.
This is a securitized commercial mortgage, your only recourse is to the estate in a BK (i.e. the property, unless the collateral manager of the CMBS violated the terms of the offering docs, then you can sue them as well).
Thank you Lou Mannheim. As a result of your comment I just went and read about CMBS loans being mostly non-recourse. I’m surprised anyone loaned them that kind of money on a mall in 2007 on non-recourse basis. Ah, well.
Yeah something smells, they took a mortgage far in excess of the properties value for what reason? What were they doing with the money and was defaulting just an easy way of firewalling some profits while converting those profits to losses to shareholders? I take out a mortgage on X for 2X dollars, and buy an equity stake in Y. I later sell Y, pocket the profit and default on on X by sticking the shareholders for the paper? Gee I have a problem with trust.
Old Engineer,
Each property has its own mortgage. These are non-recourse commercial mortgages. They’re different from residential mortgages. This one required a lump-sum payment at the end of the term, like an interest only loan. The mortgage is secured only by the property. If the owner (usually a subsidiary corporate entity holds the property) defaults on the mortgages, the lender gets the property and nothing else. That’s just part of the deal. There is no lawsuit involved and no bankruptcy.
not in calif they don’t…if they foreclose they forego deficiency judgements
Excellent Article!
“A $200-million commercial real estate mortgage on an indoor mall of over 1 million square feet in a suburb of Kansas City, MO, generated a $149.7 million loss for commercial mortgage-backed securities investors, for a loss ratio of 74.9%, when the mall was sold in a foreclosure sale.”
^ I was so stunned, I had to read this 3 times. I kept thinking I was reading it wrong.
Reading the Fed’s “concerns” about this issue was a feeling of “oh, we’re in for a correction.” Seeing reality in black-and-white is more like the feeling of the first drop on a roller coaster.
If I recall correctly, when they conducted the auction to settle Lehman Brothers’ CDS on their outstanding debt, the recovery rate was worse (18%)!
In the collapse of Lehman Brothers movie, still on youtube. There’s a scene where the BOA chairman reminds John Thain of Merrill that Merrill had to sell off CMBS for 22 cents on the dollar to clean up their balance sheet. The implication was that Merrill was lucky to get rid of it at any price.
There really is not much surprise here.
Look at the dates. The property was financed and appraised in 2007 at the height of the real estate bubble.
It was dumped in 2017, after online (read Amazon) decimated retail, and appraised at $130M.
Two years later, in 2019, the property was sold at foreclosure (fire-sale) for half of its appraised value.
Since it is an operating mall, the new owners are probably able to make their payments now.
What would be surprising is if one of the other Simon family members bought the property at the auction.
On second thought, even that would not surprise me.
“On second thought”, maybe that’s the back-up plan.
Seems like the investment firms betting other folks money, have the game heavily stacked in their favor. It the investments hit the “Fan”, as OutLookingIn stated above, Mother Hubbard’s cupboard becomes more bare, but for the finance guys, just another day at the office.
We’re going to see more of these soon. I wonder how many will be converted in mixed residential?
Why would you want to live in a decrepit mall?
Use ur imagination.
I’m guessing refurbed malls Will have The “decreipt” motif removed, if they are going to move units.
Maybe some will look like the Gaylord in Tennessee…
https://images.app.goo.gl/JkgLZJps9ZTeiCkd7
I think a small part would be residential but mainly warehousing will be the most likely utilization. Automation killed the businesses inside and can then repurpose the buildings for automated(online) sales. Not many jobs will be created in comparison to the losses but they could offer local living quarters to warehousing employees as a fulfillment center.
Follow the automation train or get ran over. Housing is no longer the front runner.
I think Wolf said somewhere that it is far too expensive to repurpose malls. That is why they are frequently left to rot or bulldozed. The homeless should be legally allowed to squat in those dinosaur churches to rapacious greed if said churches were effectively dumped by the banksters.
This is how capitalism is supposed to work. The value of Real Estate that is too expensive gets written down as it changes hands, till eventually someone acquires it cheaply enough that they can make a profit renting it out at low enough prices that it is attractive to business. Imagine one day if someone could pick up this whole mall for $100,000 what usefull things could be done. Could be profitably rented out for goat auctions, used car part stores, woodworkers, used book stores, skateboard parks, used wheelchair stores and scores of other things that are in Americas future.
The goat auction thing creeps me out, but the other businesses have serious potential. Throw in paintball, go kart racing and the worlds oldest profession and I’m pretty sure people will never want to leave!
Homeless addict rehab centers.
Mushroom farms…..minimum electricity for heat/light…….water access……just like the old Pennsylvania coal mines….grow millions of pounds of commercial mushrooms!
Most financial projects are seperate entities which operate as sepearate LLCs or special purpose entitities. The developer creates the entity to hold the mortgage. If the development does well, the developer does well. If the development folds, the development goes to the bank and the developer walks away with limited losses and minimal credit or reputation hits. Typically, the financial loss is small. If you structure it correctly, it could even be a loss before hand as it could be a captive REIT or a lower tax rate (argue to the tax authority that it should be valued as empty). Basically, heads I win and tails you lose.
Capitalism if it makes money. Socialism if it fails.
TTM, Simon Property Group had the highest Revenues and Operating Cash Flow in it’s 26 year history. It’s difficult to imagine that their best days are ahead of them.
I am watching and learning.
Just thinking about the idea of exponential growth and how the financial community never ever sees how the constant raising of rents affects those paying them.
The inevitable is and will happen. Denial isn’t a survival plan.
Time is not going to make this phenomenon vanish.
Math is the universal language.
Gravity: it’s the law.
Amputation of necrotic parts are vital for survival of the patient , the economy. We need much more of this in order to avoid the mother of all cures, economic death therapy. Good old fashioned Austrian School of Econmics mal-investment is an insidious affliction.
An insidious affliction indeed!
Human nature being what it is, those at the top of the house of cards will do everything and anything to remain in control.
Yet when everything is leveraged and that is called an asset and leveraged some more. All on the backs of a consumption based economic model where small business is squeezed out and real productive capacity is sold to pay the interest on the overly leveraged assets, it is just a matter of time before it all breaks down.
I wish it wasn’t so!
I guess then we’re doomed to see a lot more of these mal-investments in the months to come !
With so much securitization and financialization engineering, who needs a real economy, don’t look behind the curtain, just look at the stock market and “GDP”, all is well. Next I’m going to make my car pay its own loan .
Bro
You just nailed it.
Develop a way for your Tesla to be plugged in over night…and while it’s charging it can be mining for Bitcoin!
Someone write the code!!
I suggest using imaginary money to pay off your car.
DEATH OF RETAIL, eh?
I have been watching for the past few years. Simon run up to $230…it’s. still $187 today…how can that be? Never mind…just follow Don Wolanchuk…stocks are going to. the moon…the fall of communism in the late 1980s and the recognition of capitalism started the world wide boom of unparalleled dimensions…that boom is alive and well…and Wolanchuk. was the only one who saw it and called it way back then…we’re 23,000 DOW points of the 2009 March low and people are getting all bearish if the DOW opens down 170 pts. on a Monday morning
No one said anything about a stock in the article. This article had nothing to do with a stock. This was about a CMBS and the price of a mall. I think it would be helpful if you read the article before posting.
I think I know where this is. I used to drive east-west-east on I-70, and this sounds familiar. Not so much for the mall itself, but for the hotels, food places, and gas stations that always group together near such a mall. Pretty sure I’ve stayed the nite close to hear, and dang sure I’ve eaten and filled up the ol gas tank.
Considering their middle name is Growth, how bad can it be? Surely this is another fine example of a done decision, among many, and no less debatable.
‘I’m shocked Rick, investors losing money on an investment!’
A point many people seem to be missing is that this is not a failed, dead mall. It is outwardly thriving, still arguably the best place to shop in on the east side of KC. The fact that even a “successful” mall is dropping so much in value speaks volumes about the state of retail in America right now. No one is safe. There are “no” good investments in retail!
I would assume these defaults would ramp up as we get closer to a recession. Is this the 1st major one in the commercial real estate area?
And remember that malls sell thibgs at a price highter that you can find them on Amazon or Evay or maybe even your local store once you made the “fuel price+ time” calculations.
Like, you can waste time and fuel to drive to a far away mall or not waste duel and waste less time and buy local. And if it costs more to buy at the mall once yoy factor the fuel and how much you value the time you would waste… well…
Wolf, might be worth your time to look into the Miller Hill Mall (owned by Simon Group) in Hermantown, MN. They have been dealing with the closure of Sears and Younkers, as well as many smaller stores.
What makes it unique, is the lengths they are going to, to try and fill their square footage. Essentia Health (probably the Duluth area’s largest employer) is moving into the old Younker’s store. It might buy the mall some time, certainly creative, but reeks of desperation, and goes to show the struggles brick mortar stores are facing.
Did Amazon cause the “Death of Retail”, or is it because retail customers have regressed from “middle class” to “working poor”?
It would be interesting to see comparable numbers for Oak Park Mall, located in the middle of the Johnson County KS. “richy-rich” zip codes. The place is always packed as if it was still 2006.
Hmmm, sounds like that’s a bit of a chicken-egg thing. Because the death or retail means the loss of what will soon be thought of as ‘good jobs’. As people are forced into near-sweatshop labor conditions in call centers and warehouses or being the UPS gal who sprints to the door to make her metrics, then more of those former customers will be moving from ‘middle-class’ to ‘poor’. Especially after they get injured in these new modern jobs.
Perhaps it was a strategic withdrawal on Simon Properties Group (SPG)’s end. More than likely they have not paid any income tax in the last couple of decades because they kept expanding using funny money (bank loans). Now they will just write off the bad assets and keep the good ones ( more than likely these malls are sheltered under separate corporations.