Investors Pressing Pause or Play?

by Camren Skelton

Retail investors have pumped the brakes in 2018 but are poised to accelerate into the end of the year.

Interview by Randall Shearin

As we enter the last quarter of 2018, the question is what will the remainder of the year look like for investment sales and what can we expect in 2019. Shopping Center Business sat down with Southern California-based Hanley Investment Group Executive Vice President Bill Asher and President Ed Hanley to discuss their take on five issues impacting retail real estate investors.

SCB: Interest rates have increased, but the 10-Year Treasury rate has been steady for the last six months. How have interest rates and the 10-Year Treasury rate impacted investors?

ASHER: Projected rising interest rates have caused buyers to pause or be more cautious in their purchasing decisions this year. However, since February 1, 2018, the 10-Year Treasury rate has fluctuated but remained steady from 2.77 percent, as of February 1, 2018, to 2.86 percent, as of August 17, 2018, going as low as 2.72 percent and as high as 3.11 percent during that time period. In one of the Federal Reserve’s most recent statements, U.S. economic growth was characterized as strong for the first time since 2006. In the previous June statement, the economic growth was described as ‘rising at a solid rate.’ Although buyer interest and offer activity has been slow and inconsistent in the first half of 2018, the stability of overall macroeconomic conditions and lack of major volatility should increase buyer demand heading toward the end of the year.

HANLEY: The Fed revealed its intentions for two more rate increases this year — one in September and one in December. The Fed’s rate increase on June 13, 2018, was expected and baked in to markets as there was no major market volatility. It’s probable that capital markets will respond similarly in September, likely leaving the 10-Year Treasury rate static and borrowing rates similar to the range they’ve been in year-to-date, providing a continued clear runway for buyers to know what to expect when financing an acquisition and taking action on more purchases.

SCB: Is there a wait-and-see attitude among investors? In 2018, transaction volume in California is down year-over-year. What about sales and cap rates?

ASHER: In general, we are in a transitional market with more optimism than pessimism. Fears about online retailing — specifically Amazon — undermining sticks-and-bricks retail are overblown. However, the industry is rapidly moving further toward value and convenience, tied to the changing lifestyle of the average American. Activity among retail investors has slowed down in 2018 and is reflective in the sales data. Per CoStar Group, overall transaction velocity and sales volume are down and cap rates have moved up.

HANLEY: According to CoStar Group, comparing data from August 2016 through August 2017 to August 2017 through August 2018, for all retail sales above $1 million in California, sales volume and the number of transactions decreased. We see that 1,108 properties traded hands between August 2016 and August 2017 compared to 990 sales the following year. Over the same period, from August 2017 to August 2018, sales volume was $5.9 billion compared to the previous period’s total of $7.48 billion. The average cap rate increased over the same period. From August 2017 to August 2018, the average cap rate was 5.61 percent, which was up from 5.53 percent in the previous year. Although we anticipate transaction velocity to pick-up, we see the trends of decreasing sales volume and softening cap rates continuing throughout the remainder of the year.

SCB: Are grocery-anchored shopping centers still the top retail investment of choice; trading at premiums?

ASHER: Daily needs shopping is not as threatened as was perceived last year — internet sales are enhancing sales for daily needs retailers, and not threatening them. Most shoppers still want to pick certain grocery items personally. However, some items they are pre-ordering which they pick up after shopping for non-preordered items. Competition for grocery-anchored investment product continues to be high, with pricing remaining consistent due to the low supply of quality inventory and high demand from institutional buyers seeking grocery-anchored investments in major MSAs. In California, coastal Los Angeles, Orange County and San Diego remain the geography of choice. This lack of softening on pricing reflects investor sentiment that there is less risk in this area of retail. Institutional buyers will sometimes stretch to markets outside of those areas based on the circumstances, but not typically.

HANLEY: Pricing for grocery-anchored centers with reported sales volumes in core markets ranges from the high 4 percent cap to the low to mid 5 percent cap range with institutional investors typically being the buyer profile. Grocery-anchored centers in Inland Southern California — Riverside and San Bernardino counties — have seen fewer institutional buyers transact, accounting for less than 20 percent of grocery- anchored center sales in 2018.  Private investors are typically the buyer there. Values have ranged in the high 5 percent cap to low 6 percent cap range.

SCB: Are single-tenant net-leased investments still hot?

HANLEY: This category continues to possess the largest transaction velocity and the highest number of potential buyers seeking a flight to quality. These buyers especially want properties with new construction, long-term leases, internet-resistant, corporate guaranteed tenants in good locations. We anticipate a steady volume of transactions in the third and fourth quarters of 2018. Single-tenant net-leased pricing $5 million and under remains the most consistent with the smallest separation between asking and final sales price due to the category having the largest buyer pool. However, the depth of formal offers submitted from this buyer pool has started to shrink. Average listings are generating five total offers or less compared to five to 10 or more total offers 18 to 24 months ago.

ASHER: Single-tenant net-leased priced $5 million and higher have seen similar results but experiencing longer marketing periods and timing to procure a buyer due to sellers’ ‘rearview mirror’ pricing expectations, rising interest rates and the fact that most buyers need financing to transact. All-cash buyers still exist depending on certain 1031 exchange requirements. Institutional buyers are approximately 30 to 50-plus basis points higher on pricing compared to private investors. The separation between asking and final sales price has widened in this category.

SCB: The retail industry agrees the market is changing. Where’s the market headed?

HANLEY: There still remains a separation between buyers and sellers on pricing overall, but that gap is narrowing based on properties being more accurately priced reflective of changing market conditions. Buyers have been more cautious in their purchasing decisions in the last 12 to 18 months and, in many cases, sales cycles are taking longer compared to previous years. It is important to be strategic in properly pricing assets for sale moving ahead to appropriately engage prospective buyer interest in this year’s transitioning market.

ASHER:  As the illustrious coach John Wooden said, ‘Failure is not fatal, but failure to change might be.’ This year, one of the most important aspects of the market has been the recognition from the industry that the market is changing. It’s been challenging coming to terms that peak pricing is behind us, but tepid buyer demand this year has clearly demonstrated a new normal. Overall, historical values still remain at all-time highs for certain retail product types, such as core grocery-anchored, single-tenant net-leased and multi-tenant pads, even compared to top of the market pricing in 2006-2007. However, it will be vital that assets are priced in accordance with the transitioning market if we’re to see transaction velocity increase moving forward.

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