What “Quality” Means for Western Retail Investment

Posted In — Market Research | Trend Article

Quality is prevailing over quantity as Western retail investors adapt to the sector’s structural changes.

Does “quality” mean the same thing for different metros?

There’s been plenty of disruption in retail real estate: Less big-box, more grocers and small product, say experts from Kidder Mathews, the largest independent commercial real estate firm on the West Coast. GlobeSt.com spoke to several retail brokers from the firm to get their take on the sector’s investment story as the fourth quarter begins.

For Orange County, CA, the market is in a state of transition that’s focused on strength. “The market is slowing down, but quality real estate in core market are still selling for record cap rates,” said Fouy Ly, SVP in Irvine, CA. He noted that while interest rates are a concern, “the market can maintain an aggressive market cap rate and high pricing due to a scarcity premium.”

Interest rates and cap rates also came up in Phoenix. “Cap rates are increasing, but not as quickly as interest rates,” said Jenette Bennett, FVP at the company’s Phoenix region. “Investors who need financing or who are investing from outside of the US will usually prefer deals with higher cap rates. There’s a disconnect between the seller who wants a five percent cap rate and the buyer who is taking out a five and a half percent loan.”

The Phoenix market enjoys strong employment, stout population growth, and a healthy housing sector. However, the good numbers—including decreased retail vacancy and new development—come with a caveat. The compressed cap and rising lease rates mean tenant replacement or resale will be challenging, Bennett asserted. Investors must stay on top of fundamentals, including tenant credit, brand strength, annual sales, personal guarantees and security deposits.

Good things come in small packages

Good things come in small packages, from Sacramento’s retail sector to Seattle’s. Smaller-scale developments are more prevalent in the Emerald City, whether single-tenant build-to-suits or smaller product for two or three expanding retailers.

“Many buyers are avoiding standalone big-box retail with shorter-term leases,” said Jason Rosauer, SVP and shareholder in Seattle’s Kidder Mathews office. “Those willing to buy want long-term credit tenant leases or smaller, well-located retail.”

The power is also out, so to speak, for one retail property segment in California’s capital city, while daily needs product continues to thrive. “In the high-growth areas of Sacramento, new grocery-anchored centers are being developed while the power center sites have slowed down and in some cases are being rezoned for multifamily, single-family and sometimes office if the demand is there,” said Bryan Wirt, Kidder Mathews’ retail advisor.

Southern California

And in Southern California, James Auther—SVP and shareholder in the Irvine office—noted that vacant boxes from such high-profile closings as Toys ‘R’ Us, Sears and K-mart are creating opportunities.

“With construction costs continuing to climb, new development is becoming even harder to pencil, which in turn, makes these previously mentioned vacant boxes even more desirable to tenants seeking to expand.”

Colleen Colleary, a Kidder Mathews VP in Portland, echoes the quality over quantity trend. Very few retailers are looking for large spaces such as At Home, Floor & Decor and Hobby Lobby, and landlords must get creative in carving up larger spaces for smaller retailers. This includes looking at non-traditional tenants such as residential, medical and entertainment as backfill prospects.

“Large retailers are using their large footprints to do pop-up stores to start up retailers or successful online retailers. It brings in more traffic and appeals to younger shoppers,” said Colleary, who adds that ‘clicks to bricks’ operations are much more prevalent in smaller spaces under 3,000 square feet.

The only constant is change—store footprints, retail portfolios, rates, and yield expectations, and how companies are recalibrating their delivery channels. So what’s next?

“Volume will decrease, but there will still be an opportunity for thoughtful investors who understand retail nuances and have expert boots on the ground that truly understand their markets,” said Sara Daley, Kidder Mathews associate VP in Portland.

Added Auther: “The savvy landlord or investor needs to dig deeper than just the tenant’s financial statement and to the tenant’s ‘unit economics’ and full operating experience. Otherwise, with just a tiny drop in the economy, they may end up with another vacancy.”

“Location is still the basic fundamental of most real estate. Financial strength of the tenant is important, but for an investor, it is always comforting know that whatever happens to your clients’ business, if they close, the space can it be released and quickly. A solid location will always release,” said Brian Hatcher, Regional President for the Pacific Northwest.

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