Retail Real Estate Investors Remain Parked on the Sidelines (5/27)
May 27, 2009 1:49 PM, By Beth Mattson-Teig
Buyers are sitting on vast mountains of cash, but are content to wait for bargains to emerge.
With investment sales volumes nearly at a halt, investors have continued to hoard capital as they wait for prices to fall further. Yet in the current climate, where those with access to capital remain in the driver's seat, questions linger as to how much liquidity exists and what properties are actually worth. As a result, there remains great uncertainty as to when money will start to move back into the retail real estate market.
"Is there cash on the sidelines? Absolutely. Both in pension funds and institutions, as well as private wealth," says Anthony F. Buono, executive managing director of retail services for the Americas at CB Richard Ellis. "There has probably never been a time when there has been that much capital set aside in short-term instruments due to the volatility in the market."
As of January, $8.85 trillion was being held in cash, bank deposits and money-market funds, according to Federal Reserve data compiled by the Leuthold Group, a Minneapolis research firm, and Bloomberg. That volume is nearly equal to the current market capitalization of the entire U.S. stock market. Money market holdings alone hold a historic high of $3.86 trillion as of March 25, according to data from the Investment Company Institute, an association of investment companies based in Washington, D.C.
"Anecdotally, we're getting calls frequently from money managers and hedge funds suggesting they are sitting on hundreds of millions of dollars in capital, and there also is a wide range of investors in the $5 million to $75 million liquid market that allege to have capital," says Bernard Haddigan, managing director of the national retail group at Marcus & Millichap in Atlanta. Those investors are all looking for the same thing – bargains, and those value-priced properties have been slow to emerge, Haddigan adds.
Investors such as AEW Capital are flush with cash and in no hurry to spend a dime. The Boston-based pension fund advisor is sitting on about $2 billion in capital from clients throughout North America. Like many investors, AEW is waiting for more attractive cap rates. "This is a market where you don't have to rush. We're not trying to force any deals in this marketplace," says Mike Acton, director of research at AEW Capital. AEW Capital purchased about $226 million in retail properties in 2008, and the firm has not set a firm target goal for 2009 acquisitions.
Some REITs have also bolstered their balance sheets for potential deals. For example, Indianapolis-based Simon Property Group currently has priced an equity offering of 20 million shares and 3 million shares to cover overallotments at $50 per share, which will net the firm $1 billion to $1.2 billion in cash. The firm ended the quarter with $1.1 billion in cash on hand and access to more than $3 billion under its revolving credit facility. It also has dealt with much of its upcoming expiring debt. As a result, Simon has incredible buying power to tap.
Waiting for a price shift
However, this cash is being amassed at a time when the broader commercial real estate market is recording its lowest level of sales activity since the early 1990s. Sales of retail properties have slowed to a trickle, with 128 properties valued at $1.8 billion trading hands during the first quarter of 2009. That volume is less than one-quarter of the 592 properties valued at $7.1 billion that sold during the same period in 2008, according to New York-based Real Capital Analytics. In 2007, the first quarter volume amounted to 991 properties for $18.8 billion. The research firm tracks real estate sales valued above $5 million.
The lack of deal flow can be blamed on several factors–the continuing gap between bid and ask prices, uncertainties in the market, and the ongoing crisis in financial markets. All of those hurdles are contributing to investors' decisions to keep capital on the sidelines. The biggest stumbling block for many is the perception that prices remain high. Cap rates on completed retail deals were 7.32 percent during the first quarter, according to Real Capital Analytics. That's less than 100 basis points above the low of 6.56 percent recorded in the second quarter of 2007. However, most observers in the market think that retail property values are down at least 25 percent from peaks and may fall 40 percent before all is said and done.
As a result, the gap between bid and ask prices remains sizable. In some cases, the difference between the bid and ask spread is as high as 20 percent to 40 percent, says Dan Fasulo, managing director at Real Capital Analytics. "In that type of environment where sellers and buyers can't agree on pricing, it's pretty easy to see why sales activity would come to a screeching halt," he says.
So how do you resolve this disconnect between the data, bid/ask gap and broader perception that values need to fall further? For one, Real Capital's figures only cover completed deals and for the most part the properties changing hands are higher quality. So that's skewing the figures some. The cap rate on offered deals (as opposed to closed), for example, was 7.68 percent. In the past, Real Capital had recorded offered cap rates lower than closed cap rates. Some brokers think that if more lower quality and distressed assets were trading today, cap rates would be at least 200 basis points above the 2007 low. As a result, some properties will eventually trade for cap rates higher than 9 percent or 10 percent.
Yet most sellers remain stubborn on prices. Where they can, owners are opting to wait out the market--particularly if they have a property with good cash flow. That means the most likely assets to hit the market in coming months will be situations of distress where either a property is hurting or where an owner is coming up against a refinancing deadline and can't arrange a new line of credit.
"The reason that people have these expectations of steep discounts is because there is virtually no debt available," Haddigan says. Private capital can only afford so much in terms of what they're buying. Investors also have increased yield requirements due to market uncertainty and the belief that the U.S. is in a prolonged economic downturn. "Some investors have yield requirements of 25 percent to 30 percent on an annualized basis if they are going to be taking risky positions," Haddigan says. Most sellers can't–or won't–drop prices that low.
Another reason buyers are taking their time is that they have a variety of alternative investments to choose from right now. Discounted properties are emerging in all commercial property types. At the same time, other options such as distressed debt and REIT stocks are trading at incredibly low levels, and for those buyers willing to take on the risk, they could produce big returns. That being said, investors are continuing to shop for viable retail real estate buys whether their strategy is to buy and flip or take a long-term hold position.
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