Roundtable gathers top institutional investors to see what they think of the market, and to find out what they are looking to acquire.
Moderated by Randall Shearin
Shopping Center Business, with the investment sales division of Newmark Grubb Knight Frank (NGKF), recently hosted an institutional investor retail roundtable in New York City. We invited several of the top institutional investors in retail properties to gather a sense of how they judge the current state of the market, and to see what kinds of properties pique their interest. The roundtable was moderated by Randall Shearin, Editor of Shopping Center Business, and co-hosted by Whitney Knoll and Jason Archer of NGKF. Attendees were:
• Ed Senenman, senior vice president, investments, EDENS.
• George Fryer, director, AEW Capital Management.
• Cathy Clark, senior vice president, acquisitions, Ramco-Gershenson Properties Trust.
• Thomas Falatko, vice president, acquisitions, multi-tenant retail, Cole Real Estate Investments.
• David Harvey, senior vice president, sales and acquisitions, and principal, M&J Wilkow.
• Dan Branigan, vice president, capital transactions, DDR.
• Andrew Peltz, managing director, DRA Advisors.
• Herb Myers, managing director, Investcorp International.
• Doron Valero, managing partner, Global Fund Investments.
SCB: What is your investment strategy and what are your goals for the next few years?
Herb Myers: We represent foreign investors. We are typically investing on behalf of investors in six Middle Eastern countries. We have an office in Bahrain and we represent investors in Bahrain, Saudi Arabia, Kuwait, Qatar, the United Arab Emirates and Oman. We seek to invest about $250 million of equity annually. We invest in cash flowing assets. In the past, we have pursued more opportunistic investments but these days it's really a core-plus, cash-flowing profile. On the retail side, we have been active over the years, but not too active over the last 12 months given the challenging retail landscape. We are looking for solid retail investments that are well leased and generate strong cash-on-cash returns. In addition to our equity investment program, we also have an active mezzanine debt platform.
Doron Valero: We invest using primarily Israeli money; we have strong relationships with some of the life companies there. We also have relationships with U.S. institutions as well as private individuals. When we started in 2007, we knew a hit was coming to the market, we just didn't know how bad. We didn't buy anything from 2007 to 2009. In 2009, we decided to go after distressed assets and we would try to buy notes. We did, but it was not 1992 so we just bought a few. We have bought a few assets over the last 3 years. We will have our biggest transactional year in 2012; we are working on a large transaction with Investcorp. In the last 2 months, a lot of the deals that we were bidding on that did not come our way, are now coming back to us. We are focusing on core and value add properties. Anything we buy is supermarket anchored.
Ed Senenman: EDENS was primarily a developer for many years. Over the last 10 to 15 years, our ownership and structure has changed. We are a private REIT owned 92 percent by three pension funds. We have sold our B assets in recent times and invested in A assets. We look for mainly grocery-anchored, core and core-plus assets in the major markets on the East Coast. I run New York metro acquisitions for the company. In total, between my region, Florida and the Mid-Atlantic, we will do about $400 million in acquisitions in 2012. We are not afraid of development. We have a few larger development projects in the Washington, D.C., market coming on-line before the end of the year.
David Harvey: M & J Wilkow is primarily an operating partner investing in office and retail properties. We have evolved from our roots as a passive investor to active operator. Until recently we invested primarily in value-add and distressed situations and were only acquiring $20 to $25 million per year. In 2012, we developed additional institutional relationships that have allowed us to pursue core-plus opportunities. This year we will acquire $300-plus million in three major assets.
Tom Falatko: Cole is a diversified real estate firm that's been in business for over 30 years. We are focused on two property types: single-tenant assets, including retail, office and industrial, and power centers. Since the 2010, we have acquired more than $7 billion of properties and now have assets in 47 states.
George Fryer: AEW Capital Management is a global pension fund advisor founded in 1981. We have $45 billion in assets under management worldwide; about half of which is in the U.S. We advise separate accounts as well as commingled vehicles for pension funds; we execute core, value-add and opportunistic strategies for both of those. Our assets include about $8 billion of REIT securities under management as well. We are on pace to acquire our usual $300 million to $350 million in retail this year, which represents about 25 percent of the firm's overall volume. We acquire core and value-add properties outright, but will provide joint venture capital for value-add and opportunistic deals. We prefer larger transactions.
Dan Branigan: DDR is a publicly traded REIT. We were founded in the 1960s and went public in 1993. We are a fully integrated operator focused solely on shopping centers. Within that arena, we are focused on market dominant, larger community and power centers. On a limited basis, we will also do mezzanine debt investing, assuming the collateral is the type of center I just described. Our portfolio spans the country: we are in about 40 states, and we also have a large portfolio in Puerto Rico and a joint venture interest in a large portfolio in Brazil. We are seeking core and core plus properties where we can add value. We will invest about $600 million this year, and consistent with our recent investment activity, we intend to be a net buyer next year as we continue to execute our capital recycling program.
Cathy Clark: Ramco-Gershenson is a public REIT. Over the last several years, we have been cleaning up our balance sheet, shedding some lower quality assets and acquiring core assets with a value-add component. Over the last 18 months, we have sold about $90 million in assets. This year, we have acquired about $150 million of assets in areas that help diversify our geographic footprint and will do about the same next year.
Andrew Peltz: DRA is currently investing on behalf of our eighth investment fund. It's a $1 billion fully discretionary vehicle, which is comprised of equity from university endowments, pension funds, high net worth individuals, and the principals at DRA Advisors. Throughout our 25 year history, we have always sought value-add assets. Our investment strategy is to typically team up with smart local or regional operators seeking institutional capital for the purchase of properties that have an interesting upside opportunity. We like lifestyle properties for instance, even with their typical nuances. Besides all non-mall retail, we invest in office and multifamily properties, so we are interested in mixed-use town center type properties. Our goal for the next few years is to invest a couple billion dollars.
SCB: One of the trends we've seen over the last 3 years is a rebalancing of portfolios. A lot of REITs and institutional investors — of all sizes — have been moving out of markets, into markets and changing property types. Where does institutional money want to be today?
Fryer: Institutional money still wants to be in safer, secure, trusted asset classes with a heavier focus on income production versus growth. I am concerned that a herd mentality and the continued response to fear in the marketplace are actually creating a pricing bubble for best-of-class core assets. Most institutional capital players also have buckets set aside for value-add and aggressive strategies but have been reluctant to pull the trigger. For these investors, a value-add investment requires fundamentals that permit creation of solid core product once the enhancement strategy is applied. The days of putting band-aids or quick fixes on centers and then hurrying to sell them before nature comes back to call are over. Today's value-add investors want to create something lasting, while permanently moving it up a quality tier.
SCB: When we speak to REITs, they are all interested in the same 10 or 12 geographic markets. Why are the major metros so popular?
Valero: It's an old cliché. I call them lazy markets, because you can't go wrong buying in some markets. It becomes a question of what your cost of capital is. If someone is fortunate enough to be able to buy a Main and Main location and see the growth that they want, that is great. Most investors, if they are willing to be honest with themselves, I don't see the yields coming from these core plus properties at the prices that people are paying. If you look at the cost of capital for some of these assets, I'm not sure the investors can afford to buy it. Yes, they are generating income from day one and leverage is low, but they are manufacturing this 5 percent yield that will go to 7 percent. I don't remember in my history when 7 percent works. It just doesn't. In today's world, I think the opportunities are B properties going to B-plus or C going to B.
Peltz: During the past recession, many REITs or institutions wanted to shelter their income and invest in core returns in the top markets. That might prove to be shortsighted as the economy improves. We think there are better opportunities in the secondary markets. We can achieve much better returns there. We're not the kind of group that would match a pension fund paying a 5 or 6 cap for a large deal. That will catch up with them eventually when interest rates rise.
Clark: Cap rates for core properties in those markets tend to be low — too low for our cost of capital. We have concentrated more on the interior of the country — not the coasts and not the top five or six markets. In those interior markets, you can find the area that you want to own in; growing areas with affluent residents who have higher education levels. We've been able to buy in these markets at cap rates that are 150 to 200 basis points above comparable properties in coastal markets.
Branigan: We are actively sourcing and underwriting investment opportunities with a focus on the top 40 MSAs. For example, we've invested in Boston, Charlotte, Chicago, Dallas, Phoenix, and Portland, among others, since 2011. We are seeing less competition in the power center space than grocery-anchored centers, particularly as institutional capital continues to focus on the latter property type.
Myers: Kathy [Clark], I am curious to hear you say that there is a 200 basis point cap rate spread. Maybe it is the specific markets where you are active. We have thought about that strategy as well. Generally, we have found that the higher quality assets in the more desirable submarkets of those secondary or tertiary cities are closer to a 100 basis point difference. That pricing hasn't been attractive to us.
Clark: As an example, we entered the St. Louis market last year and this year we bought our third asset there. All three are well located, have good credit quality tenants, in good demographic areas with the ability to add value. We acquired at cap rates between 7.5 to 8 percent. If you look at the top five or six markets, there are comps that have sold at sub-6 percent cap rates.
Fryer: Another appealing aspect of the secondary markets is greater comfort in your underwriting standards. You are not pressed to stretch to perfection pricing assumptions, so your return on paper is probably more reliable.
Falatko: For Cole, one of our tenets has always been to look for opportunities in secondary and tertiary markets because our focus is on the quality of the real estate and whether it meets our stringent acquisition criteria. We are in 47 states, so we are in primary markets like Los Angeles as well as tertiary markets like Bismarck, North Dakota. We believe that there is the potential for enhanced yields in secondary and tertiary markets.
Senenman: REITs are looking at buying core because they are long term holders and they are not going to sell. You still need some level of growth in your income stream. You can't buy a flat 5.5 cap rate and have it stay flat.
Valero: It is all about the sustainability of the net operating income and the cost of capital.
Harvey: I like to buy the 'best asset.' That is, a dominant asset in a secondary or tertiary market. Two years ago, the acquisition cap rates for these properties were 200 basis points higher than the same combination of tenants would commend in top tier markets. The premium is not as large any more but it is still meaningful. In these less favored markets, it is very important to have comprehensive sales reporting by the majority of tenants so that the 'dominance' can be verified.
Fryer: The strongest deals I've done in the last decade were in markets like Odessa, Texas; Alexandria, Louisiana; Fort Myers, Florida; and Toledo, Ohio. Smaller markets are more cyclical and we have to recognize that cap rates can go infinite when liquidity disappears. But the cycle is as predictable as the sun rising and setting. I bought, redeveloped and sold a regional mall in Johnson City, Tennessee, as an example; I'm probably the only institutional investor who regularly uses the term, 'quaternary market!'
SCB: When you bring in an international investor, do they really care where — in the United States — the money is invested?
Valero: You would be surprised, at least with the people that I deal with, how knowledgeable and concerned about where the money goes. They are dealing with other people's money — they are life companies and pension funds — so they are really careful. There are a lot of government regulations so they are focused on markets that they feel comfortable with. I can't take them to Shelby, North Carolina, but I can take them to a secondary market. They are not players in primary markets because of the yields they need to achieve. They are more realistic; they need to achieve a leveraged 9 percent yield within a certain timeframe. They will be in power centers, quality malls and supermarket-anchored shopping centers.
Myers: We are investing primarily on behalf of wealthy clients based in the Middle East. We, and they, are focused on the top 40 markets in the U.S. Although, there are certain markets within the top 40 that we would not go to. Generally, we are not going to be competitive based on the cost of capital for assets in the gateway cities. Grocery-anchored is tough for us, unless it is lower quality. In that case, we probably don't want to buy it. We have been looking at a lot of specialty retail properties. Yesterday, I saw one in the New York metro area that has a food and beverage anchor that is selling for a relatively high cap rate. It has good sales productivity. It may not appeal to many traditional institutional buyers, but it might work for us.
Clark: We look for larger assets that have a number of anchor tenants that are credit quality. We buy power centers and grocery-anchored although for grocery anchored we want the Number 1 grocer and at least one other anchor. We are not the buyers right now of the 100,000-square-foot grocery and small shop center. With everything we buy, we look for a value add component.
SCB: A few of you like to have a value-add component to an acquisition. What are the type of assets and locations that have this today? What does 'value-add' mean today? How dirty do you want to get your hands?
Branigan: We are typically looking for some value-add component where our leasing, development and operating folks can apply their talents to create value. Value-add could mean something as small as developing a few outparcels to grow our NOI, to a much more substantial project such as reconfiguring space and adding an anchor. In February, we acquired a center in Chicago and in the first 9 months of ownership we've added a new junior anchor box, reconfigured some underutilized small shop space for a second junior anchor and are working on leasing two outparcels. At another deal we just closed, we have multiple outparcel opportunities that will add significantly to NOI.
Clark: There are many tenants who are oversized or undersized today. That can be a big play, but it often requires more money than your benefit will be, so it needs to be factored into pricing. In one of our recent acquisitions, we are downsizing an office supply tenant and re-leasing the remaining space at better rents. At another asset, we are in the process of leasing 28,000 square feet of GLA that was not priced in our acquisition.
Senenman: We bought a redevelopment property in Northern New Jersey, in a market that has some of the highest income zip codes in the country. We are knocking down most of the center and building a Whole Foods Market. We also have a Kmart that is paying $1.60 per square foot for the next 2 years at the center. Luckily, we have patient money and can afford to wait. In a year and a half we will have a Whole Foods-anchored center with a much better co-anchor.
Valero: The idea is to get your hands dirty as much as you can, other than entitlements. You want to acquire a center that is already entitled, and develop what you can with those existing entitlements. At this point, in most markets, ground up development is not worth it because of the entitlement risk.
Fryer: We are willing to get our hands pretty dirty if we acquire a Class C center and we are confident it is sitting on Class A dirt. We have done two repositionings like this post-recession, one of which is in partnership with AmREIT in Houston. It was a poorly configured older shopping center, but the site is located on a prominent intersection along the Westheimer corridor. Concurrent with a complete façade renovation, parts were torn down and rebuilt in the right places; we also sold excess land to a multifamily developer who is building 250 units and integrating them into the site plan. At the end of the day, we took something that struggled to be 75 percent leased and will soon achieve 100 percent by reconfiguring and moving tenants around.
Peltz: DRA always seeks a value-add aspect in an acquisition. Working with existing and new joint venture groups around the country, we think there are plenty of retail properties with upside opportunities in lease-up, property expansion or lease renegotiations. We just bought a distressed lifestyle deal in California. It is a 300,000-square-foot center that opened in 2008; there is the upside to finish lease up, build another 100,000 square feet and ground lease vacant outparcels. We like to get our hands 'dirty' and prefer to do it alongside a smart, entrepreneurial operating partner.
SCB: You are privy to most of the deals that go on the market. Do you buy deals mainly off-market? How are centers coming to you? What catches your eye with something that is on the market?
Senenman: The two acquisitions we've done this year and the other two that I have under contract were all done off-market. We don't want to be in an auction process; we want to be part of it just to see what's going on, but we would generally avoid on-market transactions. It is more perception than reality that a buyer obtains more favorable pricing in an off-market transaction than an on-market transaction.
Clark: We have acquired several deals off-market. There is a fair amount of limited marketing going on with sellers who are putting their toe into the market. They may call a broker who will take it out to a select group of buyers. We like those kinds of deals. We are a seller of assets of well, we don't want to go out and market them to the world if we don't think they are going to be sold at pricing that would be acceptable.
Myers: Recently, maybe 50 percent of what we have done has been off-market or marketed on a limited offering basis.
Harvey: What we like is finding assets that have been improperly marketed. There are plenty of assets that go out to the marketplace with unrealistic views of what they are worth. This process exhausts the buyer pool. We've been able to pick up a few of those the second time around when the competition has lost interest.
Valero: If you find an asset that you like — on market or off-market — you bid on it. If you lose, sometimes you get angry. Sometimes, you lose and you wait and it might come your way the second time. Life is sometimes better when it comes your way the second time because the seller's expectation has been reduced to reality.
Fryer: It is also much easier to take a project through due diligence when you are the rebound bidder because a lot of the work has already been done.
SCB: How has underwriting for your organizations changed over the last 5 years? What do you look at that you didn't look at a few years ago on a deal? How quickly can a deal close?
Peltz: Five years ago, there were more portfolio deals happening. They may not have received all the forensic accounting that needed to be reviewed. But DRA typically looks carefully at market versus lease rents, tenant sales and trends. We look more at potential rent roll downs than we did a few years ago. One thing we can do is close quick — in 30 days all cash since our investment fund is discretionary.
Senenman: That is a good point. When you were buying $1 billion in real estate in one portfolio, if you missed one thing on one property, or one on another, it wasn't going to ruin the deal. There was less risk.
Clark: We pay more attention to tenant credit, market rents and tenant footprints. In the past, some buyers would pay for space that wasn't leased but might be in the future — that's just not happening now.
Valero: I see some of these unsustainable visions coming back to the market, and some of those are what brought this industry to its knees a few years ago. Vacancy didn't bring this industry into trouble; rents did. There were rents that weren't sustainable. Everyone got crushed on that. In today's world, you have to underwrite sustainable rents and rent increases.
Branigan: We spend a lot of time reviewing tenant credit and managing our exposure to certain retailers. We also spend a considerable amount of time understanding current tenant store prototypes and appropriately underwriting those who may be oversized in their current configuration.
Valero: What is your concern with the Internet and big box tenants?
Branigan: The Internet is complimentary to overall retail sales in brick and mortar locations and provides another distribution channel for retailers. Several of our retail tenants are pursuing an omni-channel approach to merchandising, and the most successful retailers are driving incremental traffic to their stores through programs such as shop online and pick-up in store, shop online and deliver to store, or shop online and return to store. Retailers have proven to be more profitable selling merchandise via their brick and mortar locations than over the Internet. Simply put, shipping costs erode margins. It is also important to remember that Internet sales represent only about 5 percent of overall retail sales and as a result retailers are actively seeking additional new store opportunities.
Senenman: When you look at a big box power center today, don't you really have to look and see where that is going to be in 4 or 5 years? There's going to be downsizing and you'll have costs to downsize the space. You may also have lower rents because of that.
Branigan: We are trying to be forward thinking about what tenants will require for downsizing in the future and include that in our underwriting and the analysis of our current portfolio as well as any acquisitions. We have several downsizing examples in which we successfully identify tenants who will take that residual 5,000 or 10,000 square feet often at higher rents. As a result, we do not end up with a lot of dead space. We recently did a multiple location deal with Five Below to take residual space in five centers; that deal gave us a substantial net increase in rent. This is an example where we were able to utilize our tenant relationships to achieve the objectives of multiple tenants while realizing rental increases.
Peltz: I agree, we're cautious on certain retailers competing with the Internet and the rent levels they pay. It's similar to when we are underwriting lifestyle centers, we have to carefully examine rents. Oftentimes, based on where the sales levels and the health ratios are, we have to underwrite rents going in half.
Valero: If you are not buying from a lender, you might assume that the rent has already been adjusted.
Peltz: It all depends on the age of the lease. We go through reports for a property many times before we've completed all aspects of our underwriting.
Falatko: We look at several key items including the market metrics, creditworthiness of the tenants and location of the asset. The next step is looking at what the leases actually say. Are there co-tenancy clauses? What is the length remaining on the terms? Are there extensions? If it passes all of our internal tests, then we can make an offer.
Valero: Do you see a big spread between power centers and supermarket anchored centers when you buy?
Falatko: It depends on the market. We generally get a higher cap rate on power centers.
Fryer: We are becoming less aggressive for the pure grocery-anchored neighborhood center with strip shops. We are concerned that mom-and-pop tenants are the least well positioned to deal with competition from e-commerce. National tenants have integrated platforms. We are gravitating more toward larger centers that have the widest range of destination tenants possible, providing the most reasons to shop the center by multiple profiles of customers through all hours of the day.
Falatko: Look at what the grocery-anchored centers are going for in a market like Atlanta, versus the power centers. There is a large spread.
Knoll: The grocery-anchored center is still considered the safest investment. It is getting a little scary in some markets: in South Florida you are seeing cap rates below 5 percent. In power centers, some investors have a fear of the downside with the boxes getting smaller. We have vision and optimism, but we are still in a recession. You can't say people are wrong to have a flight to safety.
Fryer: Atlanta is not the right market to look at comps. It has not yet recovered to the same extent as other major markets; safety and flight to quality are still the predominant drivers in that market. Look at Texas, where the economy is rolling. The spread between grocery-anchored centers and power centers is only 50 to 75 basis points.
Senenman: We like the grocery store as a gathering place; people have to go there on a weekly or bi-weekly basis. We are not afraid of restaurants or fitness clubs; we like tenants where people go to meet other people.
Valero: And you cannot find them on the Internet!
Knoll: Ramco-Gershenson bought a Kroger-anchored center in Atlanta and tore down their small shop space to build an LA Fitness.
SCB: How are you viewing alternative tenants, like healthcare related tenants? How do your investors feel about them?
Branigan: Overall, we prefer to have traditional retail tenants. Retailers have desired co-tenants, and alternative uses do not typically meet their requirement making it more difficult to lease space and maintain an attractive merchandise mix.
Harvey: Alternative tenants sometimes raise additional scrutiny on a project. The buyer or client wants to know: why couldn't you do traditional retail? We worry that schools, large scale health operations like dialysis centers, and churches will taint the exit cap rate. But there have also been situations in which these uses are compatible. It requires extra analysis to understand if an alternative tenant helps or hurts the current traffic and long-term value!
Clark: Fitness centers don't fall under the alternative tenant umbrella in our view. Medical tenants are great for small shop space; they can be very complimentary in the centers. The issue comes in when you are talking 10,000 to 20,000 square feet when the medical use is taking an anchor space. That makes a statement that the center is not entirely being used for retail purposes.
Valero: Unless you define yourself as a service center. Entertainment and medical are becoming more important uses to service centers.
Knoll: Childrens' dentistry and orthodontics are moving out of low rise office buildings and are enjoying the visibility and location of the shopping center.
Falatko: There are spaces in most centers that are service oriented just by their nature; there is little or no storefront or it is a lower level space that an alternative tenant can use but that a traditional retail tenant would not be able to.
Valero: Daycare centers are a use like that. Some of them are great credit tenants. Another good one is a dialysis center; they use 10,000 square feet that have great credit backed by major medical centers.
Myers: You just want to be careful not to have too many alternative tenants.
Fryer: They are wonderful add-ons, but they can't replace your core retail anchor tenants. You get a question mark when you backfill a space vacated by a strong national tenant with an alternative use.
SCB: Where are we in the real estate cycle? What feelings do you have about the market?
Peltz: Consumer confidence is up. We are past the big retail bankruptcies of 2008 and 2009. Vacancy is going down; construction is still limited so supply is constrained. In our world of retail investing, things are looking pretty good for the next year or more. The overall health of shopping centers should get better based on these factors.
Clark: We are seeing good leasing traction, we are not seeing any rent relief requests and some of our tenants are in expansion mode. Interest rates will eventually go up and that will impact cap rates. Right now I would say that the market is slowly improving and that we are cautiously optimistic.
Fryer: I like where we are right now. It feels like 1995-1996; I'd call it the third inning. There are a number of factors holdings us back right now that are artificial: we have the concerns of the fiscal cliff; the Euro zone crisis; and a few months of slow employment growth. Once we clear some of these hurdles, the market will improve. Housing recovery will restore consumer confidence. The retail development spigot has been turned off for years and will permit tightening supply; retailers are already expanding in advance of rising consumer demand.
Harvey: Our portfolio is well occupied; we are not seeing as many requests for rent relief. We are optimistic.
Falatko: Our leasing folks are hearing that retailers have open-to-buys; retailers are looking for new spaces.
Senenman: We do have some concerns over small shop space with the tenants' ability to stay in business. We like urban retail; if you lose a tenant there is generally another one who will step in.
SCB: There's been a trickle of distressed assets into the market. Have any of you seen a deal that you nearly acquired in 2006 or 2007 come back around as a distressed property?
Peltz: Yes, you feel kind of lucky you were the bridesmaid back then. Someone bought a center at a low cap in 2006; it just hit the market through a special servicer and may sell for $30 million less now.
Valero: We are closing shortly on a deal — that was bought by an institution a few years ago — for 50 percent of what they paid for it. I still think we are overpaying! The only reason this property is distressed is that the rents fell.
Peltz: Although we didn't work on it back then, another deal recently came on the market that was redeveloped in 2008 for over $250 million. We recently bid on it; the final pricing was in the low one hundred millions. There's some pretty interesting opportunities out there.
Myers: There were a few deals that were on the market in that 2009-2010 period that we passed on, thinking there was too much risk. Some of those have come back to market and have sold at materially higher prices than what you could have bought them for at that time. Hindsight is always 20/20. SCB"
— moderated by Randall Shearin