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CRE Investors Can Still Profit from Retail Real Estate—If They Stick with Service-Oriented Tenants

Stores selling goods and services that can’t be purchased online are the best bets for retail real estate investment this year.

The high probability of more interest rate increases by the Federal Reserve, and other developments—ranging from geopolitical uncertainty, U.S. political gridlock and U.S.-China trade friction to sliding stock market performance—that made headlines during the recently holiday season are continuing to do so this year.

With so many sources of potential market volatility threatening investors, U.S. real estate remains a relatively safe asset where investors can protect their capital and receive risk-adjusted returns across different market conditions. Foreign investors, especially, will continue to invest in U.S. real estate to avoid currency and market risk. Despite the pullback in Chinese and Russian investments in U.S. real estate due to pressures from their respective governments, investors from Canada, European Union members such as Italy and Spain, the Middle East and other international markets are still eager to buy into U.S. real estate projects.

Sovereign wealth funds for national governments around the world still demonstrate interest in U.S. real estate, so foreign investment dollars will continue to flow into commercial, multifamily, multi-use and other real estate projects this year. As of the end of the second quarter, more than 60 percent of sovereign wealth funds invested in real estate, according to Preqin data, and all sovereign wealth funds with at least $100 billion in assets under management invested in the asset class. Furthermore, 68 percent of sovereign wealth funds invest in private real estate funds, according to Preqin, and of the sovereign wealth funds that invest in real estate, 68 percent of them are targeting North America for investments.

Institutional investors, including pension funds, will also continue to look for investment opportunities in U.S. real estate this year—and in retail real estate in particular. Among the institutional investors active in real estate which were surveyed by Preqin in the second quarter of this year, 69 percent expressed a preference for retail real estate in North America. Of those institutional investors, 26 percent were public pension funds and 28 percent were private sector pension funds. Furthermore, the number of closed-end private real estate funds concentrating on retail investments reached a record high in April 2018, with 183 funds targeting $67 billion in committed capital, according to Preqin.

However, the interest in retail-specific real estate among investors doesn’t necessarily portend positive performance for all retail real estate properties in the coming year. E-commerce has been a tremendous economic disruptor across the country, causing many stores selling items or services that can be purchased online to suffer. Department stores, as well as sporting goods, hobby, book and music stores, experienced negative year-over-year retail sales as of the second quarter of 2018, according to the U.S. Census Bureau and CBRE Research, which also reported that the second quarter was the ninth consecutive quarter in which non-store retailers were the leaders in revenue growth.

What types of retail spaces provide or sell things that “can’t be Amazon-ed?” Yoga and martial arts studios, hair and nail salons, restaurants and delis, take-out eateries, coffee and donut shops, physical therapy and dialysis clinics, gyms and fitness centers, pet stores, and other establishments offering products or services that can’t be obtained on Amazon and through other online retailers are all examples of retail establishments that are well-positioned to survive market downturns. Since the demand for what they provide can’t be satisfied online, these establishments are also the ideal tenants in shopping centers and strip malls because they are more likely to be able to keep up with their rents.

E-commerce is only going to continue to grow as we trek through 2019 and beyond. Real estate investors can capitalize on the retail disruption caused by Amazon and other online retailers by investing in real estate projects involving what “can’t be Amazon-ed.”

When considering equity or debt investments in real estate in the coming year, investors should add “something that can’t be Amazon-ed” to the criteria that projects tied to prospective investments must meet. On the debt side especially, loans tied to properties that offer products or services that “can’t be Amazon-ed” are more likely to provide healthy, risk-adjusted returns to investors—especially if the borrowers have established track records of real estate success in their local markets, and the lenders seek to forge long-term relationships with the owners and operators to whom they lend.

In our time of extreme uncertainty, real estate will continue to be a safe harbor for investors. As we look ahead to the rest of 2019, investors can take this to heart and keep an eye on consumer trends to identify potentially lucrative real estate investment opportunities.

Jonathan Lewis is founder and CEO of JLJ Capital, a middle-market private commercial real estate lender.

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