Capital Markets, Cap Rates and 10-Year Treasury with CBRE’s Phil Voorhees

Phil Voorhees, executive vice president of CBRE’s National Retail Partners – West. Phil Voorhees, executive vice president of CBRE’s National Retail Partners – West.

Phil Voorhees, executive vice president of CBRE’s National Retail Partners – West, believes investment opportunities exist in all cycles, and this one is no different.

Retail Insight sat down with Voorhees recently to talk about those opportunities, and what investors should have on their radars as we close out 2018.

RI: Tell us about the current state of the capital market?

Voorhees: In our view, this is a great, healthy time for retail capital markets in the West. Investors and lenders clearly differentiate on pricing based on quality and risk. Class A assets are pricing at near-record levels due to strong rents, low vacancy rates and low cap rates, properties off “A” are downgraded accordingly. For instance, a stabilized Class A property that’s a high-performing, grocery-anchored center in a primary coastal market with strong demographics and great net-operating income (NOI) growth might price in the mid-4 percent cap rate range. In comparison, a stabilized, larger power center in an inland or tertiary market could price in the mid-8 percent to 9 percent-plus cap rate range. That’s 400-plus basis points of spread based on quality. 

At the peak of the last cycle in late 2006 and 2007, the spread between A and C quality properties was perhaps 200 basis points. This means investors are pricing risk more appropriately. On lower-quality centers or centers in secondary or tertiary market areas, only a handful of buyers are offering, and sellers are adjusting pricing to bridge the bid/ask spread. In the last cycle, buyers were abundant — even on lesser quality assets — and acquisitions were often made with maximum leverage debt of 75 or 80 percent loan-to-value (LTV) or higher. Not the case today, where most loans fall in the 60 percent to 65 percent LTV range, meaning more equity is required in each transaction. 

Speaking generally, retail capital markets in the West seem calculated and prudent. Despite tremendous amounts of capital available for deployment, investors are not rushing in; no irrational exuberance at this point in the cycle. Tariffs and global trade tensions and increasing assertiveness (if not aggression) on the world stage by countries like Russia, Iran and Saudi Arabia could push economic stability off balance. It seems unlikely that real estate will be culpable for economic upheaval in the near term.

RI: How are investors reacting to increasing interest rates and the 10-Year Treasury?

Voorhees: It’s probably too early to tell, though increases are certainly on the minds of all investors. Over time, cap rates track interest rates, so upward pressure on cap rates should be expected. Thus far, lenders have compressed spreads (taken less profit) on new financing, offsetting, to some extent, increases in the U.S. 10-Year Treasury Yield (10YT), the “benchmark interest rate” on which most fixed-rate commercial real estate loans in the U.S. are based. Since Sept. 5, 2017, the 10YT yield is up 110 basis points (1.1 percent). Granted, that does not sound like much, but it’s a 55 percent increase in a little more than a year. This means it costs 55 percent more for the United States to borrow money now than it did a year ago. This is material when borrowing trillions of dollars!

RI: What advice are you giving to your retail investor clients, both in the current environment and in regard to the near future? 
Voorhees: Great opportunities can be found during nearly all market conditions. With cap rates still historically low due to low interest rates, it makes sense to focus on acquisitions with potential for above-average rental growth that could keep up with inflation and provide a hedge against declining values. This means highly valued (low-cap rate) single-tenant, net-leased (STNL) investments — a proxy for bonds for some investors from a yield and cashflow standpoint — may not be as attractive as strip retail centers. This is because the strip retail centers will have two to three times the rental growth of a STNL investment over a hold period. 

From the buyer’s or current investor’s perspective and depending on investment objectives and the asset type being acquired, it makes sense to lock in longer-term debt now if you expect interest rates to continue rising. From the seller’s standpoint, get to market fast! The peak of the market in this cycle seems to have been the second half of 2015, though pricing has remained strong since. It does feel like pricing has softened with the increasing 10YT yield over the past year, and further increases could produce more of the same.

RI: Where are you seeing opportunity in the West in the retail investment market?

Voorhees: Institutional capital is getting energized about the prospect of purchasing “out of favor” high-quality power centers for higher cap rates, producing strong, double-digit leveraged cash-on-cash yields Day One. We’ve seen this strategy executed on centers in diverse markets around the West, including in tertiary Washington State, Las Vegas and Phoenix. In primary markets, however, power center cap rates remain low, perhaps just 100 to 150 basis points higher in cap rate than for grocery-anchored neighborhood centers. Excluding higher-yield power center opportunities, the institutional preference for core retail centers is currently tightly defined, tempering institutional interest around the West. Less institutional interest creates an opportunity for private capital investors, particularly on larger assets. Non-core properties larger than $40 million in size may see only a handful of bids, particularly at maximum pricing. We’ve seen pricing that seems very fair, if not a bona fide value, on some larger assets resulting from less buyer competition.

RI: Can you tell us about any recent sales or new listings?

Voorhees: We’re just commencing marketing on TownGate Center in Moreno Valley, Calif. TownGate features an excellent line up of value-focused retailers like TJ Maxx/HomeGoods, Ross Dress For Less, Dollar Tree, BevMo! and Ulta Beauty. It also has value-focused entertainment and service providers like Regal Cinemas and Planet Fitness. CBRE expects investors will soon realize that discounters and value-focused retail tenants are highly resistant to internet competition. TownGate will be priced to provide a higher cap rate yield, and to produce an excellent leveraged cash-on-cash yield at one of the most vibrant retail locations in the Inland Empire.

— Interview by Nellie Day, contributing writer. This article is part of the Retail Insight newsletter by Shopping Center Business, which includes a brief series of articles and videos surrounding some of the retail industry’s biggest gatherings, including ICSC Western Conference & Dealmaking. Some of the articles and the videos in the publication are created in conjunction with our content partners, which sponsor the newsletter. Click here to subscribe and to see archived newsletters.