Centre Court Shopping Center, Atlanta, GA – a case study of a First Allied centre

This is a detailed look at one of First Allied's shopping centers.
I've chosen the Centre Court Shopping Center in Sandy Springs part of Fulton County, in the northern suburbs of Atlanta, Georgia. It is very typical of the properties in the First Allied portfolio and thanks to the excellent online records of Fulton County, we can see the full history of the Glazers' ownership.

View Centre Court Shopping Center in a larger map

Center Court was built in 1979 and renovated by its previous owners in 2001. The centre has square footage of 68,778 (making the retail space about the size of a typical Tesco Extra) with 16 lots and a large carpark. The suburb of Sandy Springs where the centre is located is very prosperous (average household income is twice the Georgia average) and predominantly white.

2002 – bought by First Allied
Centre Court was acquired by First Allied for $6.85m from Pacific Mutual Life Insurance Company in July 2002 (you can download a Fulton County record of this here).

This was First Allied's first foray into Georgia and Edward Glazer was very upbeat in the company's press release announcing the purchase:

July 2002 - First Allied Corporation has entered the state of Georgia with its newest acquisition, Centre Court Shopping Center, located at the corner of Hammond Drive and Sandy Springs Circle in Atlanta.
"With a 5 mile average household income of over $125,000, this fits perfectly with our portfolio," said Edward Glazer, First Allied President. "We love the Atlanta metro area and plan on acquiring more centers in the area very soon."
Centre Court is approximately 68,000 square feet. Lead merchants include Eckerd, Ace Hardware and Sandy Springs Community Bank.
First Allied has $500,000,000 to invest in shopping center acquisitions.
If you have any shopping centers for sale please call our acquisitions department at 310-275-8909.

In common with all First Allied's properties, the company established a new subsidiary (Centre Court Shopping Center Atlanta GA Partnership in this case) to buy the centre. Separate limited liability subsidiaries prevent any problems with the centre or its mortgage from damaging the parent company.

From county records, we can see the new subsidiary took out a $5.3m mortgage with Lehman Brothers to buy Centre Court, meaning that First Allied invested $1.55m of equity in the new venture.

Because Lehmans securitized the mortgage in their "Lehman Brothers UBS Commercial Mortgage Trust 2002-C4" CMBS, we can see all the details of the property and the loan. First Allied took at a ten year "anticipated repayment date" (ARD) mortgage at a fixed rate of 6.69%. Monthly repayments for an ARD mortgage are calculated as if the mortgage runs for longer than its actual term. In this case, 1/360th of the loan was repayable each month for a further ten years. At that point, the mortgage did not have to be repaid, but in the event that it was not, interest rate penalties would kick in. The property was independently valued at $6.9m at the time the loan was taken out.

In the prosperous suburbs of north Atlanta in 2002, the economy was booming, fed by the low interest rates that Alan Greenspan and the Federal Reserve believed were essential following the bursting of the dot-com bubble. First Allied acquired the recently refurbished centre with an occupancy rate of 98.4% (only the smallest 1,100 sq foot lot was vacant). The CMBS reports showed us that the centre generated $866k in revenue (or around $13 per square foot) in the year before First Allied bought it. With costs (property taxes, repair and maintenance, admin etc) of c. $275k pa, Centre Court, almost completely fully let, was generating c. $611k of "net cash flow" (NCF).

Applying the NCF to the price, we can see that the centre had been acquired on a yield (or "cap rate") of 8.9%, a perfectly solid, even low, valuation for a newly refurbished centre in a prosperous area of a growing city. The loan to value (using the lender's valuation) was a reasonable 77%. The prudent LTV and the fact that the yield on the centre was far higher than the interest rate paid, meant that the NCF covered the interest and repayments by 1.5x (this is called the "Debt Service Coverage Ratio" or DSCR).

2004 – for sale
In May 2004, Centre Court along with 36 other First Allied centres was put up for sale (either as a single portfolio or in two smaller groups). In the trade press, Edward Glazer was quoted as saying "It's foolish not to put a 'for sale' sign on your property if the house next door just sold for six times what you paid not that long ago."

Yet within a few months, Centre Court and the rest of the portfolio was off the market and First Allied embarked on a new way to extract cash from their retail assets, remortaging.

2005 – remortgaged
As described elsewhere, mortgages inside a CMBS cannot be repaid except in the first few months. If you want out, the mortgage has to be "defeased", replaced by a "risk free" asset like US Treasuries. Thankfully, defeasance was easy in 2005 as bond rates were not too low compared to mortgage rates. Having decided against selling, First Allied increased its exposure to retail real estate by remortgaging 25 of its centres in 2005 including Centre Court. Lehmans was again the lender (as it was for all but two of the 2005 remortgages). It put Centre Court's new mortgage into another CMBS, LBUBS CMT 2005-5 along with 10 other First Allied properties.
The subsequent three years had been good for Centre Court, the same three largest tenants were in place and the centre was 100% let. But rents had only risen by 4% since purchase from $13.10 / sq ft to $13.50 / sq ft. First Allied had trimmed a little off costs, so NCF was up to $663k pa.

What had changed since 2002, was the market value of retail properties. The independent appraisal valuation on Centre Court was now $9.7m, a rise of 41% in just three years! As this was a much greater rise than the increase in NCF, the cap rate was now much lower, 7.4% vs. 8.9% in 2002.

First Allied borrowed $8.245m under its new mortgage, an LTV (on the new, higher valuation) of roughly 85%. Of course not all of this was applied to the defeasement of the old mortgage which only had an outstanding balance of $5.1m. Applying normal defeasement costs, First Allied extracted around $3m from the transaction, around twice the original equity investment. This is a textbook example of how leveraged real estate investing is meant to work. Not bad at all for two years of doing nothing more than banking rent cheques and very handy if you wanted to buy a football club.

Although Lehman Brothers were happy to lend on Centre Court at an LTV of 85%, this level of loan to value made it difficult to securitise the mortgage. Lehmans therefore structured the mortgage as a first lien "A Note" for $7.72m and a cross-collateralised "B Note" for $525k. The A Note's LTV was below 80% (79.6%) making it easier to place in a CMBS. None of this alchemy makes any difference to First Allied who have to pay the agreed principal and interest on both Notes.

As the credit bubble was developing nicely at the time, the new mortgage was more favourable to First Allied than the 2002 version, although the rate was marginally higher reflecting the higher LTV (the blended rate for both notes together is 6.9%). The term of the A Note was fifteen years, and the first five years were interest only. After that, 1/360th of the loan was repayable monthly for 10 years at which point a "balloon" payment of $6.54m came due. The new payments on both notes combined of c. $550k (during the interest only period) were covered 1.2x by NCF.

2009 – most recent report to the CMBS trustee
The May 2010 data file from BoA Merrill Lynch, the trustee of LBUBS CMT 2005-C5 in which the Centre Court mortgage still sits, has data for the centre up to 31st December 2009.

With the recession biting, three lots were vacant at the end of December but they were all small and occupancy was still a healthy 92.3%. NCF was $667k pa and with the interest only mortgage in place, DSCR was still a healthy 1.25x.

June  2010 - occupancy down to 79.7%, interest free period over
Since the end of last December a fourth lot has become vacant at Centre Court and this time it's a big one at 8,640 sq ft, 12.5% of the whole property.

Annual rental income will fall by 13% compared to last year if this vacancy level can't be reduced. With fixed costs, NCF will fall to c. $512k pa, not sufficient to cover mortgage costs of c. $534k, a DSCR of 0.96x. The centre may manage to pay the interest by cutting back on management fees ($30k pa) and on capital spending (c. $20k pa), but it will be tight.

If that wasn't bad enough, Centre Court is one of 27 First Allied centres whose interest only mortgage periods come to an end in 2010, in fact it ended in April. From May 2010 until May 2020, the centre will have to make repayments of 1/360th of the original $7.72m A note each month. That's an additional $257k a year on top of the current interest bill of $534k an increase of 48%. The DSCR will fall to 0.66x.

The empty 8,640 sq ft lot is on the market for a rent of $8 per sq ft, and the three smaller lots for $18 per sq ft. If First Allied managed to let all the vacant space at these rates, it would only take annual revenue up to c. $1.1m (and then only once any introductory rent periods had expired) and with costs running at around $470k pa, NCF would be around $685k pa. With interest and now repayments running at over $775k pa, Centre Court wouldn't be able to pay its mortgage even if fully let.

Why and what happens next?
When First Allied remortgaged Centre Court in 2005, the step up in mortgage payments from $534k pa to $775k pa in April 2010 was set in stone. Yet when the mortgage was taken out and despite being fully let, NCF was only running at $663k.

Of course the Glazers never expected to get to the point where they had to start making repayments on this mortgage. Like many other property speculators, they were too used to the constant game of remortgaging off ever higher property prices. The first Centre Court mortgage was barely in place for three years. In the boom years, it was common to remortgage just before one interest only period ended and to start another. The capital never needed to be repaid. Perhaps they also thought rents would rise with the buoyant economy. Perhaps they didn't think.

Today of course, despite a few signs of life, commercial mortgages are not easy to come by in the United States. Nor could First Allied sell Centre Court to avoid the problems they face. NCF is running at $512k pa. Similar centres which are up for sale in the area are being offered on cap rates around 8.25%. Applying this to Centre Court gives a current value of c. $6m, a huge $2.2m of negative equity.

Even if the space can be filled and the NOI rises to c. $700k pa, the property probably wouldn't fetch more than $7m. The lease of the largest tenant, Ace Hardware is up for review in 2013, and this alone makes the property unattractive. 

What Center Court needs is an injection of new equity to reduce the mortgage burden, andgive it time to allow the US economy to recover further. As First Allied have demonstrated in 2008 and 2009 with Hebron Heights, The Shops at Cumberland Place and The Crossings at Roswell and again this February with Crosswoods Commons in Ohio, they have no money to support centres as they run into financial trouble. 

A sensible investor would be buying retail property at the moment, but the Glazers financial position means they have to watch as their properties are foreclosed on and sold at clearance prices. 

Centre Court is only one of the 31 First Allied centres whose interest only periods end in 2010. Of the 31, at current occupancy levels, 15 including Centre Court will be unable to service their mortgages when repayments begin. They can be added to the 20 other centres which already have a DSCR below 1x. If things do not improve from here, half of First Allied's portfolio will be in this position by the end of 2010. 

The centres coming off interest only periods this year were collectively valued at $393m when the Glazers took out $313m of mortgages against them in 2005. All of the $80m of equity value they had is now in danger of being wiped out. 

Savvy businessmen you say?