The investment sales market for retail properties is heating up as buyers feel more confidence in the economy and financing has become easier to obtain.

Deal volume rose in 2010 after bottoming in 2009, but activity was largely limited to class-A assets in core markets. That is now changing. Investors are moving down the value chain. Moreover, the gap between buyers and sellers that emerged during the depths of the crisis has narrowed considerably. Overall, the outlook for investment sales is bullish, with a broader range of properties attracting buyer interest and brokers predicting deal volume will continue to rise through the rest of 2011.

In April, sales of significant retail properties (those worth $2.5 million or more) reached $1.6 billion—an increase of 39 percent over the same period last year, according to Real Capital Analytics (RCA), a New York City-based research firm. Through the end of April, the market saw $7.9 billion in closed deals and another $16.0 billion in pending transactions. In contrast, through the first four months of 2010, the market saw $4.1 billion in closed deals and in the first four months of 2009 the total was $2.7 billion.

What’s more, the volume of assets offered for sale in April rose 63 percent compared to a year ago, to $4.5 billion. The figure represents the highest level of new offerings since the fall of 2008, according to RCA—and likely reflects sellers’ increasing confidence that they could get good pricing on their centers.

During the worst years of the downturn, in 2008 and 2009, the only active players were high net-worth private buyers who could pay all cash and who stuck to deals worth less than $5 million, notes Spencer Levy, executive managing director and retail sales leader with CB Richard Ellis, a global commercial real estate services firm. Today, the field is much wider with pension fund advisors, publicly traded REITs, foreign companies and private equity players all back in the marketplace.

In the first quarter of this year, the number of retail sales closed by CBRE’s capital markets group was up more than 70 percent compared to the same period in 2010, Levy says.

Another positive sign is that investors no longer limit themselves to class-A product in primary markets, the way they had in 2009 and 2010. There is now a growing amount of activity on class-B and class-C assets as well, says Bill Rose, national director of the retail group with Marcus & Millichap Real Estate Investment Services, an Encino, Calif.-based brokerage firm. The lower grade assets tend to sell at significant discounts, but at least there is now financing available to complete those kinds of transactions.

As recently as six months ago, lenders would either stay away from class-B and class-C centers altogether or offer financing at extremely onerous terms.

In the first quarter, investment sales volume in Chicago, considered a secondary market by some investors, was up 127 percent compared to first quarter of 2010, according to the CoStar Group, a Washington, D.C.-based research firm. Investment sales volume in Phoenix was up 299 percent. The increase for the country as a whole in the first quarter was 37 percent.

The investment sales market “is mirroring the capital markets and the capital markets are now open to financing class-B and class-C properties,” Rose says. “We are seeing a substantial uptick in multi-tenant transactions, in deals north of the $5 million range. Also, in terms of underwriting and getting deals listed, that [volume] is considerably higher. We are going to be awfully busy this summer and fall.”

Reasons for optimism

Two of the biggest reasons investors have come back into the marketplace en masse are improving retail sales and record low interest rates. In April, same-store sales for U.S. chain stores, as measured by ICSC, rose 8.5 percent. Year-to-date, same-store sales are up 4.9 percent—a vast improvement over recent years, when same-store sales often posted declines. Retailers have gone from shutting down new opening plans in 2008 to mulling expansion in 2010 to actually signing leases this year.

“There is a recognition by the real estate investment world that we are in a solid environment, retail sales are in very good shape, retail inventories are in good shape, so many investors started buying properties,” says Rose.

Meanwhile, the benchmark interest rate in the U.S. remains at 0.25 percent—a record low. This has given urgency to investors’ desire to get deals done before the Federal Reserve raises the benchmark, says Levy. There is also increasing competition between both primary real estate lenders and conduits to provide financing to commercial real estate buyers, which has made is easier to close new transactions. Loan-to-value (LTV) ratios on retail properties now average about 65 percent instead of 50 percent, according to Levy. On deals with really solid sponsorship, it’s possible to go even higher than that.

A May report from Cushman & Wakefield Sonnenblick Goldman, a real estate financial services firm, shows that on transactions involving anchored, class-A retail centers, with debt service coverage greater than 1.35x, it’s possible to achieve LTV ratios between 60 and 70 percent and a rate that is 210 basis points above Treasuries. For example, a recent transaction involving a regional mall, arranged through a bank, featured a 72 percent LTV and a fixed 5.75 percent interest rate, with a seven-year term and a 30-year amortization schedule.

In contrast, a class-B strip center would garner an LTV of 60 to 65 percent and a rate that will be about 245 basis points above Treasuries.

Cap rates continue to slide

As a result of improving market conditions, average cap rates on retail acquisitions nationwide fell to 7.5 percent in April, according to RCA, 20 basis points below the 7.7 percent recorded in January.

Researchers at CBRE estimated the average retail cap rate in the first quarter at 7.97 percent. The CBRE figure represents a 15 basis point decline from the fourth quarter of 2010 and a 44 basis decline from a year ago.

When it comes to class-A properties in core markets, however, cap rates have moved way down into the mid-5 percent range, Rose says. Marcus & Millichap recently closed a deal in Los Angeles at 5.4 percent, and another deal in a major city on the East Coast at 5.5 percent. Rose expects that cap rates on core product will continue to trend downward, as the volume of available product falls short of existing demand.

Cap rates on properties located in the heart of the country tend to be about 100 basis points higher than on assets on the Coasts, Rose says. CBRE estimates that cap rates on retail properties in the Midwest currently average 8.22 percent, while cap rates on properties in the South average 8.23 percent.