Stand-Alone Retail Properties Generating Renewed Interest from Investors-- Hinting at Broader Recovery To Come
By Mark Heschmeyer
As the Great Recession recedes, consumers, retailers, investors, landlords and lenders are re-emerging and the prospects for retail commercial real estate look better than they have in years.
One has only to look to one-off, stand-alone retail properties that make up the bulk of a market's retail inventory to see how the recovery is beginning -- in very small increments.
Investors appear much more willing to invest in stand-alone real estate (such as restaurants, convenience stores, etc.,) specifically in quality core locations, says Winston Orzechowski, research director for Calkain Companies Inc. in Reston, VA. With the recession almost completely halting new construction for six to 18 months, the pool of available high-quality assets stagnated.
Now that the market for such assets has picked up, it is likely those remaining investment opportunities will dwindle quickly, Orzechowski said.
"In a sense, the [retail] market exists on the day after a severe storm," Orzechowski said. "Though some heavy damage was done, investors were able to witness what held firm and what folded. The property types that are most sought-after today are the ones which showed stability and perseverance throughout the recession."
"Dollar stores, banks, drugstores and select QSRs (McDonald's) all proved their staying power," Orzechowski said. "Dollar stores cater to economically minded customers, whose ranks swelled over the past few years and, though many expected otherwise, have continued to persevere. Dollar stores do well during bad times and now, ironically seem to be given a new lease on life."
Randol Y. Mackley, senior vice president of SRS Real Estate Partners' San Jose office, agrees saying that these retail product types appeal to a large population of the investors market as well as the owner-user market. (Roger Staubach and Chris Maguire created SRS Real Estate Partners in 2009, originally under the name Staubach Retail Services.)
"Demand is strong for existing restaurants with their intact approvals and improvements," Mackley said. "New restaurants save considerable capital costs by a restaurant location where the sewer connection fees have already been paid, the necessary utilities are in place, and the restaurant's ventilation hoods and other equipment is in place."
"Convenience "c" stores are an end-cap tenant in a strip center," Mackley said. "Such centers remain of strong interest to investors especially at corner locations with more than 25,000 cars/day go by."
"Fast food locations remain in very strong demand; especially when there is the possibility of a drive-through. This drive-through feature is increasingly being sought by tenants such as Starbucks and Subway," Mackley said.
To quantify the trend, we analyzed investment activity data from CoStar Comps Analytics for such property types.
| Property Type || No. of Deals 4th Qrtr 2010 || No. of Deals 4th Qrtr 2009 || Ave. Price/SF 4th Qrtr 2010 || Ave. Price/SF 4th Qrtr 2009 || 3-Year Ave. Price/SF |
| C Store || 331 || 211 || 296 || $187 || $223 |
| Service Station || 464 || 439 || 436 || $367 || $400 |
| Bars || 108 || 113 || 113 || $82 || $101 |
| Drug Store || 142 || 90 || 319 || $290 || $311 |
| Fast Food || 323 || 263 || 324 || $296 || $325 |
| Car Wash || 126 || 103 || 160 || $148 || $197 |
| Banks || 194 || 168 || 218 || $210 || $239 |
| Restaurant || 774 || 648 || 161 || $156 || $177 |
| Auto Repair Shops || 500 || 409 || 100 || $105 || $125 |
| Auto Dealerships || 303 || 239 || 106 || $121 || $133 |
For starters, the number of such sales was up in the fourth quarter of 2010 over the year-earlier period for all such properties surveyed. In addition, convenience stores, service stations and bars traded at higher per-square-foot averages in the fourth quarter of 2010 than their three-year average. Fast food property sale prices almost equaled their average three-year price. Car washes, banks and restaurants were all trading at higher average per square foot prices in the fourth quarter of 2010 than they had one year earlier.
Only auto repair shops and auto dealerships were still trending down in prices. Mackley said that many of these properties are being recycled to alternate uses as a result of the contraction in the auto industry. However, most cities are reluctant to rezone such tax-generating properties.
"As retail investors find the REIT trade increasingly crowded, we should expect to see an increased level of interest in these types of properties," said Chris Macke, senior real estate strategist for CoStar Group. "The key to investors’ success will be whether the leases have rent escalations to offset any future inflation."
Calkain's Orzechowski and SRS Real Estate Partners' Mackley were among several retail industry professionals CoStar asked to size up the current state of stand-alone retail properties. Continue reading to find out how others are assessing the current retail market.
Liquidity for Stand-Alone Properties is Definitely Starting To Return
In our practice, we are seeing a definite uptick in interest in stand-alone retail, although a significant amount of interest seems to be in acquisition of properties, rather than leasing. A number of investors seem to believe that the tough market of the past few years has stretched smaller property owners to the limit, permitting acquisitions at favorable prices. Financing options remain sluggish, however, so the market favors those with cash.
We still see tenants fighting for concessions and more favorable terms. Larger, well-established landlords have the ability to withstand these battles, where smaller landlords seem to be more nervous, and therefore more accommodating -- even if they are not really able to afford the concessions.
Environmentally risky properties -- gas stations, dry cleaners, etc. -- and financially challenging properties remain somewhat out of favor.
Liquidity is definitely starting to return, albeit slowly. Wells Fargo Bank recently expanded FrontRunner, their small-balance ($1 million to $5 million) loan program, which could be a harbinger of good things to come -- that program was a leading CMBS program for smaller loans in the past.
We are seeing both acquisition and financing interest most strongly for established stand-alone retail properties, such as big-box national tenants or creditworthy regional players. Leasing activity seems to be making a comeback, but somewhat cautiously.
Katheryne L. Zelenock, attorney member of the law firm of Dickinson Wright PLLC in Bloomfield Hills, MI. Zelenock has served as closing or supervising counsel for several billion dollars in commercial mortgage loans destined for securitization.
Still in a Period of Consolidation
We're still in a period in which some larger tenants are closing locations and leaving some markets, or they are remaining in a market but consolidating. At the same time, other national users for these spaces are starting to express interest in expansion, however often at significantly reduced pricing from what the previous tenant paid. They are interested in taking advantage of space that is substantially built out for their use already.
Of course the dollar concept [stores] are the strongest expansion users, but sometimes other competitors in the same category may want to enter a new market if they see someone leaving it.
Liquidity is getting a bit better for the smaller investors, but the pendulum is still shifted much more on the "conservative" lending practices. Lenders may bend a bit more if there is an opportunity to build a longer-term relationship with a client and add some deposit account versus a "one-and-done" borrower.
Tom R. Helberg, principal of Bellevue Investors Co. in Sylvania, OH
Credit Tenants Driving Retail Investment Market
Competition is heating up rapidly for these assets. I think people are more afraid of what will happen to the value of their cash in a money market account (with the likely pending inflation) than they are of investing in tangible assets. High quality real estate with a credit tenant is essentially a bond that pays a high dividend, yet has an underlying piece of property at maturity.
Any high credit deals are in sharp demand currently, particularly retail deals. New Walgreens are at the top of the list.
Larry Hausman, CCIM, senior associate of Marcus & Millichap in Louisville, KY
Multi-Tenant Properties Are Still the Preference
I think only the strongest tenant brands and balance sheets will receive conventional financing in this space. Land value is a classic limit on loan amount and I think loans larger than land value will come primarily from private sources. Multi-tenant retail is certainly perceived to be more stable than single-tenant retail, but brand and balance sheet also attract capital.
We are seeing more and more leasing - Starbucks and others are leasing new stores again. Convenience store operators are definitely seeking to grow their number of stores.
Obviously lenders prefer the strongest brands and balance sheets because they are the most durable tenants. The tenant-occupied real estate is receiving the attention of conventional lenders. Owner-occupied real estate is being financed primarily by SBA and bank lenders.
Mark Fisher, vice president and managing director of StanCorp Mortgage Investors in Hillsboro, OR
Time To Get into the Game
I believe many investors and users have been sitting on the sideline and have now decided to start making a move. They feel we have hit the bottom and it is time to get back into the game. Banks are putting their REO's on the market and taking a hard look at all offers.
The restaurants are not expanding very fast but we are seeing increased activity from gas/convenience stores and a lot of automotive users.
Kittie L. Hook, senior vice president, corporate services at Cassidy Turley Fuller Real Estate in Denver, CO
Interest Spreading to Smaller Markets
The general outlook for investing in retail is much rosier for 2011 than the last few years. From my vantage point, it looks like small retail boxes and QSRs get most of the attention, followed by restaurants and C-stores.
I think the big reasons for this are the smaller deal sizes, familiarity with the brand (AT&T, McDonald's, Jack in the Box, etc.) and relative ease of retrofitting the buildings for another use.
While most of the interest has been in primary and strong secondary markets, I'm also hearing of increased interest in the smaller markets as well, which I think is due to a constrained supply of investment property in the larger locales.
As the interest in smaller market deals increases, I think we'll see increased interest in smaller (albeit profitable) credits as well which should help the liquidity of these operators.
Scott Haire, vice president of Cardinal Capital Partners in Dallas, TX
Recycling Stand-Alone Sites into New Uses
Land values and construction costs are at a low ebb, and choice locations that might not usually be available are there for the taking, so that certainly favors expanding now, strategically locking in high visibility sites or filling in the gaps for a saturation campaign.
Recycling of one (failed) use into another will also be a big segment of growth. (I recently turned a closed bank pad into a coffee bar complete with drive-aisle coffee service).
Raphael Barta, associate broker at Century 21 Riverstone in Sandpoint, ID
Core Retail Centers Still Dominating
Core retail assets are getting so much play that the returns are dropping fast. It's a core bubble vis-à-vis pricing with IRR's down in the 8% range for best in class. The buzz at ICSC Monterey seemed to be a resignation that Class B and C quality centers were going to get the play going forward, and the lender community seemed ready to go back into this market.
Based on what we have been seeing here at NorthMarq Capital, these comments are borne up by our own activity with lenders and borrowers alike. Retail debt is very low cost, especially for 5- to 7-year debt. This period gives the developer plenty of time to complete the re-leasing scenario and stabilize the upgraded centers until they are resold or refinanced with permanent debt.
The mom-and-pop vendors cannot easily attain credit or factoring for their businesses and, as such there are many vacant smaller shops. The only thing that will help this phenomenon will be less stringent lending guidelines by the banking industry.
We can be hopeful that this will happen soon after knowledge of the banks' huge cash reserves and how they got to amass such liquidity has gotten out. They are healthy now and it's time to let this industry return to lending to the average citizen.
Michael Federle, senior vice president and senior managing director for Northmarq Real Estate Services in San Francisco, CA
Segment Leaders Driving Demand
Net-lease retail product will remain an attractive investment vehicle in 2011 and we anticipate high transaction velocity. Product supply and interest rates will be the story this year. A growing shortage of product (mostly from lack of new development) is causing cap rate compression across the board. This is especially true of top-tier product (i.e. high credit, long-term lease and strong location) but can also be seen to a lesser extent in most retail product trading in today's market
Low interest rates have further enabled this run up in prices. However, pending rate increases will likely cause cap rate compression to plateau and then reverse at some point. Cap rates traditionally lag interest rates by +/- three months.
As in 2010, there is a great degree of competition amongst buyers to acquire deals leased to necessity-based retailers including drug stores, fast food concepts with a corporate guarantor and convenience stores. The demand is tri-fold: strong credits, favorable lease structures and locations that offer intrinsic value. Segment leaders such as McDonald's, 7-Eleven and Walgreens have continued to perform well through the recession, motivating investors to pursue a shrinking pool of available deals very aggressively.
Anne Perrault, associate at Stan Johnson Co. in Tulsa, OK
Waiting for Housing, Jobs To Comeback
Investors have returned to the market looking for opportunities. Once a property is priced to reflect market conditions as they are today, it is an active market.
However, for the most part, leasing has not returned and we do not expect this to change in 2011. Until job growth starts to take place, housing stabilizes and financing returns this will not significantly change.
Money has started to return for high quality "core assets." Little to no money exists for non-core, except in regards to SBA loans and banks looking to make loans to credit worthy owner-users.
Phil Ryan, associate at Lavista Associates in Atlanta, GA
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