Resizing Retail
Dec 1, 2007 12:00 PM, By Anne Field
Experts forecast the industry's prospects for 2008 and things look a little bumpy.
Private equity hiatus
Perhaps the most striking feature in the market recently has been the sudden halt of the private-equity-fueled acquisition frenzy during the past several years, as access to cheap debt has dried up — and that's likely to continue. That's slowed investment activity both at the property and company level.
For the first three quarters of 2007, the total volume of transactions was slightly higher than the previous year. But, analysts expect that to fall precipitously over the next six months. “Activity has slowed dramatically in just the last month and a half,” says Richard Latella, senior managing director of New York City-based brokerage Cushman & Wakefield Inc.
In the third quarter of this year, for example, there were $14 billion in transactions, the same amount as the year before. About half that amount, however, was in July, according to Dan Fasulo, director of market research for Real Capital Analytics. In fact, about 63 percent of respondents to a recent survey conducted by Chicago-based real estate law firm DLA Piper reported that they had delayed or cancelled commercial real estate transactions because of the credit crunch. And, 61 percent anticipate that it will take as long as 12 months before the real estate markets stabilize.
Making matters worse, there seems to be a standoff between buyers and sellers — and that's predicted to last for another three to six months. On the whole, buyers' and sellers' expectations are worlds apart. “Sellers want early 2007 prices and buyers want 2008 prices,” says James Spitzer, a partner with Holland & Knight, a New York-based law firm. That reaction has stalled activity even further.
The few deals that are being made are going at much lower amounts than expected — a 10 percent to 15 percent decrease over the past six months, according to Latella. “Buyers are having trouble getting funding and are able to negotiate a lower price.” Jason Lail, senior research analyst in the research group at SNL Financial, points to Gramercy Capital's acquisition of American Financial Realty Trust for about $3.4 billion.
“I was pretty shocked at the price,” he says. According to Lail, the price is a 29 percent discount from the 52-week high, while most deals traded at a 5 percent to 10 percent discount from 2006 to 2007. He expects such deflated prices to continue throughout much of 2008.
The secret to success will lie in the locations investors select. “Investors are going to need to be smarter about the markets they choose to invest in,” says Fasulo. “It's a city by city type of situation.” That means that the strongest markets — on the East and West Coasts, in New York, Los Angeles and the Pacific Northwest — are likely to remain strong, while tertiary and B-caliber areas will be hurt. “Quality property in top locations have been little affected,” says Latella. As a result, while the spreads between class-A and class-B level properties have been close recently, that is changing. Cap rates in those places have seen up to 25-basis-point increases, according to Latella. In less desirable markets, cap rates have taken more of a hit. They're at 50 to 100 basis points, according to Latella.
In addition, as more investors target the same class-A properties, the number of available places is likely to decrease. “A year from now, you'll see the supply of class-A products dwindle,” says Jaggi.
There will also be an increase in REIT joint ventures, which were up 26 percent for the first half of 2007, according to Latella. They'll continue to partner with foreign investors, as well as institutional investors, like pension funds.
“When money is tight we have to turn to institutional partners who understand the risks and have the capacity to step in quickly,” says Wolfstein. DDR is looking at “dozens” of these relationships, similar to last year's joint venture with TIAA-CREF's real estate group. In that deal, the partners purchased a portfolio of 67 community retail centers for about $3 billion of total asset value. Then there are new players, like Engberg's Capital and Counties Development Group, which plans to do equity deals with developers.
Lenders are also likely to continue reducing the amount of money they'll fork over and requiring more stringent terms. Spitzer expects to see terms of 75 percent against loans, versus the 60 percent to 65 percent of recent years. At the same time, however, commercial banks, pension funds and life insurance companies are stepping in to “fill the void,” says Latella.
“Over the last five years pension funds have increased their target allocation to real estate — and that will increase even more going forward,” says Brad Case, vice president of research and industry information at the National Association of Real Estate Investment Trusts. Investment from foreign investors is also likely to step up. But, that will also slow down the time it takes to do deals, since such institutions typically don't move as quickly as other lenders.
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