New Equity Brings New Opportunities To Retail

Umansky

According to New York City-based research firm Real Capital Analytics Inc., between 2001 and 2004, investment in retail real estate has grown 250 percent, more than any other product type. Retail real estate is particularly attractive to investors because of its strong growth and impressive performance. Consumer spending has created a favorable environment for retailers, which has resulted in expansion and strong same-store sales growth. Retail sales grew 7 percent in 2004 and that figure is expected to grow 4 percent this year. And, across the nation, the average occupancy rate is 93 percent, according to REIS Inc., while rental rate growth is expected to top 3 percent this year.

When retailers are doing well, retail real estate owners share in the bounty. On average, 1-year returns for retail properties were 19 percent, while 5-year returns were 74 percent, according to NCREIF. Those returns blow apartment and office numbers out of the water. One-year apartment returns were 10 percent, while 1-year office returns were 8 percent. Similarly, 5-year apartment returns were 64 percent, and 5-year office returns were 46 percent.

Many of these first-time retail buyers are investors who have been kicked around by the stock market or are trading out of another type of real estate such as multifamily or office. They're looking for an investment that is easier to manage or one that will offer better returns.

There are a lot of people who migrate into retail ownership because they feel like they understand the sector because they have shopped at many of these stores all of their lives. Unfortunately, many first-time retail buyers are naïve in assuming that retail will be a less complicated investment. Moreover, most are ill-prepared to take on the challenges of owning a retail center, whether it is a small strip center with local retailers like a nail salon or a larger big box project with category leader tenants like Bed Bath & Beyond or Best Buy.

In addition to the first-time retail buyer, there are many owners with retail holdings who are high-tailing it to different geographic areas to take advantage of better pricing and higher yields. For example, a retail owner with assets in Southern California will enter a new market like Kansas City, while a buyer from Florida will look toward Texas for investment.  

Pricing and cap rates across the country vary dramatically; the national average is 8 percent. But, we've all seen well located and well-leased retail assets in Southern California trade for cap rates below 6 percent, while similar assets in Houston, for example, sell at a 7.5 percent cap rate.

According to Sperry Van Ness' Top 10 Markets to Watch report for 2005, Raleigh, North Carolina, ranked as the most profitable market for buyers of retail properties valued at more than $5 million. The city's 6 percent vacancy rate, a projected income growth rate of 21.7 percent, an average cap rate of 10.4 percent and an average price per square foot of $118 have pushed it to the top of the list.

Among the U.S. markets with the highest cap rates on retail property deals valued at more than $5 million are St. Louis (9.5 percent); Detroit (9.5 percent); Baltimore (9.2 percent); and Orlando (9.1 percent).

Meanwhile, the markets with the lowest cap rates for such transactions are Nassau-Suffolk, New York (6.4 percent); Orange County, California (6.6 percent); Pittsburgh (7.6 percent); and Charlotte, North Carolina (7.8 percent).

Both first-time retail buyers and new-to-the-market buyers can benefit from the expertise that real estate professionals can provide. In fact, retail real estate professionals are now becoming the eyes and ears for these buyers more than ever.

Leaning on the Leasing Agent

One of the biggest challenges for first-time retail buyers and new-to-the-market buyers is the fact that they usually don't have an in-depth understanding of how retailers operate in specific markets and the dynamics of the market in which they have property. For example, these buyers may be in the dark when it comes to the dominant trade areas, a retailer's strategy in the market and current market conditions that impact lease terms.

Often, a first-time retail buyer may shop at a center close to their home without actually taking time to notice that certain retailers like to stick together. Or a new-to-the-market buyer may be unfamiliar with the changing demographics for a certain asset.  

Whatever the case may be, you can be sure that it will be difficult for a new owner to grasp the ins and outs of his new property, regardless of what kind of research he did up front. Most new owners need the expertise a leasing professional possesses, whether or not the property is a value-added opportunity with a lot of vacant space or a fully leased, stabilized asset.

As we all know, real estate — particularly retail real estate — is first and foremost a relationship driven business. In most, if not all cases, these new owners don't have relationships with retailers or the retailers' tenant representatives. Moreover, they lack the critical knowledge and expertise to navigate a complicated lease transaction.

This is where a trustworthy and knowledgeable leasing professional can make all the difference. For example, a leasing broker can maximize his relationships with other professionals in the market to see what the retailers are doing. A good leasing agent will know which retailers are expanding and which ones are looking to dispose of sites. Similarly, they'll be on top of any new concepts that are coming into the market.

With a dedicated leasing broker, these new retail owners will have someone to protect their interests. In many cases, a leasing professional will have to serve as a teacher and mentor to help a new owner break the learning curve. It is the patient broker who serves as a resource that gains a client for life, rather than the broker who loses patience and doesn't see a deal through from start to finish. Brokers who command loyalty from their clients obviously will command a higher fee and won't be viewed simply as a necessity.

Property Management Matters

Even if a new owner has a great leasing agent handling his retail property, it is critical that leasing professionals work together with property managers to ensure that an owner achieves his objectives. Never has there been a time when high quality property management is more in demand.

We've all encountered owners who treat property management as a necessary evil and choose property managers based on price rather than expertise. What many new owners fail to realize is that property management has a tremendous impact on the success of the property.

A strong property manager will be able to control operating expenses and keep tenants happy. The last thing that a new owner wants is a property manager who irritates tenants and forces them to leave. It is extremely costly to have a tenant leave because they're unhappy with the property management.

Moreover, an attentive property manager who carefully watches the performance of the retailers will know when owners can demand a bump in rent or advise them when a tenant is in distress. Unfortunately, most new owners don't grasp this concept, and these owners could end up with underperforming assets at best and a dark center at worst.

To use a cliché, most new owners don't even know what they don't know. When it comes to keeping a property in good shape and making sure that the tenants are happy, they often are unsure about what to look for, whether it's related to CAM charges or parking lot lighting.

Property managers who are able to demonstrate and explain their value will be welcome additions to the teams of a seasoned retail owner or new retail owner. In fact, top property management companies command strong fees and are considered partners rather than an expense.

A Broker's Burden

The influx of first-time retail buyers and new-to-the-market buyers is somewhat of a double-edged sword. Unlike experienced buyers who often make transactions more difficult, new owners won't see the problems with a property, they won't dissect every line of every lease and won't beat up the seller on CAM charges.

New, uneducated buyers are not as jaded and cynical as experienced retail buyers and very frequently they will pay top dollar because they aren't tainted by experience.

But, it's a huge amount of work from a brokerage prospective to work with buyers who don't have the knowledge. In fact, many new buyers become very dependent on the listing broker. It's a tremendous burden for a buyer to rely on an investment sales professional so much because it's a fine line. Investment sales professionals represent the seller, but also must court the buyer.

More frequently than not, brokers find that they maximize value for the seller because they know how to hold the hand of the buyers. In order to do that, people have to feel very comfortable with the investment sales professional. Additionally, with new buyers, investment sales professionals often have to address issues regarding financing or due diligence that usually don't occur with a more experienced buyer.

And, even when a buyer has experience purchasing retail assets, when that buyer moves out of his geographic comfort zone, investment sales brokers becomes resources because of their knowledge of the market, trade area and retailer mix.

Nine times out of 10, an investment sales professional takes on the role of educating the buyer, and in some cases, the buyer's broker. For example, I recently sold a property in Northern California for $10.5 million to a first-time retail buyer. The buyer had traded out of four residential assets and was working with a residential broker to find a retail property. In this situation, both the buyer and the broker needed guidance, and a seasoned investment broker can help them realize the value and opportunity that exists with a specific property.

Despite the additional challenges that are inherent with first-time retail buyers and new-to-the-market buyers, smart retail real estate professionals will take advantage of the hot buying environment to differentiate themselves and gain more clients. The professionals who exceed the expectations of these new buyers rather than viewing them as nuisances will succeed.

And, don't forget that a lot of first time buyers have made tremendous profits by dipping a toe in a new product type or market. In fact, many of these buyers have found success with deals that experienced money passed on. In many cases, it is the fresh eyes that see the opportunities where others only see problems.

Brad Umansky is a vice president with Sperry Van Ness, The Umansky Retail Team, based in Ontario, California.