The Retail Market Research – Q2 – 2011
July 19, 2011
By:
Sean Glickman, Vice President – Investment Advisory Group
Highlights
The U.S. Economy
National Retail Market
Orlando Retail Market
Orlando Rent Survey
THE U.S. ECONOMY
The U.S. Economic growth continues its sixth quarter of positive GDP growth and its fourth quarter of positive employment growth. It appears that the U.S. economy is better than half way through the recovery cycle. The U.S. economy has evolved firmly from an extended recovery phase to the threshold of expansion, as evidenced by improved momentum in the private sector job growth, GDP and retail sales. Retail Sales Remain Well Above Pre-Recession Levels. The recent rise in gasoline of 30% has clearly diverted expenditures from other industry segments. Total retail sales increased 7.6% in April on a year-over-year basis.
Job Growth. Growth in the Private Sector continues to advance but the momentum is waning. Powered by 15 months of continuous growth, private sector employers have contributed 2.1 million positions to the economy. However, May additions fell significantly below recent trends to 83,000 private employer jobs. The unknown consequences of provisional monetary policies, the large amount of liquidity in the banking system, the withdrawal of fiscal stimulus and subsequent reduced demand from government and inflation risk, all add complexity to the national economic outlook.
Distressed Loans and Sales. New accounting rules were issued by the Financial Accounting Standard Board could increase the number of loans that banks classify as troubled Debt. In addition, the banking regulators have also started cracking down on lenders to reclassify their troubled loans and stop the extend and pretend practices. Half of the commercial loans maturing in the next few years are anticipated to mature underwater which puts them at a high risk of being classified as Troubled Debt. May saw an improvement in distressed activity and lenders also made good progress in resolving past issues as outstanding distress. That trend should extend near-term: June has typically been an active month for workouts as lenders clean up books for mid-year reports. Meanwhile, the level of sales associated with distress ranged from 15% of office to 34% of retail volume in May.
Home Prices Home prices have dropped again to a new 8 year low, a fact that places a clear drag on the general economy. Schiller; “Nation’s economy could take another downward turn due to depressed housing prices, high foreclosure activity and lack of confidence. Tighter lending practices do not help either as lender have denied over 26.8% of the loan applications in 2010, an increase from 23.5% in 2009. According to Moody’s, the cuts in spending in the residential mixed investments account for more than 30% of the decline in U.S. GDP in recent years. On the other hand, most markets are now underpriced and as distressed loans are slowly clearing the market we are moving forward towards equilibrium. Together with low interest rate, affordability is high again. Once the housing market begins to recover it could stimulate an above normal demand in the economy and commercial real estate in 2012, 2013, 2014. This will be amplified in areas such as Las Vegas, Phoenix, Inland Empire, parts of Texas and Florida.
Commercial Real Estate sales Trend. Sales and offerings surge. May marked an important benchmark as sales achieved their highest monthly total so far in 2011, rising to $15.6b and notching a remarkable 124% gain over the year-earlier month. The growth trend was broad, as every property type registered its most active month this year and both pending deals and new offerings point to a strong June. Although regional malls are quickly gaining currency, as evident not only in recent transactions but also in a spate of new offerings, including Westfield’s 17-property US portfolio. The major markets have continued to dominate volume, with Manhattan, Washington, DC, and San Francisco still representing between 45% and 50% of total volume.
Forecast. The economy is expected to add 2 million jobs by the end of 2011, reducing the unemployment rate to the high 8 percent range; GDP is forecast to average 3.2% in 2011 before trending up the following year. Still, the U.S. economy faces numerous challenges:
With expectations of strengthening economic growth, healthy corporate profits, increasing demand and rising exports, business spending will power the recovery over the next year. The recent corporate rush to raise debt before the Fed ends the $600-billion Treasury-bond purchase program may indicate that companies finally are ready to invest rather than use the money to buy back stock, refinance existing debt or hoard cash. This suggests an imminent increase in capital expenditures, a boost in employment and commensurate improvement in commercial real estate.
Fundamentals for the industrial and office sectors have moved into recovery, while the apartment and retail sectors shifted squarely into expansion territory. Intense competition for core product and the availability of low-cost debt permits capital to flow into a broader range of asset quality and market tiers to take advantage of real estate’s long-term stability and steady income.
THE NATIONAL RETAIL MARKET
Sales of significant retail properties in May soared 185% year-over-year to $2.8b, making this the strongest month so far in 2011. The spike in activity was broad-based and not driven by any one deal or portfolio, cutting across all retail formats with strip center volume up 155% yoy in May and sales of mall and other properties up 206%. With over $7.4b of retail transactions currently pending, volume is expected to remain robust over the near term.
After bottoming in 2009, strip centers valuations have jumped 45% and are now 10% below their 2007 peak levels. There is a recognition that we are back in solid retail investment environment along with historically low interest rates which gives buyers the urgency to get deals done before the FED raises the benchmark. Rather than settle for paltry bond yields many private and institutional investors prefer to invest in retail properties that derive a steady cash flow from long term leases. Today, core assets in primary infill locations sell for cap rates as low as 5.5% and lower grade assets in secondary markets have become more attractive to value-add funds and opportunistic private equity firms. Those assets sell at an 8.5% – 9.5% cap rate.
Average cap rates inched up overall in May to 7.7%, on slight upward pressure from UN- Anchored strip centers that trade at an average cap rate of 7.2%. Median prices are between $143 – 167/SF. An additional factor may be the higher percentage of distressed retail property sales in May, which equaled 34% of volume, well above the 23% averaged to date in 2011. Signs that capital is moving to higher yielding markets are also becoming evident. Tertiary market activity is increasing at a much faster pace, with the Midwest’s volume increasing faster than any region. Investors no longer limit their acquisitions to core, class A product. As competition pushes investors from primary markets there is a growing activity in the Class B and C assets in secondary and tertiary markets as well. In recent years investors have been focused on properties with a minimum of $400 per square foot in annual sales but today they are buying properties with $300/SF in sales such as Winn-Dixie anchored centers and getting a 7-8% yield without a lot of risk. Lenders also are now open to finance those properties.
Retailers expansion and lack of new construction boost occupancy. Nearly 65 Million square feet of retail real estate has been absorbed in the U.S. over the past 12 months. Retailers announced plans to expand over 40% from last year and contraction is subsiding with store closures down 53% from last quarter of 2010 compared to same period in 2009. This year many REITs are marketing non-core assets. Westfield is marketing 17 malls and Kimco expressed their desire to dispose of 150 shopping centers. Weingarten Realty and Ramco-Gershenson are pursuing similar strategies in order to improve the overall quality of their portfolio. Another reason is the fact that many of the properties have reached their sweet spot and maximized their value as cap rates recently approaching levels not seen since the boom years.
Foreign Investors. Direct acquisitions by foreign investors rose 138% year over year in 2011 to $10.1 Billion. New investors from Asia and the Middle East along with repeat buyers from Europe, Canada, and Latin America all play a role in recent acquisitions of American assets. The trend is expected to grow as the spread between cap rates and interest rates is normally much lower in these countries compared to the U.S. The weak dollar and historically low interest rate only amplifies this investment opportunity for foreign investors.
Forecast. As property income is recovering with improvement in occupancy levels and expected increase in rental rates, the values are expected to increase. The recent contraction in cap rate was derived mostly by sales of core class A assets in primary markets but we are already seeing investors buying class B and C properties in secondary and tertiary markets. Expectations are for higher inflation that may lead the FED to raise interest rates by next year. This will make commercial real estate less favorable compared to safe investments such as U.S. Treasuries. This implies an upward pressure on cap rates in the near future.
THE ORLANDO RETAIL MARKET
Orlando was ranked number 10 by Forbes.com report that determines which U.S. cities were the next boom towns of the future based on job creation, growth in educated migration of population and overall attractiveness to immigrants. Orlando is the only Florida city to make the top part of the rankings. Central Florida is home to one of the largest universities in the U.S. The city has become the base of operation for several military, simulation, digital media and medical/life science businesses, professional sports franchises including the Orlando Magic etc’. In a few years Orlando will house two major economic boom facilities: the Amway Center and the Dr. Phillips Center for the Performing Arts in addition to the upcoming medical city in Lake Nona which is one of the largest in the world. Orlando’s foreclosure market showed significant declines in June and through the first six months of the year when compared to 2010. Seminole County — 70.5% decline, Osceola County — 66.4% and Orange County — 62.6% decline. As employment grows in Orlando so will the rate of population growth. Properties will continue to stabilize in 2011. Retail vacancy will decline and rents will inch up modestly this year as the local tourist trade recovers and employers expand. Despite the most significant job growth in any 12-month stretch in four years, retail operations have only slightly recovered thus far, lacking an appreciable rise in tenant demand. Store closures totaled about 2.7 million square feet over the past year, down from 4.7 million square feet in the preceding 12 months, but substantial numbers of new tenants have not yet emerged. Retailers such as the Aldi grocery chain have opened new stores and continue to scout locations but many others remain cautious regarding expansion. Multi-tenant property investment has recovered, with more deals executed over the past 12 months than in any year-long period since the recession started. Other assets in lower-visibility locations or with weaker anchors and in-line tenants typically demand higher equity commitments from the limited number of lenders willing to underwrite deals. As a result, investors require higher first year returns on these assets, with cap rates often starting in the mid- to high-8% range.
Sales Activity. Sales volume of all retail properties this year totaled over $474 million. This is an increase of 459% compared to the prior 12 months with a median price of $125/SF.
Construction Construction has virtually disappeared to 184,000 SF of retail space in 2010. Builders will complete 120,000 square feet in 2011, one of the lowest annual totals on record.
Employment. Following a gain of 15,600 jobs in 2010, hiring will accelerate this year with the addition of 25,000 jobs, a 2.5% increase. Job growth will support a 4% rise in retail sales.
Multi-Tenant. Sales of high-quality, well-located assets or distressed properties resulted in
near tripling of multi-tenant transactions in the past year, the most active 12-month stretch since before the recession.
Vacancy. Steady demand growth and minimal supply-side pressures will lower the vacancy rate 70 basis points in 2011 to 10.2%.
Cap Rates. Best-in-class grocery-anchored shopping centers trade at cap rates in the mid-7% range. Cap rates starting at 8.5% for lesser-quality properties.
Rents This year, asking rents will advance to $17.18/SF, compared with a 1.7% drop in 2010. Effective rents rise 1.4% to $14.65/SF, following a 2.4% decrease last year.
Outlook: Interest in local assets remains keen and will increase as investors set sight on secondary markets and class B and C properties.
Single Tenant. Transaction velocity slowed about 15% over the past 12 months. More drugstore sales were executed during the period, however, and restaurant deals increased 61%. The median price was $209 per square foot, compared with a $174/SF median price last year.
Cap Rates. Rates vary widely, ranging from about 7% for nationally branded drugstore chains to 8% or more for freestanding properties in strong locations net leased to credit tenants.
Outlook: Sales of top-rated, net-leased assets with tenants secured under long lease terms will remain intense, but deal volume may be limited by a lack of listings.
Capital Markets. The yield on the 10-year U.S. Treasury remained in the mid-3 percent range throughout the first quarter, where it will stay over the rest of 2011. Ongoing U.S. budget battles, unrest in the Middle East and lingering uncertainty concerning European debt could affect interest rates. Active lenders include life companies, commercial banks and other financial companies. CMBS staged a comeback in the first quarter, with $8.7 billion of new issuance, and will easily exceed last year’s total of $12 billion. Conduits continue to broaden their lending criteria as property operations stabilize. Loan-to-value ratios generally range from 60% to 75%, depending on asset age and quality, location, tenant mix, and tenant credit rating. Multi-tenant assets with strong anchors and a stable mix of national in-line tenants remain preferred. Debt-service ratios range from 1.25 to 1.40. Financing for lower-quality but not distressed assets will stay limited until economic factors stabilize further and investor demand increases. Rates for five-year retail loans typically start below 5% range.
Distressed Retail Nearly half of the distressed inventory in 2010 sold in the fourth quarter which is a good indication of lenders motivation to resolve their troubled mortgage portfolio while concentrating on avoiding fire sales but distress will continue to be a significant factor in the market well into 2011 and beyond. As of May 16th 2011 there are 49 distressed retail properties totaling $608.8 million. In the past 12 months 19 distressed retail properties were offered for sale at an average cap rate of 8.5% and an average price of $115/SF. 12 distressed properties closed with an average cap rate of 9.3%. The price average was $69/SF.
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Sean Glickman is Vice President of the Investment Advisory Group at CB Commercial NRT. He specializes in retail properties in Central Florida and has a Global Real Estate background. Sean Glickman – Profile . Please contact us for more in dept, localized market insight.
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The information in this report is deemed to be reliable. Every effort was made to obtain accurate and complete information; however, no representation, warranty or guarantee, expressed or implied, may be made as to the accuracy or reliability of the information contained herein. Sources: Integra Realty sources, Reis Observer, Marcus & Millichap, CoStar Group, Inc., Data Quick, Economy.com, Federal Reserve, MBAA, NAR, Real Capital Analytics (RCA), Glenn Mueller, Trepp, U.S. Census Bureau, Urban Land Institute , ICSC, Retail Traffic, Sites USA, Claritas, Retail Planet, US Retail Centers, University of CFL.
