Since the cautious environment that marked the start of the year, momentum for sales of class-B and class-C retail properties hasn’t taken off, even though demand for both core centers and quality distressed acquisitions remains quite robust.
With scores of institutional buyers looking for quality assets in primary markets, competition for class- A centers is fierce and top-tier grocery-anchored shopping centers are now trading at cap rates in the low 6 percent range, while cap rates for core malls have sometimes dipped below 5 percent, according to Kris Cooper, managing director of retail capital markets with Jones Lang LaSalle, a Chicago-based real estate services firm.
At the other end of the spectrum, private buyers have been keen to buy distressed centers that have a compelling story and good upside potential, notes Randy Banchik, vice president with Westwood Financial Corp., a Los Angeles-based real estate investment firm.
In the first quarter of the year, Marcus & Millichap Real Estate Investment Services, an Encino, Calif.-based brokerage firm, tracked approximately $16 billion in retail property trades, a 42 percent increase from $11 billion in the first quarter of 2011, according to Bill Rose, director of the firm’s national retail group. Marcus & Millichap tracks all transactions valued at $1 million or more.
Neither institutional nor private investors, however, have shown much interest in class-B and class-C assets in secondary and tertiary markets. Some of those properties have been hard hit by retailer bankruptcies and store closings, according to Matthew Mousavi, director with the investment advisory group at Faris Lee Investments, an Irvine, Calif.-based retail-specialized investment advisory firm. As a result, the centers’ owners might have been forced to lower rental rates, lessening the assets’ appeal. Plus, even though debt availability has increased in recent months, lenders may be wary of offering overly generous loan terms for properties that have tenant issues.
“There are some markets where it’s still difficult to finance shopping centers—the Southeast has been lagging behind the 30 major markets,” says Rose. “That’s certainly a byproduct of the centers’ leasing activity and occupancy.”
Class-B and class-C centers have also been much harder to valuate, with cap rates on such properties ranging by as much as 200 basis points, depending on factors like the history of anchor sales and tenant credit ratings, notes Cooper.
For instance, Gerry Mason, executive managing director with Savills, a global real estate services firm, tells the story of a REIT that put a center on the market in Nashville, Tenn. that had a good tenant list but weak sales. The lowest cap rate offered for the property was 8.5 percent, so the REIT pulled the asset off the market.
“You can still sell them [class-B and class-C centers], there are obviously people who will buy them, but sellers are usually disappointed when they find out what the prices are,” Mason says.
Not counting the mall portfolio sales that took place in the past few months, the average cap rate on sales of retail properties rose 11 basis points in the first quarter, to 7.79 percent, according to data put together by the retail valuation group at CBRE. What’s more, the retail vacancy rate remained at 13.1 percent for the third quarter in a row, indicating that retailers are still reluctant to lease new space, notes Richard West, director and CBRE’s national retail valuation group leader.
The good news for sellers is that the amount of core product available for sale continues to be very limited. That means many institutional investors won’t be able to fulfill their acquisition targets by only pursuing class-A product in primary cities and will eventually start looking more into class-B and class-C centers in secondary cities, brokers say.
It will likely be a while, however, before that transition takes place—most brokers estimate at least a year. At the moment, the U.S. economy remains too fragile and the unemployment picture too uncertain for investors to be willing to take the risk on lesser quality properties.
“As fundamentals improve, you will see improved pricing,” says Geoff Tranchina, senior vice president with Wilson Commercial Real Estate, a Los Angeles-based real estate services firm. “But through the end of the year we see the trend staying very strong with funds and institutions and public and private REITs wanting to stick with core, urban markets.”