CORONA DEL MAR, CA—Just when you think you have seen a new record low cap rate sale, another best is established the very next month in the retail sector. Is this a sign that the retail real estate bubble is about to burst? GlobeSt.com spoke with Orange County-based Hanley Investment Group president Ed Hanley and EVP Bill Asher about the retail investment market outlook.
GlobeSt.com: With the market experiencing such “highs,” if we are not in a bubble, why does it feel like we could be?
Bill Asher: The feel of bubble-type conditions to some extent can 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. In the single-tenant sector, 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 4.0-5.0% cap range. In the first two quarters of 2015, California experienced unprecedented compression once again in these categories including select sales in the 3% cap range including for example: a single-tenant Starbucks sold in Anaheim, CA at a 3.27% cap rate; a single-tenant Citi Bank in Capitola, CA sold at a 3.50% cap rate; a single-tenant McDonald’s sold in Grand Terrace, CA at a 3.50% cap rate.
Ed Hanley: 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.
GlobeSt.com: What signs do we need to look for if the bubble is about to burst?
Asher: Historically speaking, if the market was in a bubble and a burst was soon coming, a large supply of product for sale would inundate the market in a very short period of time. However, the total number of retail sales transactions in the western US for the first half of 2015 was approximately only 3% less than the total number of properties sold in the last six months of 2014.
Hanley: Although the inventory of retail properties for sale has increased in recent months, the demand still outweighs the supply, which is a key indicator that this current business cycle has a longer road ahead.
GlobeSt.com: How is the balance of investor demand vs. market supply impacting the market?
Asher: 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 compete to find retail investments that fit their acquisition criteria.
Hanley: As yields for multi-tenant retail in primary markets continue to compress due to lack of inventory, an increasing number of investors are seeking investment opportunities in secondary or tertiary markets across the country to meet their investment requirements. Buyers who are willing to purchase well-located and well-tenanted assets in small to mid-size markets are able to take advantage of above market returns at a significantly lower price per square foot.
GlobeSt.com: What other factors are impacting the market?
Asher: An abundance of capital and continued investor demand, in combination with historically low interest rates remain the catalysts that are fueling retail investment sales. And, as lenders are willing to provide attractive financing (including interest only components to boost initial cash flow) for properties located in secondary and tertiary markets, we will continue to see increased demand in markets where there was very little velocity only a few years ago. Furthermore, technology is playing a substantial role now more than ever providing real time information to owners, investors and brokers, creating new record pricing daily and taking the retail sector to new unprecedented levels in 2015, which we expect to continue.
Hanley: Political and economic instability abroad has continued to lead investors to safer and more stable regions such as the US market. Strong capital availability and alternative funding sources such as crowd sourcing further fuels the current investment climate. However, falling oil prices can impact the market as would a potential rate hike. The decline in oil prices could lead to lower inflation—a key factor that will influence the Fed’s decision whether or not to raise rates in the near future.
GlobeSt.com: How does this real estate cycle compare to past business cycles?
Asher: According to the National Bureau of Economic Research (NBER), 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. As of September 1, 2015, this cycle has lasted 74 months, if we use June 2009 as the beginning of our cycle recovery. The most recent economic expansions have lasted an average of 7-8 years, which puts us somewhere in 2017 or 2018 for the current cycle to potentially subside.
Hanley: Hanley Investment Group celebrates its 10-year anniversary this year and as a company and individuals we have achieved enormous success throughout the changing commercial real estate market cycles — from the historic highs in the late 1980s and mid 2000s, a crushing recession in the early to mid 1990s as well as the Great Recession from December 2007 to June 2009. We are now experiencing one of the best real estate markets in many years but we know that with the highs of the market, there will eventually be the lows. However, for now, just about all of the leading indicators in the U.S. point to solid growth in the short-term, despite talks of tightening economic policy. We have increased sales volume by nearly 50 percent in the last 12 months and the firm is on pace to have another record-setting year.
Visit Hanley Investment Group at Booth #1521 at the ICSC Western Division Conference & Deal Making in San Diego.