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Stability is something investors crave these days. Maybe that explains why so many financiers of grocery-anchored community shopping centers are keeping busy doing construction loans and grocery properties top the shopping list.

“They are not flashy, they are not trendy but they are the kind of real estate people need — the supermarket, drug store or discount apparel store,” says Andrew Wright, a senior consultant at Reis Inc., a New York-based research company.

That stability has attracted investors who might otherwise have been scared away from shopping centers thanks to the recent demise of major retailers including Service Merchandise and Ames Department Stores.

“The strongest demand over the last several years has been grocery-anchored retail,” observes David Keller, a senior managing director with the Indianapolis office of Holiday Fenoglio Fowler LP, which does business in 11 Midwestern states. “Far and away, grocery-anchored retail has the highest demand of any retail asset class.”

Consider the numbers for retail in general — while most property sectors experienced declines in occupancy and rental rates, the retail sector has held up moderately well. The nationwide vacancy rate in the second quarter remained steady at 7.1% and even the severest critics of the sector don't expect vacancies to drop below 7.8%.

“Investors are looking for best-quality assets in a market,” Keller says. “That's where the focus is. What property has the best real estate fundamentals, good rent rolls, high occupancies and expected low turnover rates for the next three to five years. Investors want investment-grade or close to investment-grade rent rolls.”

When looking for retail investments, Principal Capital Real Estate Investors, which places investment capital on behalf of institutional clients, including its parent organization, Principal Financial Group, has one preference. “Absolutely, grocery-anchored retail is what we like to do,” says Ken Dubas, a managing director with Des Moines-based Principal Capital. “We are doing 3-year to 20-year, fixed-rate transactions and 2-year to 7-year variable transactions,” says Dubas.

Since that market is so competitive, Principal Capital also lends on other types of retail developments, but as Dubas notes, “Everything escalates a notch when you don't have grocery-store anchors.”

Lenders still crave 75% LTV

Most lenders prefer to finance up to 75% loan-to-value, relying on the buyer to figure out a way to come up with the remaining 25% of the deal. Investors looking at a well-anchored community shopping center, however, could get 80% financing, says Dubas. “While competition forces you higher these days, you still have to be selective about which centers you finance over 75%.”

Cap rates for retail, depending on the rated credits, usually run in the 8% range, says Stuart Greenberg, senior vice president and assistant branch manager in GMAC Commercial Mortgage Corp.'s Chicago office. About 60% of the commercial real estate lending done by GMAC's Chicago office involves retail, mostly grocery-anchored centers and single-tenant net lease deals.

Earlier this year, for example, GMAC Commercial did a $5.4 million refinancing on a 53,000-sq.-ft. shopping center located in the northwest Chicago suburb of Streamwood. Completed in the summer of 2001, the center is anchored by a 15,000-sq.-ft. Walgreens Drug Store and a 7,500-sq.-ft. Blockbuster. At the time of the deal, the center was 94% occupied.

“This center was in a very good location, with a Jewel-Osco center adjacent to it and tremendous residential in the area,” explains Greenberg. As a result, the financing was fairly standard: a 10-year term at 7.25% and 27-year amortization.

In this deal, the owner had developed the shopping center and had his own equity in it. Estimating the owner was after a 12% to 13% rate of return, Greenberg notes, “He was looking for a little higher return than somebody just buying an existing center that is all leased up.”

Some deals have a few more hurdles than others. One example — a shopping center refinanced by Holiday Fenoglio in Plainfield, Ind., a western suburb of Indianapolis. This was a 174,000-sq.-ft. center anchored by Kohl's and Old Navy (together about 85,000 sq. ft.). The center opened in 2001 and the $13.3 million, 20-year fixed-rate refinancing replaced the construction loan.

The difficulty was that the deal required an 80% loan-to-value. “Most CMBS lenders were unwilling or unable to provide a 20-year fixed rate and most life companies were only willing to consider 75% loan-to-value,” says Keller. “Finally, we found a CMBS lender able and willing to provide an 80% loan-to-value on a 20-year fixed-rate transaction.”

New York-based DRA Advisors was looking for a north-of-20% return when it snapped up a 425,000-sq.-ft. lifestyle shopping center near Charleston, S.C., from Konover Property Trust for $56.2 million on behalf of its institutional clients earlier this year. “The rate of return is higher than what we [normally] expect,” explains Paul McEvoy, senior managing partner for DRA Advisors, but this property had some “hair” on it. In particular, there was debt in place, leveraged at 80% loan-to-value that couldn't be prepaid for several years.

“We assumed the loan, which is one of the reasons we got good pricing,” McEvoy explains. “It is a big transaction; not many institutions want an 80% loan and not many individuals can afford that size property. We bought the center at an attractive cap rate, about 10%.”

Cap rate comparison

Cap rates for community centers are higher than cap rates on malls and neighborhood centers, explains Scott Wolstein, chairman and CEO of Beachwood, Ohio-based Developers Diversified Realty Corp.

But community centers are also easier to leverage because of the long-term credit leases that can be borrowed against. The higher leverage-to-risk ratio means higher potential return, he says.

“An investor who is buying a mall or neighborhood center with a lower cap rate is making a bet that either the growth rate is going to be higher or there is less risk to the numbers,” says Wolstein. “We are very comfortable in the community center business where there are the best returns.”

On an unleveraged basis, DDR tries to underwrite to 12% internal rate of return (IRR); on a leveraged basis, the company tries to project to a 20% IRR.

Newly formed Rushmore Properties LLC in Chicago is pushing to close its first acquisition, a 250,000-sq.-ft., grocery-anchored shopping center in St. Mary's County, Md. It expects a leveraged return of more than 20%.

“We are leveraging about 72% loan-to-value, leveraging up as much as we can,” explains Jenny Hall a principal with the company. “It improves our internal rate of return. We look at the cash flow, what leverage we can get on the deal, what we think the property could be sold for, and then come up with an IRR that we want to get over a five-year hold.”

Dwinn-Shaffer & Co., a Chicago-based mortgage banking firm, represents insurers and conduits. The company arranged some $600 million in loans in 2001 and hopes to do the same this year.

“The rates are extremely attractive for borrowers and income-producing properties,” notes Leonard Wineburgh, president of Dwinn-Shaffer. Fixed-rate capital can be had for as little as 5.5%, but for floating-rate debt, LIBOR is under 2%. “We just made a deal at 215 basis points over LIBOR,” he notes.

During the past year, Dwinn-Shaffer financed five Best Buy stores around the country, each for 20 years and a 30-year amortization. Without being specific, Wineburgh says the returns are 9.5%-10% on a leveraged basis, and 8.5%-9% on an unleveraged basis.

Steve Bergsman is a Phoenix-based writer.

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