CREJ - Retail Properties Quarterly - May 2015
Are you in search of a low-risk yield in the 6 to 8 percent range? You are not alone. Strong investor demand for investment-grade retail assets continue to fuel a highly competitive market environment. And Denver continues to be viewed with a favorable outlook by real estate investment trusts looking to acquire $500 million power centers, 1031 exchange investors chasing $1 million to $5 million net lease investments and several categories in between. To gauge current market pricing, I took a quick look back at investment activity over the past 12 months. As many of you know, there has been a significant amount of market activity over the last year. To illustrate investor demand, let’s examine implied capitalization rates from several recent transactions. This article will focus on three general types of retail shopping centers – power centers, grocery-anchored centers and neighborhood strip centers. Our market data set has been limited to centers with stabilized occupancy where confirmation of transaction details could be attained.
Power center assets tend to be larger in size and will have an array of large format stores that specialize in specific merchandise categories. Think of a center with a 15,000-square-foot pet store, 20,000- sf electronics store and 30,000-sf soft goods store – this is the perfect example of a power center. In the past 12 months there have been several transactions in the $50 million to $500 million range. Implied capitalization rates for the four transactions in question were in the 6.2 percent to 7.2 percent range, averaging 6.41 percent. Note that the following characteristics were identified with lower implied capitalization rates: • A substantial remaining lease term for the primary anchor tenant; • Market-dominant large-format retailers with multiple soft goods retailers; • A higher ratio of tenants with credit ratings near or above the investment-grade tier; • Location in a trade area with high incomes or high population density levels; • Location with high levels of traffic exposure; • Average remaining lease term that exceeds five years; • Evidence of strong tenant sales activity; and • Less than 10 years old.
Most people already know or are able to guess what a grocery anchored center retail asset is all about. Think of the retail center with a grocery store and all the smaller retailers and service providers that make life easier – assuming a good haircut, nutrition supplements and a paycheck loan make life easier. Overall size and configuration may vary, but you should have a good idea by now as to what centers in this category have in common. Recent transactions included in our market data set fell in to the $10 million to $50 million range. Implied capitalization rates for the six transactions in question were in the 5.5 percent to 7.9 percent range, with an average of 6.53 percent. The capitalization rate for a grocery-anchored center largely is driven by the anchor tenant. Following are some of the characteristics that were identified with lower implied capitalization rates: • Market-dominant grocery chain; • Substantial remaining lease term for grocery anchor tenant; • Average remaining lease term that exceeds five years; • Established center with evidence of strong tenant sales activity; • Location in a trade area with high incomes or high population density levels; • Location with high levels of traffic exposure; • Less than 10 years old; and • Additional 1 percent commission for buyer agent (only kidding on this one).
Retail strip center sales are more common and involve a more diverse group of assets. Recent transactions included in our market data mostly fell into the sub-$10 million range. Implied capitalization rates for the transactions in question were in the 6.2 percent to 9.25 percent range, with an average of 7.51 percent. The characteristics identified with lower implied capitalization rates for this asset category mirror those of power centers and grocery-anchored centers, and are as follows: • Shadow anchored; • Location in a trade area with high incomes or high population density levels; • Location with high levels of traffic exposure; • Average remaining lease term that exceeds five years; • Established center with evidence of strong tenant sales activity; and • Less than 10 years old. In addition to looking at market activity over the past 12 months, I reached out to several brokers who specialize in retail and asked two questions. First, has investor demand and market pricing changed much over past 12 months? Second, are investors concerned about interest rate changes in the future and is that impacting pricing at this point? Broker feedback consistently suggested that demand has increased slightly over the past 12 months. One broker reported that several institutional groups are underweighted in retail and are having difficulty sourcing acquisition opportunities. This increased demand is expected to push cap rates down slightly in the near term. Investors are concerned about interest rates and they are watching trends, however, near-term demand is not impacted by investor concerns for rate movement at this time.