A fresh influx of money aimed at the retail sector has made 2021 a strong year for investment sales in the category. Factors such as the continued inflow of capital, attractive yields, diminishing fears over the demise of the 1031 exchange, and trading opportunities indicate that 2022 will likely follow in the footsteps of 2021 as a strong performing year.
Don MacLellan, Managing Director of Faris Lee, explains that since the start of the third quarter of last year, the company has seen a significant influx of capital interested in commercial investment properties, across all asset classes of retail. detail. As businesses resume semi-normal operations amid lingering COVID concerns, it has become clear that the vast amount of money that previously stayed away from investors is flowing into the retail sector. MacLellan spoke to mall business on the trends and sources of capital for retail investments that are shaping the investment space this year.
New sources of capital
In 2020, many investors have temporarily suspended their investments in commercial real estate due to performance fears. From late 2020, these investors – many of whom were active in other asset classes – resumed or shifted their focus to commercial properties, especially those deemed essential during the pandemic. This led to an explosion in trading volume, creating an imbalance between supply and demand in the retail sector.
MacLellan explains that capital comes from a variety of sources, driven primarily by the 1031 investor as well as high-net-worth family offices, REITs and large private investment firms.
“Some of this new money comes from situations where people have sold their business and started a real estate venture capital fund,” MacLellan says. “There’s a lot of that approach, whether it’s technology or another industry. They’ll be selling their business for $500 million and wanting to buy $200 million worth of commercial real estate, some of which is asset-restricted. sale to detail.
“There are a number of investors looking for commercial properties, many of whom have never owned commercial real estate before. With offices uncertain, retail has become the darling of new capital,” says MacLellan. “You can get an attractive return with long-term, low-interest debt. Many people seek to invest in commercial properties simply as an allowance from their investment management.
Significant 1031 Capital Drives Cap Rate Compression
Due to the negative perception of retail, a large number of institutions and investors flocked to multi-family or industrial at the start of the pandemic. This change made cap rates more aggressive for these asset classes and created a significant demand for investment capital for the retail sector.
With post-COVID openings, retail transaction volume has increased significantly across all asset classes, and Sole Tenant Net Lease (STNL) assets have seen their cap rates at an all-time low. MacLellan breaks down the investment environment: “The market is probably 85% 1031 exchanges for 15% new private capital, although we’ve seen so much unprecedented money lately that we’ve seen an imbalance offer demand. There is so much demand and limited supply, more there was a lot of new capital.
“As a result, we’ve seen properties go up for auction,” notes MacLellan. “Typically, it’s investors in assets up to $10 million who are interested in buying single-tenant properties. Especially after the recession, there has been such a flight to safety that the cap rate squeeze in STNL is unlike anything we’ve seen before.
MacLellan explains, “General retail demand is really just a cap rate arbitrage: I’m selling industrial or multi-family properties at a 3-4% cap rate. I buy retail at a cap rate of 6%. I finance it at 3.5%; and my cash yield is quite attractive. All of this interest has been driven by alternative returns, a lack of product, and a significant amount of capital.
Asset types and locations
“Essential” stores and those that meet the daily needs of customers are obviously the best performers in terms of sales, but value-oriented tenants also seem to be thriving, especially domestic tenants.
Restaurant sales were quite robust, but were affected by labor shortages, and rising labor costs affected net profits. QSR sales continue to exceed pre-pandemic levels. Capping rates for net leases of high-quality single-tenant assets range from 3.5-4.5% for ground leases and QSRs, historically low levels. Grocery-anchored hubs are always popular with investors — MacLellan notes that Faris Lee sold a number in 2021, all with national grocery anchors.
With assets like power centers, MacLellan hasn’t seen many deals. “The problem with power centers is that lenders are still wary of the big companies, because there have been a lot of downsizing and closures which have become widespread now. Retailers such as Kohl’s & Burlington are cutting staff, and Bed Bath & Beyond is among retailers closing underperforming stores.
Lifestyle centers are hard to fund now. “Right before COVID, everyone was into experiential retail – theaters, fitness centers and restaurants. Those are obviously all the things that have been impacted the most because of COVID, and lenders are much more conservative with these spaces now,” MacLellan says. “I will mention that this rating (like all such ratings) can vary significantly depending on location.”
Due to limited supply in West Coast locations, Faris Lee sees investors moving into secondary markets, compressing cap rates in those areas. Workers are leaving California, but they’re bringing their lifestyle preferences to markets like Boise and Salt Lake City as well as more affordable markets like Phoenix and Las Vegas, turning those markets into retail zones where borrowers can hope to obtain better capitalization rates. than in the Golden State.
New Lenders, New Perspectives on Retail
MacLellan stresses the importance of working with and educating lenders, especially in light of recent retail success. Many, he says, are obsessed with the performance of assets such as regional malls as an indicator of the industry. However, weaker mall properties have fallen victim to the retail exodus and widespread department store closures, although Class A malls have been performing well since the country emerged from the depths of the pandemic.
Still, says MacLellan, beyond malls, “the majority of our retail customers have done very well during COVID, especially if they could meet the daily needs of their neighborhood. We are looking at 90-95% occupancy rates for these commercial properties.
Many retail owners have faced postponements in the depths of the COVID pandemic, but sales have rebounded across the retail sector due to pent-up consumer demand, with some categories recording sales at strongest detail in years.
MacLellan is optimistic about the opportunities for the retail investment industry in the future: “Investors with expertise in the retail industry can seize the opportunities. For the passive investor, the returns are more attractive than industrial or multifamily.
— By Sarah Daniels. This article was written in conjunction with Irvine, Calif., headquartered at Faris Lee Investmentsa content partner of the shopping center business. For more articles by Faris Lee, Click here.