Retail Investment Market Is Heating Up

A rise in the availability of capital has created new opportunities for private buyers.

Private investors are encountering a growing number of buying opportunities in 2011 as the capital markets begin to thaw, improving real estate fundamentals encourage more owners to sell, and banks clear their balance sheets of reclaimed assets.

In the retail sector, private investors account for the largest share of activity. Their share of total dollar volume may remain at reduced levels compared to recent years, as REITs and institutions aggressively compete for quality assets in an effort to place accumulated capital.

In 2010, private investors accounted for 32% of all sales over $2.5 million, down from 50% in 2009, according to researchers Real Capital Analytics and CoStar Group. However, private investors accounted for 70% of all the deals between $2.5 million and $10 million.

At lower price ranges, financing constraints have loosened and will continue to ease. Local and regional banks have become more active lenders, in addition to a few life insurance companies.

Financing for deals under $10 million typically involves five- to seven-year loans at 60% to 70% loan-to-value. While lenders shy away from lower-tier assets with weak fundamentals, the once-prevailing caution gripping the retail sector in the downturn has begun to clear.

As a result, more debt is available for performing Class-B assets, and even Class C-plus product, in strong locations. This includes healthy, well-located assets in secondary markets where capitalization rates remain more than 100 basis points higher than in primary markets.

The increase in available debt creates more opportunities for private investors as REITs and institutions dominate the market for top-tier properties in core metros. Less risk-averse investors with cash will find more distressed assets available in 2011. Last year, private investors accounted for most of the distressed property sales, or roughly 55% of all deals greater than $2.5 million.

Lower-priced deals abound

Most distressed sales involve lower-quality assets priced at $10 million or less. Candidates for acquisition include newer properties built to serve failed housing developments in far-reaching suburbs and aging, high-vacancy shopping centers in less desirable locations.

Some of these properties could offer significant opportunities for investors with long-term hold strategies.

Larger properties in strong locations that encounter difficulties due to store closures or maturing debt, on the other hand, likely will remain top candidates for loan modifications or restructuring, limiting the number of high-quality REO assets coming to market this year.

The private investors dominate the single-tenant retail market, particularly for properties under $10 million. In the fourth quarter of 2010, single-tenant dollar volume rose dramatically to just 22% below peak levels during the boom compared to a 52% reduction in the multi-tenant sector.

Strong buyer demand for single-tenant deals has led to cap-rate compression in recent months, particularly for best-of-class deals, but returns in this segment remain well above the 10-year Treasury yield.

As of the first quarter of 2011, the average cap rate in the single-tenant sector ranged between 7.5% and 8%, while the 10-year Treasury yield fluctuated between 3% and 3.5%.

Investors still face risks. The retail market needs to evolve and reinvent itself amid backlash from the recession and an increase in online shopping. More consolidation and store closures are likely.

During the past year, retail sales less auto and gas increased by just over 5%, while non-store retailers saw a nearly 13% gain in sales.

Online sales still account for a relatively small percentage of all spending, but they will continue to climb in the years to come, undoubtedly having some effect on brick-and-mortar retailers and shopping center operations.

Bill Rose is national director of Marcus & Millichap Real Estate Investment Services' National Retail Group (NRG). Contact him at this address: [email protected].

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