“Our phones are ringing off the hook with folks who have private equity to offer,” says Lawrence Casey, chief financial officer of Donahue Schriber. And the Costa Mesa, Calif.-based real estate investment trust (REIT) isn't alone. Private equity is gung-ho on placing capital in retail real estate.

The sole realm of opportunity funds and institutional investors such as pension plans in the late-1990s, private capital has turned to real estate in a big way as returns on similar investment opportunities dwindle. “With the stock market in the doldrums and portfolios worth 25% less at the end of the year, investors are looking for something more than putting cash in the bank at a 2% interest rate,” says Hank Gordon, whose Laurich Properties develops in California and Las Vegas.

And in real estate, capital is moving, en masse, to shopping centers. Harry Cummings, president of South Holland, Ill.-based HLC Financial Services Inc., an independent financial consulting company that arranges cash flow and financing for commercial real estate clients, calls shopping centers “very hot” to investors in search of a 20-25% return.

This is not to say that private equity investments in real estate are throwing off whopping yields. According to the Chicago-based National Council of Real Estate Investment Fiduciaries, or NCREIF, realized returns on private equity investments in real estate, through May, were lower than the previous year. Retail, with returns of 6.81%, did better than office (6.33%) but worse than industrial (9.39%) and apartments (9.40%).

But, oh, how quickly things change. Last spring, retail was the least-favored place to be, observes Sandy Sigal, CEO of Tarzana, Calif.-based NewMark Merrill Cos., a developer and acquirer of shopping centers that works with individual and institutional investors. Now almost anything in retail looks good, says Sigal. “I have gone after strip centers only to find I'm getting outbid, not by 2-3%, but by 10-15%.”

A tight market

Despite the sudden popularity of retail real estate, Donahue Schriber hasn't partnered with new private equity sources since 1999 — the dollars and the deals don't match up. Unlike during the real estate recession of a decade ago, individual owners feel little pressure to unload their properties to a big fish such as a REIT. “There is not much sales activity because there is a large disconnect between what the buyer is willing to pay and what the seller is willing to sell for,” Casey explains. “And even if owners were willing to sell, where would they put that money? They don't want to go into the stock market. The alternative is not so good that many folks are motivated to sell.”

NewMark Merrill is another broker that has been looking for deals with little success. “Money is not the issue. We have much more money than deals,” says Sigal. “We have trouble placing our own equity, we have trouble placing our long-time partners' equity and we are called fairly frequently by people wanting to place equity with us.”

Probably the most important factor causing potential sellers to hold onto properties has been low interest rates. If sellers can't get the numbers they want in a sales transaction, they can turn to the debt markets for attractive refinancing. “Lenders are throwing money at them,” so they can refinance at low rates and continue to own, notes Robert Falzon, managing director of Prudential Real Estate Investors (PREI) in Parsippany, N.J., one of the largest private equity investors in the country.

Supermarket superiority

Competition among private equity sources to refinance, purchase and construct retail developments is even more intense because it is conservative, tending toward less-risky, grocery-anchored centers. “The grocery-anchored neighborhood center is everyone's sweet spot,” says Casey. “We can get funds on those all day long.”

“Where there is a well-anchored retail center there is going to be an equity player interested in the deal,” says Brian Opert, CEO of Fairfield, Conn.-based Sterling Commercial Capital LLC. “Investors are looking for anchored shopping centers with a good-quality grocer. You need to make your money work and there are not a whole lot of places to put it where there is security and a decent return.”

But grocery-anchored shopping centers are not everyone's cup of tea. In fact, PREI has turned away from that particular type of development. “There's plenty of money around that would have an interest in financing a well-anchored grocery center,” says Falzon. “For us, the established center that has a 50,000-sq.-ft. box anchor and 40 in-line stores is a little less attractive today.”

Falzon believes that grocery-anchored centers are more vulnerable than they have been historically (because Wal-Mart and Target supercenters continue to steal market share from traditional grocers), and prefers community shopping centers with a grocery anchor plus two additional anchor spots filled by popular discount tenants such as T.J. Maxx or Marshalls.

Malls are not on PREI's shopping list, or anybody else's, for that matter: “You are not finding private guys going after malls,” says Falzon.

There is a lot of money waiting to be placed, but it is looking for more conservative placement, says Arthur Nevid, managing director of Mountain Funding LLC, a Charlotte, N.C.-based capital lender and investor. “Investors are looking for conservative investments, worried about anything with high risk, worried about credit risk. They don't like lending to dark spaces.”

Maximizing upside potential

Creating the proper deal structure has become paramount in these uncertain times, and spreading risk through joint ventures is becoming a more popular vehicle.

“Joint ventures are the backbone of what we do,” notes PREI's Falzon. He leans toward deals in which the other party takes the construction risk, while Prudential takes on the leasing risk. The party taking on the construction risk gets enhanced returns because its joint-venture partnership with Prudential elicits attractive financing. “From our standpoint, we get better yields on a deal than if we bought stabilized property,” Falzon says.

The real estate arm of Toledo, Ohio-based Dana Commercial Credit looks for transactions involving new development or existing structures that have upside potential. To make them happen, “Either through a loan vehicle or a joint-venture relationship, we participate with the developer on the upside of the transaction,” explains Rex Paine, vice president of Dana Commercial's real estate group in Austin (which is in the process of being sold). “Our niche is an equity investment of under $10 million.”

Opportunity funds and life companies are more interested in joint venture, equity-type transactions, says Stephen Henderson, a senior director with Tremont Realty Capital in its Hartford, Conn., office. “Some of the REITs also look for joint ventures, but, in general, REITs would prefer not to partner and do the deals themselves.”

He adds with a note of caution, “Who you get into bed with today on a joint venture is going to tell the story. On the debt side, you make a loan, and if it fails, then you foreclose and take the property. It is a little cleaner on the debt side than it is on the equity side.”

MY KINGDOM FOR A SALE: WHERE'S THE INCENTIVE?

For the real estate industry, the major difference between this economic downturn and the real estate recession of a decade ago is that owners are under little pressure to unload properties. There have been few, if any, fire sales. In fact, there have been few, if any, sales period.

“There is not much sales activity because there is a large disconnect between what the buyer is willing to pay and what the seller is willing to sell for,” says Lawrence Casey, chief financial officer of Costa Mesa-based Donahue Schriber. “And even if owners were willing to sell, where would they put that money? They don't want to go into the stock market. The alternative is not so good that many folks are motivated to sell.”

Probably the most important factor causing potential sellers to hold onto properties has been low interest rates. If sellers can't get the numbers they want in a transaction, they can turn to the debt markets. “Lenders are throwing money at them,” so they can refinance at low rates and continue to own, adds Robert Falzon, managing director of Prudential Real Estate Investors in Parsippany, N.J.

NewMark Merrill, a Tarzana, Calfi.-based developer and acquirer of shopping centers has been looking for deals with little success. “Money is not the issue. We have much more money than deals,” says Sandy Sigal, chief executive officer of NewMark Merrill Cos. “We have trouble placing our own equity, we have trouble placing our long-time partners' equity and we are called fairly frequently with people wanting to place equity with us.”

Owners are not selling because they have nowhere to put their money if they do sell, Sigal says. “We have assets that we sold and are still trying to find something to trade into.”