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Manhattan Retail Condo Sale Could Signal Trend for Wealthy Foreign Chains

Manhattan Retail Condo Sale Could Signal Trend for Wealthy Foreign Chains

A high priced retail condo acquisition in midtown Manhattan by Spanish firm Inditex signals that now is an opportune time for well-capitalized foreign retailers to buy flagship properties in major U.S. cities.

While retail condominiums don’t come on the market often, seven brokers Retail Traffic spoke to say that in the right locations, the condominiums can be a surefire investment due to their popularity with potential tenants and high income streams.

“The number of transactions involving retail condominiums has definitely increased in recent years,” says Gary Schwartzman, managing director of the retail group with Grubb & Ellis, a commercial real estate advisory firm. “In the urban markets, particularly New York, Chicago, and to some extent Boston, Miami and Los Angeles, retail companies started to see this strategy as being as smart one. But in addition, the number of foreign investors coming into urban areas is generally larger. Investors’ appreciation for retail real estate is growing very quickly.”

What’s more, in the current climate, with the U.S. commercial property market on the mend and the dollar falling relative to other currencies, foreign companies might feel they have a limited window of opportunity to strike favorable deals.

The catch is that they need deep pockets to finance these transactions.

On Friday, Inditex Group, which operates retail chains Zara, Pull & Bear, Massimo Dutti and Stradivarius, revealed it agreed to pay $324 million to buy a 38,750-square-foot retail condo at 666 Fifth Ave. in New York City from a joint venture led by the Carlyle Group. The price works out to $8,361 per square foot, the highest figure ever paid for a retail space larger than 5,000 square feet, according to New York City-based real estate research firm Real Capital Analytics.

Savills LLC, a global real estate services provider, represented Inditex in the transaction. As part of the deal, Savills negotiated an early termination of a lease on an NBA Store that formally occupied the space. Inditex plans to operate a flagship Zara store at the location.

“The opportunity to acquire this [kind of] location doesn’t come along often,” says John D. Lyons, CEO of Savills LLC. “It’s totally unique and you can’t replace it with something else. And so when these kinds of opportunities arrive, we see overseas sources be aggressive in wanting to acquire those sites.”

International intrigue

Lyons says foreign investors, including some retailers, have shown an increased interest in acquiring sites in major U.S. markets of late because American real estate is seen as both stable and offering high returns on investment.

In fact, Savills recently formed Savills Cross-Border Investments Group, which focuses exclusively on helping foreign investors acquire real estate in the United States. The group is run by five investment professionals.

Today, foreign investors are largely interested in primary markets, according to Lyons. On the retail condo side in particular, he lists New York, Boston, Washington, San Francisco, Los Angeles, Chicago and Miami as the most likely cities to see the kind of deal Inditex just announced.

Recent data backs up Lyons’ observations. A survey published in January by the Association of Foreign Investors in Real Estate (AFIRE) found that more than 60 percent of respondents named the U.S. as the country offering the best potential for capital appreciation. In addition, New York and Washington, D.C. ranked as the two top global cities. Meanwhile, retail ranked as the second most favored asset class, trailing only the multifamily sector. (AFIRE’s survey respondents hold more than $627 billion in real estate around the world.)

Scarce supply

While retail condominiums in prime locations are considered an excellent investment, most brokers suspect that it will be largely foreign retailers that will pursue such acquisitions.

One reason is that buying opportunities continue to be rare, according to Ron A. Solarz, executive managing director with Eastern Consolidated, a New York City-based real estate investment services firm. Solarz recently sold two retail condominiums in Manhattan, anticipates closing the contract on a third and has started marketing an 11,400-square-foot retail condo in Soho. (The listing price on the property is $17.25 million).

In general, however, “demand is greater than supply,” Solarz says. “There are more investors and users looking for deals than there are spaces to show them. It’s a seller’s market.”

That’s because once investors get a hold on a retail condo in a world class city like New York, they tend to hold onto it for the long haul, says Brad Mendelson, executive vice president with Cushman & Wakefield, a commercial brokerage and consulting firm. After all, vacancies at such properties are rare. And if a tenant does leave, the owners usually don’t have to wait long to find a new retailer to backfill the space. Plus, rents in prime urban retail corridors tend to be sky high.

In fact, the condo at play in the Inditex deal is a rare example of a retail condo changing hands twice in a relatively short time frame. The condo Inditex acquired was part of a larger deal about three years ago. At that point, a joint venture led by the Carlyle Group bought a 49 percent interest in an 84,855 square-foot condo at 666 Fifth Avenue that included the NBA Store along with a Brooks Brothers and a Hickey Freeman. The venture paid $525 million for the space, which works out to $6,187 per square foot, according to Real Capital Analytics.

For Inditex to rent the space on a 15-year lease would cost approximately $300 million, according to Schwartzman. (That’s what the value of Uniqlo’s lease at the same address works out to.) The $324 million Inditex paid is higher than that, but ownership gives the firm full control over the space and enables Inditex to lock in its real estate costs long term, Schwartzman notes.

Priced out

Inditex, however, may be among only a handful of retailers that can afford to pay that kind of premium. The scarcity of available condo supply means that when one does come to market, the asking price is often more than most retailers can afford to pay. Solarz says he’s been showing condos to plenty of retailers, but as a rule, they get outbid by wealthier investors.

In the case of the 666 Fifth Avenue deal, Inditex was able to win out in part because foreign chains have an advantage over domestic retailers due to the favorable currency rates. In addition, it’s one of a few foreign players with access to enough capital to make this kind of deal, according to Mendelson. In Indetex’s case, an investment arm run by major stakeholders in Inditex bankrolled the deal. Other retail operators that have the capital and the financial structure to make high priced retail condo acquisitions include H&M, Top Shop and Uniqlo.

What’s more, Inditex’ investment division has a history of buying occupied retail condos, so it doesn’t always end up as a direct user of the space, Mendelson adds. Mendelson and Cushman & Wakefield represented the owners of 666 Fifth Avenue in leases with Uniqlo and Hollister.

“They can finance it differently, they’ve got different credit sources, they’ve been doing it for a while,” he says of Inditex. “I haven’t seen any domestic retailers go into the real estate side of it; certainly, the opportunities have been there.”

Culture, too, may be a factor.

Most European retailers prefer to own their stores because retail leasing in European countries tends to be more complicated than in the U.S., say Annette Healey, senior vice president, and Nina Kampler, senior managing director of urban retail, with CB Richard Ellis, a commercial real estate services firm. So when market conditions in the U.S. favor acquisitions, like they do now, the European chains jump at the chance to buy good assets. In contrast, U.S. retailers largely prefer to focus on operations and stay out of real estate ownership.

Going forward, more U.S. chains might look into purchasing retail locations instead of leasing them because the strategy might help them capture the inherent value of the asset, says Lew Kornberg, head of the corporate retail solutions team with Jones Lang LaSalle, a Chicago-based real estate services firm. But he notes that there aren’t enough retailers well capitalized enough and enough condos valuable enough to spark a major change in the mentality of U.S. chains.

“The Inditex transaction is a real statement, it’s planting a flag in a huge way, given the cost of that real estate,” Kornberg says. “But when buying in New York, the underlying real estate is inherently valuable. That’s not the case in outlying markets. I think there are a handful of locations in the U.S. where this may be the front end of a trend for very well capitalized retailers who believe they are dramatically mitigating their risk by buying the underlying asset.”

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