Last week, Los Angeles-based Westwood Financial Corp. announced it had acquired the 6,336-square-foot Stroh Ranch Retail Center in Parker, Colo. The center — 21 percent leased at the time of the— is emblematic of the type of property that Westwood is targeting as it plans to spend $100 million buying small, distressed strip centers.
Westwood purchased the center for an undisclosed price, but paid half of what the property fetched at the peak of the market.
The company seeks retail centers that contain less than 20,000 square feet of gross leasable area (GLA). Westwood has invested $30 million on those types of assets over the last 12 months. With more properties that fit that mold hitting the market, Dykstra thinks the firm may hit its $100 million goal before the end of 2011.
So far, Westwood has acquired five distressed assets as part of the effort and is continuing to seek properties that range in price from $1 million to $10 million.
Built in 1999, the Stroh Ranch Retail Center in Parker, Col., currently counts Pizza Hut as its only tenant after Blockbuster vacated last year, leaving the property 21 percent leased.
Joe Dykstra, executive vice president at Westwood, says the firm’s philosophy is that in many cases it can acquire small, well-located strip centers with high vacancies, quickly address issues at the property, and re-lease the space in order to quickly flip the stabilized asset back into the market. Generally, the firm is targeting cash-on-cash returns north of 20 percent on these kinds of deals.
“It’s a lot easier to fix these small problems than some of larger properties that might require a long-term business plan,” says Dykstra. “We don’t want to own small properties long term. In most of these properties, the issue is leasing,” he emphasizes.
“We’re looking for properties that are well-conceived. We’re not looking for something at the edge of town. Other than the fact that the rents were above market and it has some vacancy, it is still a good property.”
Dykstra says there have been more of these kinds of properties available in recent months as small banks and special servicers increasingly pursue an exit strategy.
“It’s very clear that servicers and some of the banks are being aggressive in disposing of smaller assets,” he says. “There’s a lot of product out there, and there is a lot more coming.”
Sellers increasingly capitulate
Other distressed retail assets controlled by special servicers and banks have sold in recent weeks. In one case, Houston-based Baker Katz, a full-service commercial real estatefirm and X Team International partner, acquired the 120,000-square-foot Four Corners Shopping Center in Tomball, Texas, for an undisclosed price.
The center includes a 45,000-square-foot former Kroger space and is 35 percent occupied by such retailers as Tuesday Morning, Rent-A-Center, Firestone and Domino’s Pizza. The seller was LNR Property LLC, which obtained the property in foreclosure in 2010.
In another deal, Cardinal Equities, through its affiliate Paradise Capital Group, has acquired from U.S. Bank a 50,000-square-foot retail and office complex in Dos Vientos Ranch, a master-planned community in Thousand Oaks, Calif.
Built in 2008, the property was foreclosed on by the construction lender in late 2009. It is 20 percent occupied. Paradise Capital has engaged CB Richard Ellis to head up leasing for the center.
“This is a wonderfully designed and well-thought-out retail center, and we view it as one of the retail jewels in our portfolio,” Paradise Capital Group President Peter Cohen said in a prepared statement.
“Unfortunately it fell victim to the perfect storm of unforeseen circumstances. We are in a position to aggressively market the office and retail space in order to attract the best possible tenant mix to serve Dos Vientos and the surrounding area,” added Cohen.
Dykstra strongly believes that Westwood has several competitive advantages it can exploit in pursuing these types of deals. The properties it is pursuing are smaller than what most firms it size target, so it is competing instead with local buyers who might not as be well capitalized. Westwood tends to pay all cash in these deals, enabling it to close quickly.
Moreover, as a firm with a large portfolio of shopping centers, Westwood has relationships with national tenants.
As of December 31, Westwood owned 104 retail properties —predominantly neighborhood centers — that contained about 6.4 million square feet of retail GLA. It has inked deals with several big-name tenants, including Chipotle and Massage Envy to fill vacancies at some of the other small, distressed retail centers it has acquired.
By and large, the issue facing most distressed retail centers that Dykstra visits is that the properties were acquired by their previous buyers at the height of the market with large amounts of debt and rents north of $30 per square foot.
At the peak of the market, shopping center effective rents nationally topped out at $17.64 per square foot in the first quarter of 2008, according to Reis Inc. At the end of the first quarter of 2011, effective rents were $16.55 per square foot.
In the last few years, however, many retail centers have experienced a rise in vacancies coupled with a dramatic drop in market rents as retailers have retrenched.
“If you lose two or three guys, you might be breaking even, or maybe even losing money and under water on your loan,” says Dykstra. “You don’t have cash flow. You run out of reserves. And then you have no ability to pay tenant improvement allowances or broker commissions to re-lease the space, even at lower rents. So, you’re stuck.”
Some of these centers have sat languishing for 18 to 24 months as lenders or receivers came in and did little to resolve the issues. But today, as the investment sales market has begun to heat up, there is new motivation to sell the centers.
Many special servicers have much larger distressed assets that require their full attention, so they have a sense of urgency about disposing of the smaller assets.
Not for the faint of heart
When Westwood takes over a financially troubled property, it often has to cover a ton of expenses including foreclosure costs, back taxes, rent taxes, deferred maintenance, and other assorted costs that are not typically part of transactions for stabilized centers. Still, taking all that into consideration, the firm expects it can generate its 20 percent cash-on-cash returns.
In many cases — because the previous owner was paralyzed and had no ability to pay broker fees or tenant improvement (TI) allowances — potential tenants may have shied away.
“You have to reintroduce property to the market,” says Dykstra. “But you put your name out there, and now maybe tenants take another look.”
All told, Dykstra says that the firm is generally able to sign leases in the “high teens to low $20s per square foot range” on these assets.
Previous Westwood purchases toward the firm’s $100 million goal include the September 2010 portfolio acquisition of 68 former McDonald’s-owned properties located across the U.S.
Westwood also has purchased a non-performing note, a real estate owned (REO) strip center, and an opportunistic investment property from a private individual, all within the last year.