Investment Demand – Experts Talk About 2015 and Beyond

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Western Real Estate Business

COMPRESSION IMPRESSIONS
Are you adjusting your rearview mirror to grasp a clearer view of today’s retail investment market? Warning: cap rates in the mirror may be lower than they appear! Nothing looks as it seems anymore as cap rate compression continues in the retail sector. Just when you think you have seen a new record-low cap rate sale, another best is established the very next month.

Single-tenant cap rates have compressed about 20 basis points in the past 12 months — from the second quarter of 2014 to the first quarter of 2015, according to CoStar. Meanwhile, multi-tenant cap rates have compressed an estimated 30 basis points for retail property sales in the Western United States. As owners evaluate what their property is worth in today’s market, the rearview mirror approach of reviewing recent sales comparables is quickly becoming old news. Cap rate compression has been moving at a much faster rate, especially compared to the last market peak between 2005 and 2007. Technology is playing a substantial role now more than ever. It’s providing real-time information to owners, investors and brokers who are paving the road for today’s market, creating new record pricing daily and taking the retail sector to new, unprecedented levels in 2015.

An abundance of capital and heightened investor demand, in combination with historically low interest rates, remain the catalysts fueling the retail sales engine. At the beginning of 2014, industry experts predicted interest rates could increase as much as 50 to 100 basis points by year end. The 10- year treasury rate was 2.77 percent as of April 1, 2014, compared to 1.87 percent as of April 1, 2015. The opposite occurred over that time period based on macro-economic metrics such as increased national job creation, but lackluster wage growth. This has the Fed uncertain about when the next rate increase may occur. The Fed will likely discuss this potential rate hike at its next meeting in September. Meanwhile, the retail industry continues to take advantage as lenders remain eager to allocate money and stay competitive on spreads to attract refinances or new purchase loans.

Even with historically attractive financing, the lack of supply continues to frustrate the current pent-up market demand. Transaction volume for retail sales out West between the second quarter of 2014 and the first quarter of 2015 has increased 18 percent in the single-tenant niche and 9 percent in the multi-tenant segment, according to CoStar. Although the transaction velocity and inventory of retail properties listed for sale have increased, it is still a generally supply constrained marketplace as more off market transactions are occurring and competition for marketed properties is at an all-time high.

The single-tenant, net-leased market has been one of the hottest investment types in the country in the past couple of years. It continues to experience the most velocity nationwide, while achieving unparalleled cap rate levels, especially in California. Before 2014, corporate tenants with long-term leases, such as banks (Bank of America, Chase and Wells Fargo), fast-casual restaurants (McDonald’s and Chick-fil-A) and coffee retailers (Starbucks and Coffee Bean & Tea Leaf) sold in the 4 percent to 5 percent cap range. California experienced unprecedented compression in these categories in 2014, with sales closing in the mid- to high 3 percent cap range. These included the following examples: a single-tenant Starbucks that sold in La Mirada at a 3.43 percent cap rate; a single-tenant Chase Bank in Laguna Hills that sold at a 3.86 percent cap rate; and a handful of single-tenant McDonald’s across California that sold between 3.59 percent and 3.9 percent cap rates.

All single-tenant categories have experienced cap rate compression in the past year. Hanley Investment Group represented the seller in the sale of a portfolio of single-tenant Family Dollars in central and Southern California at an average cap rate of 5.75 percent. The majority of single-tenant, standalone dollar store sales in California has previously transacted at a 6 percent cap or higher. Even drugstores (Walgreens, CVS and Rite Aid) experienced continued compression of about 25-50 basis points. Newly developed drugstores with 20- to 25-year lease terms are consistently selling in the 5 percent cap range, not only in California, but nationwide. Some of these properties are currently under contract and scheduled to close escrow, breaking into the 4 percent cap range.

The most significant cap rate compression in the drugstore segment has occurred with Rite Aid. Previously a distant third in the category in regard to credit strength, Rite Aid has turned its brand around. It has seen various 6 percent cap rate range sales in California, including a newly developed stand-alone store in Escalon, which sold for a 5.4 percent cap rate in October 2014.

Grocery-anchored shopping centers in metropolitan areas continue to be the most sought-after investments, especially those with a corporate grocer, long-term lease and above-average sales. Those assets continue to transact in the 5 percent to 6 percent cap range in the Western United States.

Shadow-anchored, multi-tenant properties have seen a more significant adjustment in values over the past year as well, with an approximate 100 to 150 basis point compression in cap rates. Hanley represented both parties in the sale of a 35,735-square-foot, multi-tenant retail property in Turlock this past September. The property was anchored by Costco, which was not part of the sale. Other notable tenants included Dollar Tree, Party City, Sherwin Williams and Metro PCS. The sales price represented a cap rate of 6.39 percent, a record cap rate for a multi-tenant, shadow-anchored center in Central California valued at more than $10 million. The continued lack of supply of quality, available retail product, coupled with increased purchaser demand, is one of the primary drivers for a record-breaking sale like this in the multi-tenant retail segment.

We make numerous comparisons to the previous peak of the past cycle (2005-2007) and the record pricing, cap rates and larger transaction velocity compared to today’s current market. That rearview image is long gone. There is little doubt 2015 will be another historic year in the industry, which will see continued record pricing and cap rates that will surpass those of 2014. The overall velocity of transactions may not be at the accelerated pace of the last cycle’s peak, but with interest rates remaining steady and not expected to increase until the end of the year (if at all), and with record-high investor demand and scarcity of product, this environment still has a long road ahead of it. So enjoy the ride!