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Retail Real Estate Investors Hunt for Yields in Secondary Markets

Retail Real Estate Investors Hunt for Yields in Secondary Markets

With anchor stores like Giant Foods, Home Depot and Marshall’s, Palmer Town Center in Easton, Penn., is decidedly outside the ranks of trophy properties. Those attributes, however, did not stop 14 investors from bidding on the open-air center before it sold for $32 million.

The transaction generated a cap rate of between 7 percent and 7.5 percent, according to a professional familiar with the deal. Had the property been located in the primary market of Philadelphia, the rate of return might have been as much as 150 basis points lower, says Tom Lagos, executive vice president of Lagos Shopping Center Advisors, a practice affiliated with Los Angeles-based Colliers International.

Still, Palmer Town Center looks like a promising asset for its new owner, which is part of a wave of investors allocating money to healthy retail properties located in urban secondary markets.

“For investors seeking yield, they are more attracted to secondary markets,” Lagos says.

Macro industry research also supports what retail investment professionals are witnessing on the ground. In 2016 investment in secondary urban retail properties increased by 43.5 percent, while investment in primary markets were down 46.1 percent, according to JLL’s Retail Investment Outlook for Q4 2016.

Gateway cities such as Miami and Los Angeles experienced an overall 2.4 percent decline in tourism from international arrivals during the year, particularly from South Korea and Hong Kong. That negatively impacted spending, according to JLL. Combined with a decline in retail investment overall and retailers scaling back physical locations, brick and mortar shopping centers are under relentless pressure to stay competitive.

Retail properties in secondary cities are meeting investor demands for both steady incomes and strong demographics. For those investors, those attributes are more than enough to offset whatever the properties lack in prestige.

Retailers Are Looking Past the Humble Book Cover

As consumers accelerate their shift to online shopping, it seems like retailers will inevitably face the task of cutting back store locations and retrenching to markets that can support strong foot traffic and sales.

Department store retailers are mark locations for closure and some of those units are attracting attention from retailers that want to enter markets with strong demographics that the chains had often overlooked before. These retailers are willing to take over spaces from department stores, even as they develop and refine multi-channel retailing. 

One property in Overland Park, Kan., for instance, is attracting interest from retailers like Nordstrom Rack and Restoration Hardware.

“Retailers are saying to themselves … why not look at markets where we have strong demographic information, and our rents might not be as high, so that we will achieve a better profit margin?”says Anjee Solanki, national director of retail services for Colliers, U.S.

But some institutional investors will not consider retail properties in a secondary market like Fresno, Calif., says M. Daniel Wald, an executive managing director based in the San Francisco office of Cushman & Wakefield, a global real estate services firm.

“They feel capital should be allocated to places where the certainty [of income] is higher,” Wald says. True enough Fresno, Calif., is nestled in the San Joaquin valley and cannot match the tony Bay Area or the fast-paced affluence and wealth of Los Angeles.

Yet that might be short-sighted. One shopping center in the Fresno area offers 13,000 people living within a one-mile ring, and an average household income of about $55,000. The property is anchored by a profitable Bed Bath & Beyond and a grocery store, Ward says. Its regional draw from more affluent areas also works in it favor, raises the average household income of the center itself to about $84,000.

REITs, Focusing on Prestige, Supply a Yield-Hungry Market

Investors might be allocating more funds to secondary market properties, but that does not mean that supply and cap rates are about to drastically tighten in the near term. Retail REITs, private landlords and retailers have been repositioning their portfolios, aiming to stock portfolios with properties in more densely populated trade areas. They are shedding properties that no longer fit into the upmarket core.

Brixmor, a New York city-based REIT specializing in grocery-anchored community and neighborhood centers, for instance, is focusing on acquiring properties in more densely populated and highly productive retail corridors, according to its fourth quarter update on its 2016 acquisition and disposition activity.

In December the company reported that it had acquired the 127,000-sq.-ft. Felicita Town Center in Escondido, Calif., within the San Diego area for $40.1 million. A newly expanded and highly productive Trader Joe’s market anchors Felicita Town Center. Within two months earlier Brixmor had sold two retail centers, one in Pompano Beach, Fla., and another Elyria, Ohio, for a combined $70.5 million. 

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