Sunny Days In The Northeast
Demand for retail investment in the Northeast is hot.
Lynn A. De Marco

Climate is defined as the weather averaged over a long period of time — and it is a great analogy for our market cycles. Our climate is the metrics and market dynamics that influence our appetites for risk and reward; the weather — sunny days and storms — are the ups and downs we encounter along the way. The prevailing “weather” pattern has persisted for the last 5-plus years creating one of the greatest investment climates we have seen or may ever see. Demand for retail investment in the Northeast is, in a word, hot.

Let’s explore the dynamics — capital, fundamentals, volume and pricing that make the Northeast so desirable.

Capital — Money Talks

As we all know, the influence of the capital markets has been profound. With the 10-year Treasury, (the benchmark for long-term debt) comfortably below 5 percent and no indication that drastic change is on the horizon, leveraged investors have enjoyed an abundance of affordable capital and aggressive terms. Spreads for retail continue to compress as lenders compete heavily for product, especially those centers that offer a prime location combined with a high quality, credit tenancy. Lenders are becoming more wary of secondary and tertiary locations and weak tenant lineups, but still with minimal consequence. Competition and pressure to place money has fueled popular offerings including full term interest only and highly structured capital stacks that minimize equity requirements.

Institutional players, armed with new allocations continue to be very aggressive especially on core assets and larger transactions. Joint ventures between the institutions and REITs help diversify the risk profiles. According to Real Capital Markets institutions, REITs or foreign investors were the buyer in 43 percent of the transactions in the Northeast in 2006, second only to the Western region at 46 percent. The Northeast was the most active market for REITs, capturing 22 percent of the deals, the highest in the country.

 The Fundamentals

Interest in the Northeast continues at a high level because of the desirable economic fundamentals that buoyed values in the region and support value appreciation into the future. Strong demographics, defined by high population density and strong household incomes, and barriers to entry are important metrics sought by investors and the Northeast region provides both.

The Northeast is the most densely populated in the United States and home to the top tier metro areas of Boston and New York City. Many of the most affluent counties in the country are found throughout this region as well.

Barriers to entry, seen as high land costs, lack of available land, rising construction costs, and onerous approval processes, are prevalent throughout the region. The supply side limitations and controlled additions to inventory have served to keep vacancy rates low and promoted rental and NOI growth.

Turn up the Volume, Please

Historically, the Northeast region typically lags major metro areas across the country in number of strip retail investment sales. Strip center deal volume in the Northeast peaked in 2004.

For most of 2006, national retail investment volume was off compared to 2005. There were several reasons for the drop. First, as key market indicators continued to improve in other product types and investment vehicles, there was an increased appetite for residential, office and industrial, each with double-digit percentage volume increases. Secondly, there have been fewer offerings of core retail product and a more cautious approach to tertiary markets and Class B/C quality assets.

Despite a very slow start, retail sales volume accelerated in the second half of 2006 especially in light of the several mega-portfolio acquisitions of Kimco-Pan Pacific ($4.0 billion), DDR-Inland South ($6.2 billion) and Centro Watt - Heritage Property Trust ($3.2 billion). The appetite for large deals continues into 2007 with the closing of the Crow Holding portfolio and the announcement of the $3.7 billion acquisition of New Plan by Centro Watt.

The impact of the mega-deal trend will be felt into 2007 and beyond as many of these groups will also seek to shed assets that don’t meet strategic criteria from large portfolios helping fuel the investment machine. In addition, an increase in product offerings for individual assets and small portfolios is anticipated spurred on by investors who have been waiting on the sidelines and those forced to execute a capital event due to debt maturity. How much retail will be traded in the Northeast this coming year is to be seen but, if recent years trend is any indication, it will never be enough to satisfy the demand.

The Pricing Forecast

The 2006 average cap rate for lifestyle and power centers was 6.3 percent in the Northeast, eclipsed only by the Western region; grocery strips averaged a second ranking 6.9 percent. For all Northeast retail in 2006, cap rates decreased 10 basis points to an average 6.6 percent and prices per square foot increased 14 percent to $235 per square foot, second only to the perennial leader, the Western region.

The rarity of offerings amplifies the desirability and competitiveness of the region; the by-product is seen as increasingly aggressive pricing. Pricing remains strong on Class A projects in key locations achieving sub-6.0 percent cap rates on top quality, infill properties. Cap rates have retreated on non-core assets supporting differentiation that recognizes top quality projects, prime locations and investment grade tenant credit.

Climate change does happen, but typically after a significant event or the culmination of smaller shifts. Everyone keeps watch for signs of cooling in terms of general concerns over interest rates and inflation as well as repercussions from current events such as the sub-prime lending debacle. However, with no imminent disruption to investment real estate on the horizon, Northeast retail continues to be a desirable pick in a portfolio. The hot investment climate is a byproduct of abundant capital and solid fundamentals however, the greatest obstacle for retail investors, as always, is finding acquisition opportunities in the region. SCB

Lynn A. De Marco is senior vice president for Staubach Capital Markets - East Coast Retail Investment Team.


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