May 18, 2018
By Dennis Kaiser
ICSC’s RECon 2018 is just about to kick-off its annual gathering of leaders across the retail industry. Leading into the conference, Connect Media wanted to find out what’s on the minds of retail investors today, and the ways the industry is adjusting to e-commerce.
We sat down with CBRE’s Phil Voorhees to hear from one of the nation’s top retail investment brokers. He shares insights into the trends shaping the industry, and how retail and industrial are now bedfellows in our latest Q&A.
Q: What is top-of-mind for the retail investment sector today?
A: A number of factors are on the minds of most retail investors. For the first time since December of 2013, the US 10-Year Treasury Yield (10YT) is over 3% and apparently staying there. Lender spreads increased +/- 15 bps in the past two weeks, and except for lower loan-to-value loans, this means effective interest rates at 5.0% or better on most retail projects. Over time, cap rates track interest rates. Consequently, CBRE sees a strong investor focus on rental growth; the compounded annual rental growth rate/CAGR.
Q: Where does capital want to be and why?
A: This continues to be a “barbell” market, with strong demand for “core” retail assets (the top 3% of all retail, or the best center or two in each market), and strong demand for value-add assets (perhaps 5-10% of the market), priced with appropriate risk-adjusted returns. Tepid demand for “average” retail properties creates an opportunity to buy well-located, but non-remarkable properties for fair prices, and at some of the best long-term, fixed-rate financing ever available, particularly at lower LTV levels.
Q: What are some examples of investments that reflect these trends?
A: Our team has a community center in Washington State trading at just shy of a 9% cap rate, and at less than half of land-inclusive replacement cost. In 2015, this property could have priced lower than a 7% cap rate. Rents are low, and tenant sales performance is above average. Just a heck of a buy-side deal. In broader terms, in the last cycle, the spread between cap rates and the 10YT got as tight as 75 basis points (.75%) on core assets. That spread is approximately double now on core assets, and on properties like the Washington property referenced above, the spread approaches 600 bps – 6.00%. Just remarkable.
Q: How have two asset classes, retail and industrial, become bedfellows now?
A: Retail centers provide the customer-proximate locations ideal for “last mile” distribution, a key link in the industrial supply chain. Though, retail rents remain 3-5 times higher than industrial rents in better markets. The opportunity here lies in the right sizing of older, box retail spaces, using remainder space for industrial or distribution use from a developer’s standpoint. From the tenant’s perspective, the nation’s best retailers figured this out in 2016 if not sooner, and are working to better utilize space for last mile distribution strategies in tandem with their omni-channel retail approach.
Q: That pairing has implications for each property type and those who invest in them. What adjustments have been made?
A: The implications vary across the spectrum of retail property types. Working from small to big, single-tenant retail investments continue to trade at exceptional prices, a spread above the 10YT, as desirable, cash-flow-producing investments housing uses that are not susceptible to internet competition. The same holds true for “pad” retail strips, housing food, beverage, service, light medical and fitness uses. Investors understand the value in these locations and use types, and CBRE expects more institutional interest in these smaller retail formats in the years to come. Larger strips and neighborhood centers, traditionally anchored by a grocery store and usually with a junior anchor or two, continue to experience strong demand from investors for the same reasons.
Power centers represent the biggest opportunity for an industrial/retail merger, due to physical plant type. The number of box retail tenants per category have been contracting for a number of years, and not just as a result of internet competition. With as low as 20-25% building to land coverage ratio, retail has potential as a covered land play, providing potential for site densification and vertical development in the future, particularly if self-driving cars (or self-driving car services) proliferate in the future. The same is true for well-located regional malls. For power center and mall product types, the retail/industrial connection may be less significant than retail/multifamily synergy. This will depend, of course, on the location and trade area fundamentals, but changes and exciting repositioning opportunities for existing retail projects are clearly underway.
For comments, questions or concerns, please contact Dennis Kaiser