For those with retail property to sell, the message is simple: Make sure you understand the dynamics of your investor pool — especially if that pool includes former multifamily investors looking to move into retail. It's likely you will find a 1031 buyer who is motivated to pay a more aggressive price to get a better cash-flow position.
Consider the case of a client we moved from multifamily to retail investment.
David Long, a Southern California-based private investor, wanted to upgrade his portfolio by purchasing newer property in Orange County, Calif. His investment choice to date had been high-maintenance multifamily properties in the inland Southern California counties of Riverside and San Bernardino. Working with our team, the client used proceeds from an apartment portfolio sale to purchase a 19,322-square-foot retail/office building in Brea, Calif., for $3.7 million. That building was part of a 55,000-square-foot mixed-use center called The Village at Birch Street Promenade. This investment improved his portfolio and bettered his lifestyle. We've demonstrated to apartment owners that there is a greater advantage to owning a retail asset with strong credit tenants and a professional management team, than overseeing numerous individual lease agreements among a portfolio of apartment units.
Multifamily to Retail
In California, multifamily dwellings are a hot commodity creating greater competition for a shrinking pool of properties. For those with assets to sell, there is a limited opportunity to achieve a significant gain trading similar properties. However, if that buyer instead looks to retail, there is more opportunity for profit. On average, apartments are trading at a 4.5 percent cap rate. Rather than compete for another larger multifamily property at a similar cap rate, we have moved 1031 exchange buyers over to retail real estate where they can likely achieve a cap rate in the 6 percent to 7 percent range on a Class A retail property.
This split is what makes the apartment buyer pool more aggressive. Another factor: Buyers typically have to keep larger cash reserves on hand for apartment maintenance, which further minimizes their gain. In comparison, a triple-net retail lease with a corporate tenant in a retail property means that maintenance can be passed along to tenants. For an individual apartment owner, resurfacing a parking lot or painting a building exterior may have to wait if cash reserves aren't available, thus minimizing the long-term value of that asset.
We've also seen that the capital markets are much more aggressive. Lenders are providing as attractive rates to private retail buyers as they have been for the apartment market. The CMBS market has streamlined the financing process and made competitive capital available for retail investment properties as well as other property types.
Apartments tend to be more management intensive than retail. Our client was tired of commuting to San Bernardino to oversee his properties. He wanted to exchange high-maintenance investments for ones that would require less time yet provide more profit. As is the case for most private multifamily investors, ownership may choose to manage the properties without help from a management firm. This creates a time burden that, especially for individuals, can hinder their lifestyle.
Proximity to the asset is also important. An apartment owner who needs to defer capital gains may be forced out of the local market if the pool of apartment properties is limited. However, by converting to a new property class, such as retail, buyers may be able to find assets they can oversee that are still closer to home.
Another key factor that makes retail a strong move-up choice for apartment buyers is the greater depth of research available to analyze risk. Beyond a simple renter's credit report, the tenants in a retail center can provide a buyer with a better analysis of past and future performance. At Faris Lee, we walk buyers through an examination of a potential retail acquisition that may include sales performance, retailer history, occupancy, length and terms of leases, tenant credit history and location attributes. For example, Starbucks-anchored centers are popular because buyers get something they know, coffee. Nevertheless, we also make sure that the buyer understands the difference between a Starbucks on the early morning commute side of the street vs. one in a less-desirable location.
We've also found that retail break-up strategies create greater entry-level opportunities for individual investors that might be moving out of multifamily investments. As noted, the private investor's single-building acquisition was part of a retail break-up strategy of a mixed-use property developed by CIM/Brea Inc., a Hollywood, Calif.-based developer. From the perspective of a private investor, the acquisition provides an ownership position in an asset that encompasses 55,000 square feet of retail space including apartments over ground floor retail, with 30 apartment units and 17 retail stores. The Village is a key part of Birch Street Promenade, encompassing 400,000 square feet of retail, apartments and office space. It's a centerpiece in Brea's $100 million downtown revitalization.
With The Village, Faris Lee completed 10 individual sales over a two-year period worth $45 million. For the client, the transition from multifamily investment to retail provided an opportunity to own Class A retail property, closer to home in a high-profile project. Underscoring the success of that transaction, the same client purchased a second retail building in The Village totaling 15,558 square feet for $3.95 million within six months of his first purchase. Retail investment also provides better estate planning for the individual, creating a portfolio of less management-intensive properties for the family.
For a number of reasons, Birch Street Promenade proved a lucrative opportunity for the private client. We've seen, the opportunity to advise apartment investors to the merits of retail investment creates a greater pool of buyers who appreciate the investment opportunities provided by retail assets. In turn, this aggressive buyer pool is even better news for the retail seller who takes the time to understand their dynamics.
Richard is president of Faris Lee Investments, a retail investment advisory and brokerage firm in Irvine, Calif., www.farislee.com.