Tough Deal Financing
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   What are the most common problems in financing those tough urban retail specialty development deals? And how can those problems be turned into opportunities? We’ve been covering the mysteries and strategies of financing in every issue of ESP Magazine, digging into the finance strategy behind each project we feature, revealing new and unusual finance sources, and running down the gamut of public/private finance arrangements in our articles and columns.
   
    So we spoke with Jim Fried, senior vice president of Tri-Stone Companies in Boca Raton, Florida (561-750-9008). Fried works to get financing for owners and developers of commercial/industrial, mixed-use, and entertainment specialty retail projects. Tri-Stone’s executive team, under the leadership of CEO Michael Zucker, has handled more than $5 billion worth of transactions and financing around the country, so Jim Fried has knowledge of the latest financing techniques and key investment players for urban retail specialty projects nationwide.

    But Fried has a special interest (and lots of hands-on experience) in the Southeast markets. Fried is also an expert on Florida, the nation’s number one state for leisure destinations, where he arranged the sale of Miami’s Mayfair in The Grove and is currently working on the financing for a project that will contain the second flagship Baywatch Cafe concept in Miami’s famed South Beach. (See our interview with Baywatch Cafe team leader, Michael Berk, in the June 1999 issue of ESP.) So we thought Jim Fried was a good choice to talk with us about the challenges that retail and leisure attraction developers face in financing retail specialty projects, especially during this period of promise and resurgence in urban development.

The Primary Problem

    The most common problem facing an urban retail specialty project is finding a lender. That seems obvious, but here are the reasons why finding a lender is difficult, according to Fried’s appraisal:

    “Urban land is expensive. And it is often difficult and more expensive to assemble the necessary site for the proposed project. Secondly, urban projects often involve historic buildings. These create registration and other governmental issues that must be dealt with by the developer. And historical sites often drive up construction and refurbishing costs.”

So generally urban specialty projects are expensive to develop at the real property level. According to
Fried, this sets in a spiral of cost issues. “The cost of land tends to drive up all prices. Rents must be higher. Lenders are wary of pioneering projects, which is how most urban retail specialty proposals are viewed. These projects present higher risks. This means the developer needs to be successful quickly, or the project will be out of business.”

    Fried says that typically, because of all these pressures, “The urban retail developer needs percentage rents. But banks can’t finance behind that arrangement.” Government subsidies will help the financing picture presented to a lender, but Fried says that government cooperation is even more important to the success of most urban retail projects. “Usually, in these urban settings, if the government agencies are not your development partners, they tend to be your enemy.” More on government financing later.

Special Problems Financing The
Entertainment Attractions in
Specialty Retail Projects

    “Lack of strong credit is a problem for most entertainment companies,” Fried says. “Many themed concepts, particularly restaurants, have taken on enormous debt in order to expand.” Savvy lenders may be wary of some themed entertainment tenants. Fried says that it is becoming apparent in financing circles that there is a universal problem for themed entertainment attractions. “These entertainment tenants tend to be concept-driven,” Fried says. “But many themed attractions have proven to fade fast. Patrons don’t come back again. A shopper or diner may have been attracted to a themed offering at a major tourist destination, but that doesn’t mean success and repeat business in every urban setting. This is particularly true of themed restaurants. And the more a concept-driven tenant requires an investment in a special setting, the more a lender worries about an exit strategy for a site that has been built to suit that special concept.”

    Fried notes that movie cineplex tenants offer no financing relief for developers hoping to impress their investment banker: “Most theater chains, which are the mainstay entertainment anchor for most entertainment retail projects, are extremely weak financially.” He suggested we check out some theater chain credit ratings with Standard and Poors (212-208-1427; standardandpoors.com/ratings/search/index.htm). So we sampled United Artists Theatres Company. As of April 1998, its corporate credit rating was B+ and its outlook was negative. So we figured we’d check Loews Cineplex Entertainment Corporation. Backed by Sony, the news had to be better for Loews. But it wasn’t. Although rated “stable,” as of July 1998, a BB- was the best it could muster for both its bank loan rating and its corporate credit rating.

Some Financing Solutions

Government Financing
   
    So how can an urban retail specialty developer turn these problems around? According to Fried,

       The key here is to get the government working for you, if possible. For instance, see if your chosen site is in a federal “empowerment” zone. State governments can also be helpful. New York State has been very active in the retail development of Manhattan and the boroughs. But best of all, perhaps, is a public/private partnership with a municipality for downtown redevelopment.

Naming Rights and Corporate Sponsorship
   
    Fried points out the growing importance of naming rights as a source of development financing. So far we at ESP have seen the impact of these intellectual property rights in stadium projects. But Fried believes these rights will become more important for all types of projects. He also foresees the growing value of corporate sponsorship, a source of income that ESP has reported on in the last few months in stories about Simon Properties’ malls and Mackie’s World, the first mall for kids.

Corporate Partnerships
   
    Another strategy that Fried suggests, particularly for entertainment-driven projects, is a union by the developer with a major entertainment company that has the financial power to issue stock to help fund development. With cash raised, bank financing out of cash becomes possible.

Problems With Mixed-Use Projects
   
    We asked whether mixed-use projects were easier or harder to finance and the answer came fast and hard. “They are much more difficult to finance because many lenders, buyers, and developers specialize, or feel more comfortable with one type of use. And lenders are always worried about their exit strategy if the project goes sour.” Fried, who brokered the sale of Coconut Grove’s Mayfair Project, notes that often the best way to solve this problem is to break the uses down into separate development programs. “Say there is a parking garage element, a shopping center, office buildings, and a hotel. You stand a better chance if you design the project so you can present each part to a lender who feels comfortable with, say parking garages, or hotels. This requires foot work and knowing the lenders, particularly in the local market.”

    Traditional malls are still the easiest projects to finance. Developments that have unique “attraction” infrastructure designed for special ride attractions, or themed environments, are difficult to present to lenders. Lenders worry that they will not be able to reposition the property if the concept or attractions fail to work in the proposed location. But Fried suggests that demographics and how the proposition is presented to a lender can make all the difference.

The Easiest Projects To Finance

    For instance, the easiest project to finance is one that has the most high credit tenants, particularly in established retail fields. “Lenders are not risk-takers.” The hardest projects to finance are: “Untried concepts, in untried locations, by untried developers.” High tenant improvement allowances necessary for many concept projects will also kill a financing deal. “Particularly if the money is going toward the creation of a unique or themed setting that can’t easily be turned around for another tenant. The more unique, the less flexible a project presents to a lender, the more concerns the deal raises about how the property can be saved if it needs to be repositioned.

    “Unless,” Fried notes the exception, “a public company like Mills, with heavy equity reserves, wants to experiment with an untried concept. Banks will finance an untried concept if there is a tried and true developer with heavy equity.”

What About the Terms of the Deal?

    Urban specialty retail developments, particularly with entertainment tenants, require much higher tenant incentives, and usually have less bankable tenants, who are also less proven retail successes.” So once again, the urban specialty retail developer, particularly one who has a theme or entertainment concept at work, needs more equity to attract financing. Rates go up and down independent of these considerations, of course.

A Shift In Trends

    And Fried observes a shift in trends. “It is true that traditional malls are harder to develop than they were because the sites are not as readily available as they were in the past. There are a number of revolutions in retailing taking place, and new models for development are in vogue. But demographics will always tell. Some traditional malls are in a general decline because the demographics supporting their locations have changed. But I think regional malls with the right population and income figures are still very viable.” Fried also notes that regional banking sources who understand their local markets may be more willing to finance the project that fits the local demographics, as the banking institution perceives it.

The Importance Of The Presentation

    “You have to know the statistics for the city or region in which your project is located. The urban renaissance, the idea of ‘the 24-hour city’ is very powerful in the lending world. Lenders will listen to your presentation if you can set the frame for the project with demographics and a trend like the 24-hour city. I use that concept all the time with lenders. And it is a valid proposition. You have to know what is vital and workable in the urban environment where you seek your financing.”

    Young professionals, according to Fried, are returning to the city for its unique neighborhoods, its traditions, and its sense of community. Lenders are aware of these trends and love the idea of an urban landscape where retailing and dining and entertainment takes place around the clock. This powerful theme can be used to help sell urban retail specialty projects to investment bankers.

    For information contact Jim Fried, senior vice president, The Tri-Stone Companies, 150 East Palmetto Park Road, Suite 400, Boca Raton, FL 33432;
561-750-9008, Fax 750-1575.