CREJ - Retail Properties Quarterly - November 18, 2015
In 2015 we have seen many of the bullish predictions for the Denver metro market realized. Vacancy rates fell and are on pace to decrease approximately 80 basis points on the year to 5.2 percent. Rental rates increased by 2.4 percent thus far and are projected to increase a total of 3 percent on the year. Job growth is robust and varied across several sectors. Denver’s strong fundamentals and continued growing economy attracted significant interest from investors across the country, with sales of multitenant retail properties increasing by 22 percent over the last 12 months. Many investors now view Denver as a primary market competing for their investment dollars along with the U.S. coastal markets, which have long attracted investors due to their strong fundamentals. The investment sales market is red hot with multitenant-retail investment properties average price per square foot increasing 9 percent to $255. Single-tenant retail sales increased 15 percent, with a 7 percent increase in the price per sf to $330. Grocery-anchored centers, Class A power centers and net-leased, single-tenant properties leased to tenants with a strong credit profile are the most sought after product types. They currently are trading at capitalization rates as aggressive or, in some cases, more aggressive than they were prior to the downturn in 2008-2009. One of the most high-profile transactions in the last quarter was Metlife Real Estate Investors’ purchase of Clarion Partners 80 percent interest in the Denver Pavilions for $106.19 million. Gart Properties retained its position in the property, indicating the property (as a whole) was valued at just under $133 million, at a reported 5.5 percent capitalization rate. With many investors priced out of these higher-quality, more aggressive segments of the market, we see an increase in activity in transactions of Class B and C shopping centers without an obvious “upside” angle. These centers are stabilized, have a limited number of national credit tenants, and typically were built 20 or more years ago. In general, they have been trading at cap rates between 7.75 percent and 8.75 percent, depending on their location and tenant mix. Since 2009 these centers made up only a small percent of the investment sales market. However, as many private and entrepreneurial investors are unable to achieve their desired returns in the equity markets and the more aggressively priced retail centers, these centers have proven to be a good value that provide strong cash-flow streams when financed with the cheap financing currently available. Value-add shopping centers with major problems to fix or centers with high vacancy rates also are highly sought after, but with vacancy rates declining and the overall market improving, the supply of these centers continues to decrease, resulting in a limited number of transactions. New retail developments remained relatively limited, with only 640,000 sf delivered in the last 12 months, much of which was single-tenant retail buildings. This is changing, however, as there are currently 3.2 million sf of retail developments in the pipeline. The bulk of these new developments are in the outlying suburban markets, such as Alberta Development’s Promenade at Castle Rock, or the recently announced Simon Property Group development Denver Premium Outlets in Thornton. The limited supply of retail space and strong tenant demand put upward pressure on rental rates and downward pressure on vacancy rates. After years of flat or very low rental rate growth, we are on track to see 3 percent growth by year’s end. Downtown Denver, Cherry Creek and the Colorado Boulevard corridor remain the most sought-after submarkets. A key question regarding the future strength of the retail market as we enter 2016 is when the Fed will raise the federal funds rate. Predictions are all over the map; however, the markets are predicting a better-than 50 percent chance the first increase occurs prior to March. This expectation of raising rates in the near term is resulting in a number of buyers aggressively pursuing sound investments with a desire to lock-in historically low interest rates. In addition to the question of when interest rates will rise, there also is a question of how much a hike in the federal funds rate will affect the 10-year Treasury and 10-year swap rates, which are the key benchmarks for commercial real estate loans. One or two small bumps in the funds rate may or may not have much of an impact on the key benchmarks (and the interest rates that can be obtained on commercial real estate financing). However, any such increases will exert upward pressure on these rates. A sharp upward movement of 60 to 75 basis points or more in loan rates would have a substantial negative impact on retail real estate values. Most likely we will know the answers to these questions within the next 12 months.