In the midst of falling property values and stagnant investment sales, Macquarie DDR Trust put a portfolio of 52 shopping centers worth a book value of $1.9 billion on the market in April. The venture's decision immediately sparked heated discussion throughout the commercial real estate industry: Why put these assets on the market when valuations are so depressed? And perhaps more importantly, will they actually trade?
Experts speculate that Macquarie DDR desperately needs cash and is willing to brave the market to get it. Rich Moore, an analyst with RBC Capital Markets, doesn't feel too confident the 12.5-million-square-foot portfolio will sell — either in its entirety or in pieces. Previously, REITs and their institutional equity partners would be the most likely buyers to acquire the portfolio, which consists primarily of power centers occupied by big-box retailers. Today, those investors aren't buying, and those that are buying retail properties now aren't interested in power centers.
In the event these Macquarie DDR assets do sell, it could be a signal that things are loosening up. However, Moore speculates the impact on property valuations and pricing would be far less significant, simply because the seller was distressed and desperate for cash and prices would be “too low to be indicative of the entire market,” he says.
Experts estimate the bid-ask gap between buyers and sellers is as large as 400 to 500 basis points, depending on how motivated the seller is and how well-financed the buyer is. This gap is causing many properties to languish on the market for 120 to 150 days, according to Bernard Haddigan, a managing director and senior vice president of Marcus & Millichap Real Estate Investment Services. Historically, the average time on market was 45 to 60 days, although it shortened to 30 days during the 2006-2007 froth.
“Valuations are standing on wet sand on the seashore; they're deteriorating on a daily basis,” Haddigan says.
For example, Matt Smith, vice president and director of acquisitions at Dallas-based Centennial Real Estate, expects higher cap rates in the coming months. That's why the company, which owns and operates a one-million-square-foot portfolio of neighborhood and community centers throughout the Southwest, hasn't made any acquisitions in more than 16 months. The firm sold assets in 2006 and has been waiting for the market to correct ever since. “Patience is the buzzword for acquisitions today,” Smith says. The overriding reason is uncertainty related to pricing and valuation.
Private buyers pounce
Acquisition activity in the retail sector remained sluggish during the first quarter 2009, with only 128 transactions closing for a total volume of $1.8 billion, according to Real Capital Analytics. The average cap rate increased to 7.2 percent. To compare, in the first quarter 2008, 592 retail properties changed hands for a total volume of $7.2 billion at an average cap rate of 6.9 percent.
Last year, retail investment sales volume for properties $5 million and above totaled just over $20 billion, nearly 70 percent less than 2007, according to Real Capital Analytics. Many of the most active buyers in previous years have retreated. Few publicly traded REITs are buying (with the exception of Cedars Shopping Centers Inc.), and most private equity firms cannot overcome their fear about the future of retail. Moreover, they insist on buying at the very bottom of the market (whenever that may be).
“Private equity firms, especially opportunity funds, are not comfortable jumping in now because they don't think we've reached the bottom, and they're having trouble underwriting future NOI,” says Chris Angelone, executive vice president/partner of CBRE's capital markets group in Boston.
By and large, the buyers active today are private investors, such as Ormond Beach, Fla.-based Jaffe Corp. The firm, which boasts a shopping center portfolio of two million square feet, recently acquired the 250,000-square-foot Ormond Towne Square from Developers Diversified Realty Corp. after several years of being inactive. President Dick Jaffe thinks the time to buy is now and scoffs at the idea of waiting for the bottom of the market.
“If you sell at the top of the market or buy at the bottom of the market, you can only attribute it to luck,” Jaffe says. “I want to buy at a price where I feel confident, and the properties I'm buying now are being offered at great values.”
In addition to private buyers, non-traded REITs like Inland Real Estate Group and Cole Capital are taking advantage of their all-cash positions. Last year, Inland was the most active fundraiser of all unlisted REITs, raising $2.2 billion, according to Robert A. Stanger & Co., a Shrewsbury N.J.-based investment banking firm that specializes in non-traded REITs. It invested $886.3 million in retail properties in 2008, according to Joe Cosenza, president of Inland Real Estate Acquisitions Inc. and vice chairman of the Inland Real Estate Group Inc. So far this year, Inland has raised $209 million in its Inland American non-traded REIT.
Cosenza sees a market with little competition, better pricing, and higher cap rates. “If you don't have a long-term positive view on retail, then get the heck out of here,” he says. Cosenza adds that cap rates for quality real estate today are “extraordinary.” For example, Inland is acquiring properties at returns of 9 percent or more.
Focusing on food anchors
Of course the operative word here is “safe” — and that's why food- and drugstore-anchored centers are once again the favored property type within retail. In fact, food- and drugstore-anchored centers account for more than 70 percent of retail properties that have traded within the past three months, according to Real Capital Analytics. Case in point — all 17 of Inland's retail acquisitions this year have been grocery-anchored centers.
Although power centers and lifestyle centers have been popular acquisition targets over the past three to four years, most active buyers now consider those assets risky investments. Power centers have lost their allure primarily because of concerns about the long-term health of the retail tenants. For example, Linens 'n Things and Circuit City have shuttered stores, leaving millions of square feet of vacant space across the country. Power center owners who are dealing with dark stores have no obvious replacement tenants. “The list of retailers that make an investor wince outnumbers the list of retailers an investor would be interested in,” says Tony D'Ambrosio, a member of Colliers Spectrum Cauble's Atlanta-based investment services team.
Investors are shying away from lifestyle centers for much the same reason. Additionally, co-tenancy concerns make these assets even less attractive. Lifestyle centers are particularly vulnerable to co-tenancy issues since developers and owners routinely accepted stringent co-tenancy provisions from national retailers such as Banana Republic, Coldwater Creek and Victoria's Secret, among others. In contrast, at neighborhood centers and regional malls, landlords only granted co-tenancy requests to anchors. As many of these traditional lifestyle center retailers close stores, co-tenancy provisions are triggered, resulting in several store closures instead of just one or two.
Desirable debt
Aside from the fact that investors feel confident about the “necessity retail” aspect of food- and drugstore-anchored centers, these properties also are at the right price point for most investors — under $25 million. Since loan-to-value ratios have dropped, and lenders are requiring more equity from their borrowers, smaller “bite-sized” deals are more attractive to investors, Montgomery says.
Although the most prolific buyer today, Inland, is an all-cash buyer, most investors are still using debt to finance their acquisitions. However, the only investors that can obtain debt are the ones that are willing and able to put up their balance sheets as collateral.
The Jaffe Corp., for example, took on a partial recourse loan from a regional bank to acquire Ormond Towne Square. Like many other investors, the firm previously financed acquisitions using debt from portfolio lenders and conduits. Yet Jaffe says he is willing to accept the bank's terms because there are attractive acquisition opportunities today.
Similarly, Warrendale, Pa.-based H.L. Libby Corp. also used recourse bank debt to acquire Henderson Square, a 165,929-square-foot center located in Henderson, N.C. Shadow-anchored by Wal-Mart and anchored by Belk & JCPenney, the center was acquired for $8.3 million.
Unlike most investors, Libby Corp., which owns 20 shopping centers totaling three million square feet, actually prefers bank debt because of the flexibility it offers with prepayments and value-added situations. The firm is borrowing at 300 to 400 basis points over LIBOR, which is under 5 percent today.
Other successful buyers have sought out deals with assumable loans or seller financing. For example, America's Realty LLC has acquired 16 shopping centers totaling more than $200 million so far this year, and 60 percent of the deals have been financed by the seller, according to president and CEO Carl Verstandig.
The Pikesville, Md.-based investor, which focuses on low- to mid-priced retail and owns 178 centers in 10 states, acquired 25 centers in 2008 and 28 centers in 2007. It has purchased most of its properties from REITs and other institutional owners including Regency Centers Corp., Vornado Realty Trust, Kimco Realty Corp. and GE Real Estate.
Distressed sellers
Even distressed sellers are willing to offer seller financing. General Growth Properties along with Centro Property Group and DDR are well-known distressed sellers, but there are other operators selling assets to raise money to pay off debt maturities on other assets, some of them nonperforming.
And these owners are often selling at very attractive prices. Consider DDR's sale of Ormond Towne Center to the Jaffe Corp.: Although Jaffe declined to disclose the purchase price, local experts say the grocery-anchored center sold for $20 million — about 50 percent of what the asset should have sold for given the in-place tenants and NOI — because DDR needed cash.
Similarly, Centro Properties and its joint venture partner JPMorgan Investment Management sold New London Mall in New London, Conn., for $40.7 million. Cedar Shopping Centers Inc. acquired the 260,000-square-foot center at a 7.7 percent cap rate, according to John Williams, managing director of Savills LLC, the New York City-based firm that brokered the sale. Williams says the grocery-anchored center had attractive assumable financing, which helped it sell at a higher cap rate than other similar properties. However, he notes that the same center would have traded for 100 basis points lower just 12 months ago.
Libby Corp. also benefited from Centro's distress by buying Henderson Plaza at about a 10 percent cap, Libby says. “We never thought we would see the day when centers like this sell at 10 percent cap rates and above,” he says. “For companies like ours, that have been waiting and complaining about people overpaying on deals, now is the time to strike.”
While Libby understands why investors are “scared” of retail right now, he doesn't agree with their decisions to remain idle. “Yes, retail is going to be under pressure for a while, but you can't just sit around because the economy stinks,” he says. “Today is the buying opportunity of a lifetime.”