Bottoms Up
May 1, 2009 12:00 PM, By Jennifer Popovec
Investors savor higher cap rates and a lack of competition.
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.
