CREJ - Retail Properties Quarterly - February 2015
When working at TrammellCrow Co. in the late 1990s,I led a group undertaking single-tenant, retail and build-to-suits all over the United States. We developed many projects throughout the country and even outside of the contiguous U.S., including Alaska and Puerto Rico. We would build the same building with the same lease for all of our clients in different markets. I always found it interesting how many almost identical properties we could sell, but the price would vary somewhat dramatically. We built an OfficeMax in Ponce, Puerto Rico, and the lease was in English. However, all the underlying documents were in Spanish. I have to admit, relying on a local lawyer to interpret and approve all of the underlying documents that were in Spanish was daunting. The location, language issue and the fact that you could not do 1031 exchanges in a U.S. territory at the time, pushed the cap rate and we were able sell the property up 100 basis points higher than what the same lease and building prototype sold for in similar locations in the continental U.S. This was in spite of proven high sales figures for retailers like OfficeMax in Puerto Rico. I decided after that deal to always factor in some of the more intangible factors that influence real estate investors. Since 2002, we have been investing in and developing properties in Colorado and California. I am amazed at the special connection these two markets have and the benefits that Colorado gains from California investors’ infatuation with our real estate. Many elements go into property valuations. Factors include the quality of the improvements and the location, quality and length of the income stream, and, maybe most important, the amount of the income stream. Colorado real estate generally gives California investors a slightly higher return, which, without a doubt, is a factor. However, the mountain resort image of our state and the lifestyle, along with a lot of direct flights are big differentiators that should not be overlooked. In my experience, Kansas City, Missouri, from a cap rate perspective, is penalized for being flat, Minneapolis for being cold, and Cleveland for, well, being Cleveland. We are blessed with beautiful mountains, great weather and a healthy lifestyle within which Californians connect. Of course, as Coloradans we would like to pat ourselves on the back and say this infatuation exists because of the vibrant economy and quality communities that we have created. One might argue we have had little to do with it, but rather the landscape, proximity to California and weather are blessings we are fortunate enough to have. We have an image created by the physical beauty, weather and lifestyle that attract real estate capital from other parts of the country, but especially from California. Most Californians are proud that they live in a state with beautiful mountains, beaches and very pleasant weather. The massive metroplex stretching from Ventura County north of Los Angeles, to the Mexican border in San Diego is one of greatest economic engines in the history of the world. The Bay Area in the north is not as large, but extremely significant. Add it all up and that is a lot of real estate worth a lot of money. Real estate prices in these markets are high with low cap rates. I found that when an owner of a small apartment building in Los Angeles sells his property for a 4 cap, often the joy of selling is tainted by the fact that in order to buy something else in California, it’s going to command the same crazy cap rate. To get an acceptable return, he would have to aggressively raise rents and drive net operating incomes up. Many owners decide to look outside California for better returns. This is where the Colorado connection seems to flourish. Over and over again when selling retail assets, buyers from California step up to the plate and close on deals over local investors. Comments like, “I have always taken my kids skiing in Vail, so I would love to own property there,” or “Colorado is such a beautiful place,” are anecdotal comments I hear. What I have not heard is, “I want to own real estate in Colorado because of the legalization of marijuana.” Actually, I have heard statements to the contrary. And our neighbor to the west, Utah, is gaining more investor interest because of some of the high-profile decisions and events that may negatively affect Colorado’s image. In my experience, sometimes not many sophisticated economic metrics like demographics and employment growth are being applied. It is an image and a connection that Colorado has with California. These are investors buying assets under $5 million, and they are not institutional in nature. However, they are not short on real estate savvy and typically manage assets in a competitive California marketplace to get to where they are. They also have a lot of money to place when they sell even the smallest of assets. If you own smaller retail assets, especially single-tenant, triple-net assets, you should make the California connection when you go to sell. In addition, we should all care about the image and perception of our state.