Buyers targeting the retail sector are increasingly considering lower-quality assets and properties in secondary and tertiary markets, creating a more robust investment sales climate.

Volume is up again this year. In the first quarter, for example, 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.

Crucially, as capital markets improve and conduit lenders continue their reemergence, there are loans to finance the rise in activity.

"The loan market has provided a lot of wind for everybody's sails. … "There are a lot of capital providers and they are providing very cheap loans,” says Joe Dykstra, executive vice president with Westwood Financial. “The market's better than it was last year, but it's hard to know if it's underlying properties or if it's all financial related."

But the activity is coming at a steep price. Investors and brokers say that some deals that have closed recently have boasted cap rates between 4 percent and 5 percent—levels not seen since before the recession.

"We're seeing new precedents in cap rates--we're doing a few projects right now with 4 percent cap rates,” says Nicholas I. Coo, a senior managing director with Faris Lee Investments. “Six months ago you would see a 200 basis points difference between assets in a large MSA and assets in tertiary markets. Now it's more 75 basis points."

"I cannot believe how high the prices are, and how low the cap rates are. We're on our toes,” adds Sandy Sigal, CEO and president of NewMark Merrill Cos. “Do I believe the low cap rates are sustainable? No. They are a function of low interest rates. I am very convinced we have to be careful what we buy because we don't know when the door will close and that great deal at 6 percent will become 8 or 9 percent."

Action down the value chain

This frothiness is leading investors to consider assets today that they might have stayed away from a year ago in order meet their yield targets.

“The volume is not as robust as what people may have thought it might be at this point of cycle,” says Thomas Dobrowski, managing director with Rockwood Real Estate Advisors. “There’s really a shortage of high quality malls transacting. So institutional buyers are frustrated. … Does that lead them to look at markets they wouldn’t target and at assets that are not traditional institutional quality? I think we’re heading in that direction.”

For example, Rockwood is currently marketing a portfolio of three class-B- Michigan malls—the kind of assets that may have not generated as much interest a year ago. But Dobrowski thinks buyers would be more interested today given the improved capital markets and the fact that the assets themselves are performing. “The fundamentals at these assets have improved over last the 12 months and there is leasing momentum,” he says.

Passco is an example of an investor that is looking at lower-quality assets, including those with a value-add play. The firm is considering properties that have vacancies that it can lease up or ones that have a number of pad sites that it may be able to sell off individually. “Our sweet spot is $25 million,” says Gary Goodman, senior vice president with Passco. “We were always in it for the long term, our financing is usually 10 years. We don’t play the game of getting in and out quickly.”