There have been 11 business cycles from 1945 to 2009, with the average length of a cycle lasting about 69 months, or a little less than six years, according to the National Bureau of Economic Research (NBER). If we use June 2009 as the beginning of our cycle recovery, as of September 1, 2015, this cycle has lasted 74 months. The words “frothy” and “peak” can be frequently heard when attempting to best describe today’s current real estate environment so it is no surprise that many are wondering when the bubble will burst.
According to CoStar, average cap rates for single-tenant net-leased retail investment sales in the western United States (the most sought-after category in retail transacting with the greatest velocity) compressed another 30 basis points in the first six months of 2015. New record cap rate and pricing levels continue to be established surpassing those set at the height of the last market. That said, during the second quarter, 2015 the 10- year treasury rate reached its highest level (2.50 percent) since October 2014, and is anticipated to rise further by the end of the year. So, are we in a bubble? Some would argue that the bubble has yet to even be inflated. Even with the volatility of the 10-year treasury rate, which had a low of 1.68 percent in January 2015 and a high of 2.50 percent in June 2015, overall rates are still at historical lows and continue to fuel the retail investment market.
The supply of available opportunities continues to be anemic as demand remains at unprecedented levels and is positioned to increase as both domestic and foreign investors jostle to find investments to satisfy the abundance of capital starving for product.
The total number of retail sales transactions in the western United States for the first six months of 2015 was approximately 3 percent less than the total number of properties sold in the last six months of 2014, according to CoStar. Historically, if the market is in a bubble and a burst is coming, a large supply of product will inundate the market in a very short period of time. Although more properties have come to market for sale in recent months, the amount necessary to satisfy investors has not been realized at the present time and is one key indicator that this current cycle could have a longer runway than some might think. The feel of bubble-type conditions can somewhat be attributed to the premium prices and cap rates being paid in a specific market or property type, but may not represent the overall market conditions and fundamentals. The single-tenant net-leased market exemplifies this as it is one of the hottest categories in the country experiencing the most velocity nationwide while continuing to reach unparalleled cap rates levels, especially in California.
Before 2014, corporate tenants with long-term leases such as banks (Bank of America, Chase, Wells Fargo), fast-food restaurants (McDonald’s, Chick-fil-A) and coffee retailers (Starbucks, Coffee Bean & Tea Leaf) sold in the 4 percent to 5 percent cap range. In the first two quarters of 2015, California experienced unprecedented compression once again in these categories including select sales in the 3 percent cap range including the following examples; a single-tenant Starbucks sold in Anaheim, California, at a 3.27 percent cap rate; a single-tenant Citi Bank in Capitola, California, sold at a 3.50 percent cap rate; a single-tenant McDonald’s sold in
Grand Terrace, California at a 3.50 percent cap rate.
Convenience stores (7-Eleven, Circle K) and drugstores (Walgreens, CVS, Rite Aid) have recently experienced continued compression of approximately 25-75 basis points. Newly-developed drug stores with 20-25-year lease terms are consistently selling in the 5 percent cap range, not only in California but nationwide, with some properties now breaking into the 4 percent cap range. Hanley Investment Group recently represented the buyer and seller in the sale of a 14,280-square foot single-tenant Walgreens in Cypress, California. The sale price represented a low to mid-4 percent cap rate, a record sale for a lease with 18 years remaining on the initial term. Hanley also recently represented the buyer and seller in the sale of a brand new single-tenant 7-Eleven in Buena Park, California that sold for a high 3 percent cap.
Besides the run-up on single tenants,multi-tenant retail property values have been increasing and are well supported by tightening fundamentals and sustainable in-place cash flows. The majority of legacy rents for historical tenants has been adjusted and new tenant rents are realistic to today’s market standards. Owners have optimism that rent and overall Net Operating Income (NOI) will continue to rise and that most markets are in the growth part of the cycle. Multi-tenant retail shopping center values over the past two years have seen a more significant adjustment in values with an approximate 50-100 basis point compression in cap rates. Though,
according to CoStar, the average cap rate for multi-tenant retail sales transactions in the western United States for the first six months of 2015 was relatively flat (6.40 percent) compared to the previous substantial decrease that took place in 2013- 2014. There are numerous multi-tenant retail properties (most non-grocery anchored) for sale in the sub-6 percent cap range pushing values in today’s marketplace. The compression of cap rates in
this niche possibly plateauing may not be so much a sign of a bubble but investors and lenders learning from their faults in the last market cycle that got overheated. Moreover, it could be a better representation of investors’ utilization of improved fundamentals to making more cautious and educated acquisitions.
There are many macro-economic metrics to consider when speculating how long the current market conditions will last and if a bubble market exists. Unemployment is the lowest since 2008, but with lackluster wage growth. Inflation remains tame with recent reports showing a 0.2 percent annual rise in prices, far from the 2 percent Fed target rate. New construction levels are approximately 33 percent of what the levels were in 2007, and haven’t recovered anywhere near those of the early 1990s, providing further evidence of a constraint in supply. All are factors that affect the 10-year treasury rate which has always been one of the lead indicators to the state of the market and whether a bubble exists.
At the beginning of 2014 industry experts predicted the 10-year treasury rate could increase as much as 50-100 basis points by the end of 2014. Almost the exact opposite occurred over that time period. As of the end of July 2015, the 10-year treasury rate was 2.29 percent. Various economists speculate the 10-year treasury rate will not get to 3 percent by the end of the year, with January 2014 being the most recent time it occurred. While the market patiently waits for the Fed’s decision on the next potential rate hike discussion in September 2015, the retail industry will continue to take advantage of today’s market as lenders remain eager to allocate money and stay competitive on spreads to attract refinances or new purchase loans. 2015 will be another historic year in the industry. The overall velocity of transactions may not be at the escalated pace of the peak of the last cycle (2005-2007), but with rates remaining steady and not anticipated to increase until the end of the year, combined with the record high investor demand and scarcity of product, there is no bubble in sight.