Retail

Retail Goes Downtown

Investors pursue opportunities in the heart of the city.

By Rich Rosfelder |

At the Chatham Market retail center on Chicago’s South Side, shoppers may be surprised to find a new convenience store tucked in next to a Potbelly’s sandwich shop this summer: Walmart Express. Slated to be its first urban location, the store will occupy a mere 10,000 square feet. Walmart plans to open more than 30 small-format stores in U.S. cities this year.

And it’s not the only major retailer setting its sights on urban markets. Target plans to open 10 small-format CityTarget stores by the end of next year, and Best Buy expects to add 150 Best Buy Mobile stores in fiscal 2012.

This growth strategy makes sense, since more than 80 percent of the U.S. population resides in urban areas and convenience is highly valued by shoppers. But it also represents one of the fundamental changes in the retail property market landscape. And investors are taking notice.

“The majority of the investors I talk to are focused on urban infill, value-add product with maturing leases and a need for new physical plant,” says Bill Rose, Western regional director of Marcus & Millichap’s National Retail Group. “Walmart’s grocery concept is a huge sign of the direction things are going.”

This boost in interest reflects a wider improvement in the sector. In 2010, the retail property market saw a 41 percent increase in sales volume to an estimated $47 billion, according to Marcus & Millichap, which forecasts an additional uptick of more than 25 percent this year. Blackstone Group’s recent $9.4 billion purchase of Centro Properties Group’s U.S. shopping center portfolio is a clear benchmark in this upward trend.

The growth in retail investment sales, small and large, indicates that a recovery is on track. But as online shopping increases and owners compete for traffic, a revitalized retail property market may look quite different than it did just a few short years ago. Like the major retailers and sector investors, CCIMs are adjusting their strategies accordingly.

Summer in the City

Across the country, single-tenant net-leased properties and investment-grade anchored shopping centers remain the go-to retail investments. “Both are hot items and a dearth of product is driving them togenerate capitalization rates in the range of 6 percent or 7 percent in most major markets,” says Cynthia C. Shelton, CCIM, CIPS, CRE, director of investment sales for Colliers International in Orlando, Fla. “Those without credit or that aren’t single-tenant triple-net are all over the board in cap rates, from 8 percent to 12 percent, and hard to finance.”

In many markets, this flight to quality follows a path toward urban centers. Like Rose, Nancy L. Miller, CCIM, vice president of Bull Realty’s National Retail Group in Atlanta, has seen a recent boost in sales of small-box single-tenant net-leased properties under $2 million near the city’s central business district. Two types of investors are competing for these assets, she says: “older investors who are sitting on cash earning little and real estate investment trusts looking for somewhere to park monies at a higher yield and greater stability than multitenant retail.” At the beginning of the year, these properties were seeing cap rates in the low 7 percent range. Miller also has noticed an influx of townhouses in the city core, which she expects will strengthen retail growth.

Some suburban transactions will be spurred by opportunistic investors capitalizing on attractive per-square-foot prices and first-year yields, which have surpassed net-lease cap rates in Miller’s market by as much as 100 basis points, according to Marcus & Millichap. But the outer reaches of the urban landscape generally won’t see a lot of action this year.

Community Effort

Where hot product isn’t as plentiful, CCIMs are focusing on community connections to spark retail transaction growth. The Pittsburgh CBD, for example, is experiencing a major influx of residential tenants — most of them newcomers to the city. “Demand for my lofts is about one year out, and some owners have upward of 100 tenants waiting,” says Diane Baer Yecko, CCIM, a broker with BT Property Associates in Pittsburgh.

Once all of these people find a place to live, they’ll eventually need to eat. Or at least that’s what restaurateurs are counting on. Second-generation opportunities and aggressive landlords helped spur a flurry of activity in the second half of 2010, with Sharp Edge Bistro, Nathan’s Famous, Elements Contemporary Cuisine, Tavern 245, and others setting up shop in the Pittsburgh CBD, Grubb & Ellis notes.

Yecko works with the Pittsburgh Downtown Partnership, which uses incentive programs to attract retail owners and tenants to small downtown spaces. Through its Vacant Upper Floors program, the PDP recently funded the owner of a 2,000-sf sushi restaurant on Forbes Ave., currently a hotbed of retail development. The owner converted the upper floors to residential lofts, which immediately were rented. “At present the PDP only funds projects after the owner secures financing for the retail portion, but we’re considering changing that so we can be the first lender for qualified owners,” Yecko explains.

Mixed-use retail and restaurants also are attracting attention in the East San Gabriel Valley submarket in Los Angeles, where John Hsu, CCIM, CPM, chief executive officer of STC Management in Whittier, Calif., primarily focuses on serving the growing Asian-American community. “Several large pieces of commercial land recently traded in our area, and the owners have been discussing mixed-use development options with us,” Hsu says. “And restaurants continue to be one of the most vibrant retail segments in our area. If a shopping center can secure popular restaurants, its chances of success increase tremendously.”

Strong retail centers cater to the needs of the consumer, Hsu notes. This is especially important in an area where traditional Caucasian centers have attracted traffic from nearby Asian communities. Retail deals in Hsu’s submarket are trading at below 6 percent cap rates — and as low as 4 percent — with multiple offers from Asian investors. In addition, owner-users are taking advantage of Small Business Administration loans and lower property prices to buy instead of lease.

“We have differentiated ourselves from the competition by launching an extensive marketing campaign and working hand-in-hand with owners and tenants,” Hsu says. “We believe that by helping the people and establishing synergy with the community, shopping centers will thrive regardless of the economic climate.”

Value Cities?

Many consumers, still reeling financially, are relying on discount retailers — and discount retailers are relying on them. Dollar General and Family Dollar top the expansion list this year, with plans to open 625 stores and 300 stores respectively, according to Marcus & Millichap. And unlike many other retailers, this is one segment that is active in both urban and fringe/suburban markets.

In Waterbury, Conn., Tom Hill III, CCIM, SIOR, broker with Tom Hill Realty & Investment LLC, is seeing an influx of discount retailers, including professional consignment shops and no-frills grocers such as Aldi. Driven by the market’s 10 percent unemployment rate, “these single-digit rent payers are filling the vacancies in better strip centers,” Hill says.

But consumers aren’t the only ones looking for discounts. Investors are sniffing around fringe/suburban areas in search of attractively priced distressed properties. So far, however, product has been slow to come to market, as extend and pretend is still a popular strategy. “With distress, I’ve gone to court with owners and their attorneys to testify that the market is awful and plead with the judge for a reasonable extension,” Hill says. “It works with many judges!”

Nicholas L. Miner, CCIM, vice president of investments with Commercial Properties in Scottsdale, Ariz., expects more distressed properties to come to market this year. “With the new reality of where prices are, I foresee more foreclosures, which will allow the property to reset and start at lower rent rates because the basis in the property is lower,” he explains. However, Marcus & Millichap reports that most non-lender distressed sales in small markets are expected to be restricted to low-quality assets with limited discounting.

Suburban Strategies

Until significant job growth returns, small retail shops in secondary and tertiary markets will continue to challenge brokers and owners. While major chains are reporting strong numbers, small retailers’ lackluster performance will keep the overall retail vacancy rate from dipping more than 20 basis points to 9.8 percent in 2011, according to Marcus & Millichap.

“It is going to be a slow recovery,” Miner says. “For centers on the outskirts of town, it will take years to absorb the space because the housing markets in those areas are still depressed.”

In the meantime, how can commercial real estate professionals in these markets preserve asset values and drum up investment interest?

Hsu suggests filling as many vacancies as possible by any means necessary. This may include low rental rates for shorter terms, owners opening their own businesses in centers, month-to-month leases, and hourly rentals. “Vacancies must be addressed because they can sometimes have a domino effect on the rest of the property,” Hsu says. “Furthermore, lenders have also been shying away from properties with higher vacancy rates, even if the current cash flow is more than sufficient to cover loan payments.”

It’s also a good idea to set aside money for tenant improvements. “Savvy tenants don’t just want free rent when they move into a space,” Miner says. “Every dollar tenants invest in TI is one less dollar they have to make their business successful and redeploy that capital.”

Current tenants also may still be feeling the recession’s effects. “Learn more about the health of your tenants,” says Henry Englehardt, CCIM, senior vice president with Colliers International in Walnut Creek, Calif. “Find out if they’re hurting on the top line or the bottom line, and make decisions about rent concessions based on where they’ve taken the hit.”

Also, Englehardt adds, “understand tenant options and the reality in which you’re competing.” If nearby owners are given the chance to lure a tenant away, they’ll probably take it.

And whether dealing with a distressed property on the edge of town or a sparkling single-tenant net-lease building in the heart of the city, protecting one’s own asset is paramount. “The future depends on CCIMs’ ability to stay in business during this tricky time,” Hill says. “I’m doing broker price opinions, small leases, keeping all my big deals going during re-trades and extensions, appearing on two different radio stations, and getting all the public speaking gigs I can show up for. You have to keep your name out there, renew your listings, and keep canvassing and asking for the order!”

Rich Rosfelder is associate editor of Commercial Investment Real Estate.

Schooling Retail Specialists

In March, Cynthia C. Shelton, CCIM, CIPS, CRE, director of investment sales for Colliers International in Orlando, Fla., taught courses and participated in panel discussions as dean of the College of Financial Analysis at the International Council of Shopping Centers’ University of Shopping Centers master’s program. Commercial Investment Real Estate asked her to discuss that event’s hot topics.

CIRE: What retail sector challenges were ICSC University program attendees most concerned about?

Shelton: Finding product and financing to close deals is still difficult. That said, all of the students said they are busy and optimistic about a market comeback. They’re also seeing limited (or no) new construction except among discounters such as Dollar General.

Redevelopment is the new development. Investors are looking for tired or distressed centers and trying to purchase at a price that allows them to hold and reposition as the market recovers.

CIRE: What advice did you share with them in your courses and panel discussions?

Shelton: Work on motivated sellers as well as buyers with realistic expectations and the ability to perform.Most of the real deals are gone, yet some buyers still believe they can purchase quality investment assets at below replacement cost: That’s not happening. The few properties that are selling below replacement cost require cash to hold and reduced rents or adjustments to keep tenants.

CIRE: Are you seeing any signs that point to an impending recovery in the national retail market?

Shelton: Retailers are starting to expand again but at a much slower rate.Many retailers, such as the discounters, are able to get space at affordable rates now compared with three years ago. Rental rates seem to be stabilizing in many markets, but some other markets are still seeing drops and renegotiations upon renewals/options.

All in all it appears as if many markets are starting to recover or at least stabilize.A few areas of the country are struggling — especially Ohio, Michigan, and other places where job growth is weak.

CIRE: How has your CCIM education helped you face challenges unique to the retail sector?

Shelton: The education has helped me get to the basics of investment analysis and not get caught in the ups and downs. The fundamentals of real estate are: market rental rates, market absorption, price per square foot, tenants expanding, and available financing. These items seem to get out of whack and require a turn in the market. We just came out of that and have to wake up and rethink.Real estate is a long-term investment, not a short-term flip like stocks!

The other great benefit is the contacts in the CCIM world. The networking connections are powerful and have helped me get necessary information and market knowledge to assist in acquisitions and dispositions or sometimes just to determine a direction for me or my client.