Simon Pullout From Mall Draws Ire of ORIX

Special servicer ORIX Capital Markets said that Simon Property's decision to walk away from an aging Florida mall should cause investors to be wary about the willingness of even the biggest institutional sponsors to stand behind properties that run into trouble.

Simon, the biggest mall operator in the U.S., surrendered the Palm Beach Mall two weeks ago after defaulting on a $50.7 million fixed-rate mortgage that was securitized in 2003 and scheduled to mature in 2012.

Simon had owned the struggling 1.2 million-square-foot mall for more than 10 years. The Indianapolis REIT started emptying out tenants several years ago in order to reposition the property. But the effort lagged amid the economic downturn, leading Simon to throw in the towel and turn over the keys to ORIX, the special servicer of the $1.2 billion securitization that includes the mortgage.

The decision left ORIX bristling. "We are surprised that Simon was unwilling to support this mall after having abandoned its reposition strategy," said chief executive Mitch Wasterlain. "It is not the way Simon has behaved in the past, and it is causing us to re-examine our other exposure to Simon."

While Simon didn't return a call seeking comment, there's no question that the company was well within its legal right to bail out. Securitized mortgages carry no recourse to the borrower, meaning that lenders or bondholders can't lay claim to any other assets if a default occurs.

Indeed, some investors were unfazed by Simon's action. "We're all big boys," said one longtime investor. "CMBS is nonrecourse, everybody knows that. In the old days, if a REIT chose CMBS financing instead of unsecured debt, which was recourse, you knew there was a risk the borrower could walk away. In the go-go years, the bankers tried to make you forget that, but it was always true."

Still, it's relatively unusual for a big-name player with deep pockets to simply stop making loan payments. Borrowers of Simon's size and stature are generally viewed as more likely to stand behind properties - if for no other reason than to protect their image. Lenders and bondholders often consider the sponsor when evaluating the creditworthiness of loans, and rating agencies can give more favorable treatment to loans on properties controlled by major institutional players.

Simon's action suggests that institutional owners may be more willing to walk away from properties given the level of distress in the market. That might prompt investors to adjust how they evaluate bonds.

The loan on the 42-year-old Palm Beach Mall was originated in 2002 by J.P. Morgan, which securitized it the following year via a pooled offering (J.P. Morgan Chase Commercial Mortgage Securities Corp., 2003 PM1). The 6.2% mortgage had an original balance of $54.8 million.

At the time of origination, Fitch said the mall was "considered to be inferior to its competitors." In-line sales were $252/sf, well below the peer-group average of more than $350/sf.

A few years ago, Simon mapped out a strategy to reposition the property by turning it into a mixed-use center that would be anchored by an Ikea store and would include restaurants, shops and residential units. The vacancy rate rose as tenants left when leases expired, evidently in conjunction with Simon's plan to revamp the property, which is in West Palm Beach. Between October 2008 and January 2009, Dillard's and Macy's closed anchor stores. That has left only two anchors - JC Penney and Sears - and about a half-dozen in-line shops open, according to local retailers.

Fitch, which put 11 classes of the securitization under review for downgrade on March 11 because of the Simon loan, said the mall's occupancy had fallen to 69% in September, from 91.6% at issuance. The debt-service-coverage ratio declined to 0.74 to 1, from 1.40 to 1 at yearend 2007.

The repositioning went awry when Ikea dropped out as the potential anchor. Simon soon after turned over the property to ORIX, whose ire was heightened because it has assumed a unstable property whose performance had further deteriorated while the now-abandoned repositioning was being planned.

Simon's pullout has prompted investors to look at other properties that the REIT might jettison. Attention centered on Highland Mall in Austin, Texas. Dillard's filed a lawsuit earlier this month against Simon and its partner, General Growth Properties, claiming that they had allowed the 1.1 million-sf mall to decline to the point of being a "ghost town." J.P. Morgan securitized a $70.5 million loan on the property in 2002 via a $798.9 million pooled offering (J.P. Morgan Chase Commercial Mortgage Securities Corp., 2002-CIBC4). It was the largest loan in the collateral pool.

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