Biding their time
Sep 1, 2008 12:00 PM, By Elaine Misonzhnik
Making the grade
The biggest issue holding back buyers is insecurity about the retail real estate landscape. No one wants to take on excess risk in this environment. That means many buyers are very hesitant to consider purchasing class-B properties at all. If they buy, they want returns in the low to high teens and they want them now, says Joseph C. French, national director of retail properties with the Irvine, Calif.-based investment brokerage firm Sperry Van Ness. Current pricing and the amount of equity necessary to complete deals don't allow those kinds of returns.
Meanwhile, the risk environment has become more precarious. Retail vacancies continued to climb — in the second quarter, vacancies at shopping centers averaged 8.2 percent, a 50-basis-point increase from last year, according to Reis, Inc., a New York City-based provider of commercial real estate information. Store closings are piling up. Expansions are slowing. And people are generally worried about the deteriorating state of the economy.
“Come Christmastime, things will probably be even less exciting than they are today from a retail standpoint,” says Arthur M. Milston, managing director with Savills. As a result, “if it's a class-B center, [opportunistic buyers] are taking a pass on them,” according to French, and if it's a class-C property it becomes virtually unsellable.
What's more, even class-A assets in primary markets are receiving more scrutiny. Buyers want to know not only how well-leased a property is and what the rents are, but they are keeping an eye out for any potentially troubled tenants. The last thing they want to walk into is a situation where a tenant paying above-market rents files for bankruptcy or closes a store and leaves them in a situation where they will be unable to re-lease the space and still get the same rents, notes Robert Bach, senior vice president and chief economist with Grubb & Ellis, a Santa Ana, Calif.-based commercial real estate services firm.
Buyers also want to know which part of the market the center serves, who the tenants are, what kinds of rents are currently being charged and how they compare to similar properties in the surrounding area, as well as how much competition is out there. “All of those factors will be part of how you underwrite the deal and then you look at your 10-year growth hold and combine it with the risk, and given the pressure on the economy, your likelihood of leasing up vacant space needs to be more conservative in your underwriting than it was in the past three years,” says Daniel Taub, COO and senior vice president of acquisitions with DLC Management Corp., a Tarrytown, N.Y.-based owner and manager of shopping centers. “The cap rate then becomes a very property-specific number.”
Urstadt Biddle, for example, recently paid a mid-seven cap — not a discount number by today's standards — for a 60 percent interest in Ferry Plaza Shopping Center, a 63,433-square-foot shopping center in Newark, N.J., a secondary market. But the center's anchor tenant, Pathmark Supermarkets, is the dominant grocer in the Ironbound section of the city. That made the REIT feel confident about the long-term value of its investment, according to Rotonde. “Each situation is different,” she says. “If it's a center in a lower income area, but it's doing great numbers, we'll take it.” Ferry Plaza is valued at $26 million and features an existing first mortgage of $11.9 million.
Because of the risk factors, however, buyers are generally setting their sights on class-A properties with few leasing concerns. The problem is that owners who hold centers of such high quality only want to sell if they can achieve 2007 cap rate levels. Short of achieving that, they are content to hold their properties and wait out the market, adds Charles J. Urstadt, CEO of Urstadt Biddle.
“As an institutional investor, you really want to focus on the urban centers and you can't get your hands on those,” says David Lynn, managing director and head of research and investment strategy at ING Real Estate, the real estate arm of the global financial services firm ING Clarion, which earlier this year set up its own acquisition vehicle, ING Commercial Real Estate Opportunity Fund, with $250 million in equity earmarked for income-producing residential and commercial properties and land loans. “The sellers were experiencing rapid cap-rate compression in the past few years and they got spoiled by it.”
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