The investment market remains a seller's market throughout the United States and should continue into 2005. Each region has its own opportunities and challenges for both the investor and the seller.
Sellers have high expectations. However, market activity continues to be restrained because most sellers need to reinvest their proceeds into another deal — ideally in the form of a 1031 exchange to avoid taxes. Many sellers would love to sell their properties and take advantage of today's low cap rates. However, lacking attractive reinvestment opportunities, these investors simply hold on to their properties.
In terms of buyers, the market has moved down the continuum from institutional to entrepreneurial investor. To meet their investment needs, most buyers have broadened their investment criteria. To get desired yields, buyers are willing to accept a lot more “hair” on the deal — significant vacancies, environmental issues, fewer creditworthy tenants, etc.
Adding to the challenge of buying properties is the influx of foreign capital. Both European and Asian investors that are accustomed to lower yields on retail real estate are willing to accept this market's lower cap rates. There is greater interest from West Coast buyers — especially buyers trading out of multi-family properties. These buyers are selling their apartment buildings in Southern California at 5 percent cap rates and buying retail properties in the Northeast at 7 percent to 8 percent cap rates.
Southern California cap rates continue to decline, and both grocery-anchored and specialty and strip centers are trading at sub 7 percent caps. This is especially true for deals under $10 million as there is a surplus of capital chasing the few opportunities. Centers that are sold free of loans are especially desirable due to favorable interest rates.
Investors that were priced out of the market have purchased retail centers in Las Vegas and Phoenix, both a quick one-hour flight from Los Angeles. Now, prices in those cities are on a par with those in Southern California, so investors with property in Phoenix are looking to Tucson and Las Vegas property owners are exploring Reno.
Drugstores have been extremely active in Southern California. With four national drug chains and one West Coast chain competing for locations, prices for prime corners that can hold a prototype drugstore with a drive-thru have increased substantially. This has made it difficult for retailers such as fast-food chains to acquire corner locations, as they cannot pay the rents the drugstores can. As consumers embrace 24-hour drive-thru prescription pick-up, inline drugstores may have difficulty surviving, especially for Californians who view their car as a second home. Landlords or potential investors who have large format inline drugstores in their retail properties should plan for a replacement tenant or downsizing as part of their long-term leasing strategy.
Investors are working harder than ever to be first in line to present their full price offer, or in some cases offers over listing price. Throughout the Southwest region, private investors are driving the market. Texas, Oklahoma and Colorado are seeing an influx of wealthy East and West Coast individuals wanting to complete their 1031 exchange. Institutional and private investors that once focused on the top 20 cities are now looking at secondary markets with healthy economies. Texas, Oklahoma and Colorado are all on the radar of many private and institutional investors.
Although the Denver commercial real estate market is expected to remain flat in 2004, well-located and newer retail shopping centers are in short supply and sell quickly. Analysts speculate the overall recovery in Colorado will be slow. One major challenge Denver will face in overcoming the current economic downturn is luring new companies to the state.
Unlike Denver, Texas is seeing a tremendous increase in new jobs. February 2004 employment figures show that 50 percent of all new jobs added nationally were in Texas. New jobs and economic growth will help reduce the approximately 14 percent vacancy rate now seen by retail property owners.
The Midwest continues to expand the retail marketplace with major middle market retailers such as Meijers, Costco, Wal-Mart — which recently purchased 19 acres to build its first Chicago store — and Sam's Club continuing their expansion.
The continued expansion of retail locations throughout the Midwest indicate that there are developers out there who are noticing the lack of supply and doing something about it. Recent large projects that have been started in Minneapolis and Northwest Indiana are targeting these big-box retailers who want stand-alone stores in heavily traveled areas, and are willing to pay for them.
Moving away from higher populated areas, cap rates for these properties are approximately 50 basis points higher than in the Chicago area. However, the price per square foot paid over the past 12 months has been higher in St. Louis, Indianapolis, Minneapolis, Detroit and Cincinnati than in Chicago, where cap rates have been lower. In the fourth quarter of 2003, the volume in Illinois was almost 29 percent of the total 112 deals for strip malls closed in the quarter. The opportunity to purchase property in the Midwest is much more difficult than on the West Coast due to the number of properties offered for sale. In the entire Midwest there are only 61 retail strip center properties on the market for more than $5 million, compared with 160 on the West Coast.
— Gwen MacKenzie, Brad Umansky with Sperry Van Ness senior advisors Leslie Cox, Joseph French, Dan Martin and Thomas Dalzell.
GWEN MACKENZIE
BRAD UMANSKY
Vice presidents of Sperry Van Ness, an Irvine, Calif.-based commercial real estate firm that provides realty advisory, brokerage, consultation, asset management, property management, leasing and financial services.