It's becoming apparent that for retail real estate investors, 2008 has been the year to “wait and see.”

But the issue isn't that investors don't have money to spend. It's quite the opposite in fact. In the first half of this year, private equity firms, pension funds, insurance companies and public and private REITs amassed tens of billions of dollars for investment in commercial real estate in the United States. But with their laser-like focus on top-quality assets in the best locations and high long-term yields, they haven't had the opportunity to deploy much of that capital, industry sources say. And they might not begin buying in earnest until midyear 2009.

Take Greenwich, Conn.-based shopping center REIT Urstadt Biddle Properties Inc. It's not one of the largest players in the REIT universe, commanding a portfolio of just 3.7 million square feet. But it's always been a solid performer. For the second quarter of 2008, ended April 30, Urstadt Biddle reported FFO per common share of $0.28 and FFO per class-A common share of $0.30. Its core portfolio occupancy stood at 92.4 percent.

The company has plenty of cash with which to grow. Urstadt Biddle has set aside between $75 million and $100 million in equity for new purchases this year (capital that can be extended through prudent use of debt). “We're definitely aggressively out there pounding the pavement,” says Joanna Rotonde, acquisitions manager with the firm. However, the firm has spent only a quarter of that money with two closed deals and a third under contract, according to James Aries, senior vice president and director of acquisitions for the firm.

What's it waiting for? According to president and COO Willing Biddle, the firm has been actively searching for new assets, but the issue is that cap rates still haven't risen to where they need to be for acquisitions to make sense. “If cap rates continue to rise and buyers are willing to adjust their expectations and … we are able to sell stock at appropriate prices, then we would … allocate more capital to shopping center investments,” Biddle says. Biddle adds, he expects cap rates to rise another 50 to 75 basis points across the board, with higher increases for class-B properties than class-A properties.

Similar calculations are being made in boardrooms across the country. Players have purchasing power, but they feel the conditions have not deteriorated enough to justify major buying sprees. In the first half of this year, U.S.-based opportunity and real estate funds raised $33 billion, according to Private Equity Intelligence Ltd., a London-based firm that tracks real estate private equity funds. Furthermore, opportunistic small cap investors held $54 billion for investment in the first quarter, with between $6 billion and $8 billion set aside for retail, estimates Stephannie Mower, executive vice president and managing director of national investment services with PM Realty Group, a Houston-based real estate services firm. However, the sales volume on retail property during the first six months of the year amounted to just $12.2 billion, according to New York City-based Real Capital Analytics. That figure represented a 62 percent drop from the first half of 2007. The biggest sales commitment to date has been Centro Properties Group's agreement to sell 29 centers totaling 5.1 million square feet from its Centro America Fund to an unnamed private real estate advisor for $714 million. But the deal, which is scheduled to close in early fall, is somewhat of an anomaly, since Centro faces enormous pressure to pay billions of dollars in debt it took on to fund large acquisition sprees in the heady days of 2007. Centro reported that it incurred a 10 percent discount to the portfolio's previous book value in the transaction.

Companies actively searching for buying opportunities include Credit Suisse, Goldman Sachs, Forsyth Partners, MSD Capital, Behringer Harvard and Washington RE Investment Fund, among many others, according to Mower. Even some public REITs — Kimco Realty Corp., Urstadt Biddle, Cedar Shopping Centers, Acadia Realty Trust and Inland Real Estate Group of Cos., among others — remain on the lookout for acquisition opportunities.

Right now, what all buyers have in common is they want to deploy their money more carefully than in years past, since lack of available credit means they have to put more of their own cash into each transaction, says Gerard V. Mason, executive managing director in the New York City office of Savills, a global real estate services provider.

Making the grade

The biggest issue holding back buyers is insecurity about the retail real estate landscape. No one wants to take on excess risk in this environment. That means many buyers are very hesitant to consider purchasing class-B properties at all. If they buy, they want returns in the low to high teens and they want them now, says Joseph C. French, national director of retail properties with the Irvine, Calif.-based investment brokerage firm Sperry Van Ness. Current pricing and the amount of equity necessary to complete deals don't allow those kinds of returns.

Meanwhile, the risk environment has become more precarious. Retail vacancies continued to climb — in the second quarter, vacancies at shopping centers averaged 8.2 percent, a 50-basis-point increase from last year, according to Reis, Inc., a New York City-based provider of commercial real estate information. Store closings are piling up. Expansions are slowing. And people are generally worried about the deteriorating state of the economy.

“Come Christmastime, things will probably be even less exciting than they are today from a retail standpoint,” says Arthur M. Milston, managing director with Savills. As a result, “if it's a class-B center, [opportunistic buyers] are taking a pass on them,” according to French, and if it's a class-C property it becomes virtually unsellable.

What's more, even class-A assets in primary markets are receiving more scrutiny. Buyers want to know not only how well-leased a property is and what the rents are, but they are keeping an eye out for any potentially troubled tenants. The last thing they want to walk into is a situation where a tenant paying above-market rents files for bankruptcy or closes a store and leaves them in a situation where they will be unable to re-lease the space and still get the same rents, notes Robert Bach, senior vice president and chief economist with Grubb & Ellis, a Santa Ana, Calif.-based commercial real estate services firm.

Buyers also want to know which part of the market the center serves, who the tenants are, what kinds of rents are currently being charged and how they compare to similar properties in the surrounding area, as well as how much competition is out there. “All of those factors will be part of how you underwrite the deal and then you look at your 10-year growth hold and combine it with the risk, and given the pressure on the economy, your likelihood of leasing up vacant space needs to be more conservative in your underwriting than it was in the past three years,” says Daniel Taub, COO and senior vice president of acquisitions with DLC Management Corp., a Tarrytown, N.Y.-based owner and manager of shopping centers. “The cap rate then becomes a very property-specific number.”

Urstadt Biddle, for example, recently paid a mid-seven cap — not a discount number by today's standards — for a 60 percent interest in Ferry Plaza Shopping Center, a 63,433-square-foot shopping center in Newark, N.J., a secondary market. But the center's anchor tenant, Pathmark Supermarkets, is the dominant grocer in the Ironbound section of the city. That made the REIT feel confident about the long-term value of its investment, according to Rotonde. “Each situation is different,” she says. “If it's a center in a lower income area, but it's doing great numbers, we'll take it.” Ferry Plaza is valued at $26 million and features an existing first mortgage of $11.9 million.

Because of the risk factors, however, buyers are generally setting their sights on class-A properties with few leasing concerns. The problem is that owners who hold centers of such high quality only want to sell if they can achieve 2007 cap rate levels. Short of achieving that, they are content to hold their properties and wait out the market, adds Charles J. Urstadt, CEO of Urstadt Biddle.

“As an institutional investor, you really want to focus on the urban centers and you can't get your hands on those,” says David Lynn, managing director and head of research and investment strategy at ING Real Estate, the real estate arm of the global financial services firm ING Clarion, which earlier this year set up its own acquisition vehicle, ING Commercial Real Estate Opportunity Fund, with $250 million in equity earmarked for income-producing residential and commercial properties and land loans. “The sellers were experiencing rapid cap-rate compression in the past few years and they got spoiled by it.”

Class-A centers have been slow to come to the market, says Richard Walter, president of Faris Lee Investments, an Irvine, Calif.-based national retail brokerage firm. The owners who are putting properties up for sale right now are doing so primarily because they need to raise cash and not because they are in distress, so they are still holding on to their best centers, he notes. That has been the experience for Stonemar Properties, a New York City-based real estate investment firm, which planned to buy centers worth $150 billion this year, with a focus on class-A and class-B properties in secondary and tertiary markets. So far, Stonemar only spent half of that money because sellers have not been putting high-quality centers up for sale, says Jonathan Gould, CEO of Stonemar.

“We are going after first-quality properties, but it's just there is not that much that we see that we are even interested in pursuing right now,” Gould notes. DLC Management Corp. serves as another example of the frustration cash-flush investors face in the current environment. At the beginning of the year, DLC earmarked $250 million in equity for new acquisitions, with a focus that tends to be less narrow than that of many other opportunistic buyers. The firm goes after value-add assets in secondary markets as long as they promise to bring in high returns. As of mid-August, however, DLC had only closed on one transaction, a 133,000-square-foot Bigg's-anchored shopping center in Cincinnati that took just $10 million in equity to complete. “There is still a wide gap between our underwriting and sellers' expectations,” says Taub. “This year we would expect to see [fewer] deals to look at, but we have actually seen an increase. That said, we've only closed on one deal.”

There is general agreement in the market that cap rates do need to rise further to help move buyers from the sidelines and back onto the playing field. In the past 12 months, cap rates on grocery-anchored shopping centers have moved 40 basis points, to approximately 7 percent, according to Bach. But if the credit crisis does not abate, they will likely rise another 50 basis points to 100 basis points. That means until sellers are willing to accept cap rates of up to 8 percent on class-A assets, experienced real estate players will continue to wait.

According to Lynn, it's because “nobody wants to be a sucker” and start buying before the market has hit bottom. And the consensus among sales brokers is that we are not there.

So long value-add?

Besides appropriate valuation, opportunistic buyers want to avoid taking on properties that need any work at all. The so-called “value-add” play has almost vanished. With a few exceptions, including DLC and Urstadt Biddle, buyers want to focus on the best quality centers in core markets, says French.

For example, although Inland Real Estate Group of Cos., which year-to-date acquired shopping centers worth $576 million, is willing to look in densely populated secondary markets, it will not consider purchasing any asset that needs additional work. The firm wants top-notch properties, with strong tenants, preferably the kinds of centers consumers visit more than once a week.

“I am not looking for the centers where I have to completely redevelop them, put a new face on them, put in a new parking lot,” says Joe Cosenza, a vice chairman with the Inland Real Estate Group, an Oak Brook, Ill.-based REIT and president with Inland Real Estate Acquisitions, Inc. “I don't have time for that right now.”

If a property features a vacancy rate of more than 30 percent, investors don't want to risk putting a lot of equity into it, adds Walter. They want quality real estate.

Distressed debt signals

One factor every buyer is monitoring is the situation in debt markets. The idea is that some owners may have expiring debt that needs to be refinanced and with debt markets the way they are, borrowers are looking at much more expensive debt. As of the second quarter, however, commercial mortgage delinquencies totaled just 2.1 percent according to Foresight Analytics, an Oakland, Calif.-based provider of real estate market consulting services. (In contrast, the delinquency rate on residential mortgages was 6.4 percent through the end of the second quarter, according to the Mortgage Bankers Association.) As a result, few owners are being forced to sell.

Whether the credit markets, and the commercial mortgage-backed securities (CMBS) sector in particular, will begin to thaw in the near future and how much their behavior will affect the number of retail foreclosures remains a mystery for most researchers. So far, default rates have remained minimal, says Mower, and not many people have had to refinance. As of the second quarter, only 4.1 percent of the $770 billion in outstanding CMBS debt needed to be refinanced, according to Reis, but the number will climb as maturities on loans made in 2006 and 2007 begin to come up.

Even if a significant number of owners have a hard time refinancing their properties, the banks might take a lenient stance towards them, according to Milston, because securitized loans, which cover a wide range of properties, can be so difficult to unwind.

“It's a more convoluted process now than it was in the 1990s,” he notes. “In some instances, lenders will want to force a sale, but in a lot of [cases] they will try to extend the loan without taking back the property.”

With few centers facing foreclosure, the retail sector might not see the kind of buying frenzy many are expecting, according to Walter. If this year's retail investment sales volume reaches a third of what it was in 2007, when transactions worth $65 billion closed, we should consider ourselves lucky, says Mason. And next year, everything will depend on what happens in the credit markets, a question that remains hard to answer at this point.

If the credit crisis is not resolved within the next 12 to 18 months, however, it could spur more activity. “When the CMBS refinancing deals start coming up, there might be more opportunities,” Walter says.

On the flip side, whether a property has debt in place also becomes an important factor in how much interest it gets from prospective buyers, according to Phil Voorhees, senior vice president of retail investments with global brokerage firm CB Richard Ellis.

With the lack of liquidity in the market, nobody wants to scramble for a loan. They would rather assume an existing mortgage that is likely to have more attractive terms than what a buyer can get from a lender today. Those centers that feature built-in financing can get 10 to 15 bidding offers, and those without often get none.

Everybody agrees, opportunistic buyers won't start aggressive acquisitions until the first quarter of 2009 and with few distressed assets, they could spend just a fraction of their money.

“There is a wide gap between buyers and sellers and that gap will close slowly,” says Bach. So what's a reasonable expectation? Bach says if volume of deals reaches 2005 levels — $47 billion — then 2009 would have to be considered a good year.