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Next Chapter in Retail's Recovery

Single-tenant, net-lease assets provide investors with attractive opportunities.

Beleaguered by falling retail sales and consumer demand, retailers faced one of the most challenging years on record in 2009. The intensity of the recession generated high levels of store closures and distress, forcing many retail owners to renegotiate lease terms to prevent space from going dark.

But in the first quarter of 2010, the retail sector began to stabilize. Positive consumer demand was reported in the first quarter of 2010. Retail sales rose 1.6% in March compared with February and were up 7.6% from a year earlier.

As the economy slowly improves, risks to tenants are abating, providing investors with a more solid perception of future revenue potential.

Moribund market resuscitated

This improved visibility has started to generate acquisition activity for investors targeting top-tier assets. Opportunity investment funds seeking distressed properties have become more active, but they have fallen short of allocation targets as lenders postpone foreclosures.

Some buyers, for example, expected last year's bankruptcy filing by mall giant General Growth Properties to bring a wave of distressed properties to the market, but the REIT is in the process of restructuring its debt and will likely not have to liquidate core holdings.

In addition to prime assets in core locations and some distressed properties, single-tenant assets will be among the best investment opportunities this year.

Investment activity for single-tenant assets slowed more modestly than most property segments in 2009, and the sector should be among the first to recover.

Buyer demand will pick up as the stabilizing economy moderates the frequency of tenant-initiated rent renegotiations. Having successfully raised cash on the secondary market, traditional single-tenant buyers, particularly REITs, will actively pursue large properties with national-credit tenants.

Financing will remain a challenge for investors, as banks attempt to limit their exposure to real estate debt.

Gas station sales spike

One sector of the single-tenant market, the gas stations/convenience stores segment, staged a strong performance in 2009. Sales at gas stations accelerated much more quickly than total retail sales in recent months, due in large part to rising oil costs.

The anticipated resumption of employment growth in late 2010 bodes well for continued health in this sector, as an increase in the number of daily commuters will spark demand. More diverse offerings, including movie rentals through Redbox and similar companies, should boost customer foot traffic.

As the economy rebounds, property expansion will take hold, as highlighted by 7-Eleven's plans to open more than 550 locations by 2011.

Sales velocity for convenience stores/gas stations has held up better than for most other single-tenant, net-lease assets, dropping only 15% last year, after peaking in 2008.

The casual dining segment should also recover this year. Corporate chains are positioned to regain market share as conservative consumer spending forces poor-performing restaurants with fewer financial resources to close.

As consumers closely monitored their spending through the downturn, industry sales growth eased to the slowest pace recorded in nearly two decades. A net closure of more than 1,600 restaurants was recorded last year, including a number of independently operated and regionally based restaurants with limited abilities to trim costs.

Large, national chains have fared better than independent restaurants through the downturn, supported by a greater facility to leverage the efficiencies that come with scale to streamline operating costs.

Overall retail investment activity is expected to remain subpar until meaningful job growth resumes. Assets will trade, however, with buyers preferring urban locations in primary markets where population supports demand.

Bernard J. Haddigan is managing director of Marcus & Millichap Real Estate Investment Services. You can reach him at [email protected], or (678) 808-2700.

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