Institutional, Foreign Investors Target Quality Assets and All-Cash Buyers Jostle for Smaller-Than-Expected Pool of Distressed Properties while Investors Continue to Ignore Middle Market
While still a far cry from the avalanche some predicted would hit the market a year ago, distressed shopping malls and strip centers have contributed to a marked increase in retail sale activity this year. At the same time, a rush by institutional investors to pick up quality core properties at the other end of the retail property spectrum has also led to an increase in retail property sales in a number of large metro markets, according to CoStar Group data.
Houston, Tampa/St. Petersburg, South Florida, Long Island, Boston, Detroit, Philadelphia, Los Angeles, Denver and Phoenix all reported double-digit increases in retail property sales volume in the second quarter. Distressed transactions as a percentage of overall retail property sales activity continues to rise, albeit as more of a trickle than a flood. Such deals account for as many as one in five sales, which are easily snapped up by opportunistic capital.
Meanwhile, among a second group of investors, a scarcity of core assets coming to the market has resulted in multiple bids, leading to firmer closing prices. These two groups are driving the sales transaction market at present. “At some point, their appetites will be satiated through more product coming to trade and the bifurcation will end, or else they will learn to eat elsewhere,” CoStar Real Estate Strategist Suzanne Mulvee said in a report.
Some larger deals closed in the second quarter, lending some hope that a stronger uptick in trading is on the horizon. Kimco Realty Corp. sold a 33-property retail portfolio, including assets in Florida, Southern California, and the Washington, D.C., area, for $370 million. Simon Property Group acquired a stake in the 2.3 million-square-foot Galleria mall in Houston for an estimated $260 million. In Detroit, the 1.1 million-square-foot Westland Shopping Center mall traded for $80 million, the same price it last sold for in 2003.
In general, these trades involved properties with high occupancies and good credit tenants. The other type of deals getting done today are foreclosure sales and single-tenant, net-leased properties, with few buyers seeming to be willing to take a chance on tenancy risk. This distaste for high vacancies is reflected in the rock bottom discounts some buyers are receiving. In Cincinnati, World Properties picked up the 1.4 million-square-foot Cincinnati Mall for $10.5 million, a surprising $7.50 per square foot paid for an asset that traded for $70 million in 2002. In the Chicago suburb of St. Charles, Moison Investment Co. purchased the 847,000-square-foot Charlestown Mall for $9.5 million, or $11 per square foot.
But who are these investors, many of whom are bidding ferociously for core and core-plus assets as well as deeply distressed shopping centers in big coastal markets in Southern California, New York, Philadelphia and Washington, D.C.? And what will become of the huge “middle market” of troubled and stabilized non-investment-grade properties in secondary and tertiary markets across the country?
CoStar set out to get the views of executives and experts with some of the nation’s largest retail brokerages to measure the depth and prospects of the recovery in retail investment markets. They reported strong and steady activity in the ‘extremes’ of the retail property — “extremely well-located and well-tenanted” Class A centers with strong anchors, and “extremely distressed” shopping centers with upside potential, for which investment funds have stockpiled tens of billions of dollars over the last two or three years.
“The retail investment marketplace in Southern California has seen a flurry of activity in the past several months, causing some excitement in what has otherwise been a very quiet year,” said Edward B. Hanley, president of Hanley Investment Group Real Estate Advisors, citing two-month period in which the firm has sold seven shopping centers totaling more than $40 million and more than 250,000 square feet. Hanley is marketing three more grocery-anchored neighborhood shopping centers at a price totaling $112 million.”
“There seems to be a more steady supply of distressed opportunities in markets outside Southern California,” too Hanley added, “and therefore I am seeing evidence of buyers from Southern California chasing those properties.”
“In addition to a few high profile bank-owned properties, we have also seen more equity sellers begin to come to the market with institutional quality shopping centers,” Hanley said. “Although the market fundamentals for retail properties still have some time left to completely recover, look for retail investment sales activity to increase as investors begin to tire of waiting for the avalanche of distressed opportunities that has failed to materialize. The equity sellers range from partnerships and family trusts to institutional owners. The buyers include syndicated groups, high net worth individuals, some institutional companies and numerous funds.”
Factors helping break the stalemate between buyers and sellers include falling capitalization rates and stabilizing pricing combined with positive news from the economy and capital markets that are combining to make now the best time in years to enter the market, some analysts said.
“The flow of distress is not slowing down for one minute,” said Donald MacLellan, senior managing director, Faris Lee Investments. “As the economy continues to trudge along with no real recovery in consumer spending and jobs, you’re going to continue to see distress, especially with all the loan maturities happening.”
That should lead to more investors making the decision to buy, he added.
“The attitude of the investor is completely different now than in 2009. On stabilized assets, there’s lending out there, and there’s tremendous capital available on the distress side. We’re seeing multiple offers on distress throughout the markets, whether it’s Phoenix, California or Las Vegas.”
MacLellan, along with Faris Lee President Richard Walter, represented Miami-based special servicer LNR in the $11.75 million sale of The Town Center Ontario, a 128,330-square-foot distressed property that was 85% vacant. French company Oxylane Groupe, one of the largest manufacturers of sports apparel and equipment in the world, paid all cash for the 8-year-old center, where it intends to open one of its first U.S. retail locations.
This transaction helps illustrate why the flow of distressed and foreclosed property has been more of a slow mud slide than an avalanche. High vacancy caused the property to fall into receivership 16 months ago. The eventual foreclosure offered buyers the opportunity to acquire it at a much lower basis than those of other competing centers in the area, Walter said. Faris Lee sought out owner-users to address the tenancy issue and worked closely with special servicer LNR. Providing an additional level of complexity, Oxylane Groupe has no U.S.-based personnel, which made making it more time-consuming to qualify it as a buyer.
“In this current market, we’re finding that distressed retail transactions require a strategic mix of expertise,” Walter said. “The team needs to understand location, market timing and have a depth of experience working with everyone likely to be involved in the transaction including owners, lenders, retailers, servicers, receivers and, in this case, city officials,” Walter said.
Hospitality and retail are the two largest and fastest growing areas in the distressed portfolios, MacLellan said. While the disposition of retail real estate by special servicers is much higher in 2010 than in 2009, and continues growing, servicers have only so much capacity and personnel to process transactions. Lenders and servicers can take up to 18 months to move a property from receivership to sale.
“There has been a lack of flow on the distressed side compared to what we thought was going to happen a couple of years ago, just because of the intricacies of CMBS debt and borrowers, who try and restructure the debt and modify the loan,” he said. “There’s a lot of negotiation, and that takes a while.”
“We’ve seen quite a bit of offer activity on distressed assets,” MacLellan said. “There’s a pent-up demand and a lot of capital. We have 26 offers on a two-story 25,000-square-foot retail-office deal in South Orange County (CA). It’s an REO receivership sale for a CMBS lender and the lender will finance, so we got tremendous interest. We’re seeing that across the board, whether it’s a higher profile lifestyle center REO or a strip center. We have a single-tenant asset that got nearly 10 offers.
“The offers are coming from all across the board. There are the private, high-net-worth investors who have sold companies and invested in distress. You have overseas money, whether it’s strictly an investment group, or in our case, an owner-user. Or you have opportunity funds created in last couple years, developer-operators, value-add — all of them have been on the sidelines for the last 2-3 years.”
MacLellan said there’s a pent-up demand also for core retail, stabilized and well-anchored with grocery or drug stores. But there hasn’t been much of it on the market.
“The pension funds are chomping at the bit to fund some core retail, but it’s not really out there. They’ll pay strong prices, but that’s just because alternative investments are pretty low. You either see core-plus which is stabilized institutional property, or distressed. Those are the two markets where there is pent up demand and limited supply.”
“Both the core and distress are highly desirable. The stuff in between has to be priced right.”
There is tremendous pent-up demand nationally for quality retail product and some of it has surfaced to the market or been in off-market situations a fair amount over the last several months, remarked Kris J. Cooper, managing director, capital markets, Jones Lang LaSalle in Atlanta.
“There is actually what we consider a bubble in the market because even though retail has not recovered fully, there is significant downward pressure on cap rates and increasing prices on core product. Cap rates have not gone down to the boom period, but they are aggressive. Most buyers want grocery anchored product which they feel is the most stable.”
The core buyers are the combination of institutional, REITs and a few private and foreign, German and others. The distressed buyers are primarily private, Cooper said. Distressed buyers have been very active throughout 2010 and while they have different agendas, they are only paying on in-place NOI.
“The lenders are coming back, so liquidity has somewhat returned to the market, but most distressed buyers are still paying all cash,” said Cooper.
“The next 12 to 18 months will see more distressed assets that are finally priced to actually sell, and hopefully more class A, B and C assets.
Alan N. Pontius, national director of commercial leased investment properties for Marcus & Millichap, who now oversees the National Retail Group, said the opportunities to get quality cash-flowing real estate with funds earmarked to produce stable returns on a comparative basis “looks better than ever at the moment.”
“What you see is a shortage of quality product, a landscape with low yields, and you have funds with definitive time frames to be invested or they have to be returned. You put all these things together at one time, and that’s why you see ferocious bidding on the highest quality assets,” Pontius said.
“Even though the economic picture, especially on the jobs front, looks like it’s been muted again and growth outlook and the economy continue to be choppy at best, we’re still past that horrendous period of late 2008 to mid ‘09. So if I’m an investor, I’m thinking if we still have some rough patches to work through, I don’t think there’s heavy downside risk. The interest rate environment is fantastic, the yield is very low and it seems logical that if I lock up truly quality real estate today, it’s pretty good timing.”
“If I’m a seller and looking at an asset and trying to determine my timing, and this is an asset that’s running to the end of its hold period, if I believe I’ve stabilized that asset today and NOI growth from today to a year from now is nominal, I’ve got to think this is a great time to enter the market as a seller with a quality asset.”
“There is huge demand for quality product right at this minute, and as a seller I can take advantage of that condition.”
Buyers are eager to find good quality grocery anchored retail properties with limited risk, added Jones Lang LaSalle Managing Director Margaret K. Caldwell.
“There is a ton of capital chasing these types of deals, but not the same investors that are or were interested in purchasing troubled assets. More institutions are considering selling core assets due to the decline of cap rates to near-historic lows. While cap rates might be close to levels where properties were originally purchased, in many cases the NOI has deteriorated.”
Unfortunately, Caldwell said, many potential sellers cannot recover their initial investment.
“If this situation did not exist, there would be more sellers. We are experiencing all types of investors attempting to purchase retail; it just depends on the quality of the deal,” Caldwell said.