With a multifaceted approach to real estate, Taylor Street has an ear to the ground when it comes to investing, selling, financing, leasing and managing commercial properties. The Phoenix-based advisory firm is closely following the pandemic’s effects on retail. Vice president Jake Baratz and investment advisor Boston Chauthani
recently sat down with Shopping Center Business to share some of their key insights. To plan for the future in the middle of a pandemic, the firm is advising investors to carefully evaluate market activity at the highest level in individual markets as well as at a national level.
In the big picture, Taylor Street reports that many of the same principles from the Great Recession apply to what’s happening today. Investors and consumers are flocking toward reliable retail. Single-tenant net lease properties are weathering the storm successfully. These kinds of internet-resistant, needs-based businesses have a strong foothold for many reasons.
Baratz says Taylor Street has seen strong demand for deals that are essential, well-located and typically newer construction in sectors such as auto parts, drugstores, dollar stores and quick serve restaurants (QSRs). “Merchant developers have seen particularly strong interest with multiple offers and cap rates from the 5-percent to mid-6-percent range,” he says. “People are comfortable potentially paying a slight premium for an asset they feel comfortable is going to be open and operating for the long term, regardless of coronavirus or online retailing. Those deals are still moving.”
Who Is Feeling the Effects of the Pandemic?
Taylor Street says that single-tenant, net lease properties are doing well, while multi-tenant strip centers are being somewhat sidelined with investors and landlords as a second wave of business closures advances in Arizona. The long-term security and less management-intensive aspects of the single-tenant, net leased assets are attracting a wide range of investors. On the flip side of the coin, multi-tenant strip centers and anchored power centers with big box retailers and a higher percentage of local and regional tenants — as opposed to national credit tenants — are starting to feel the effects of the pandemic. Financing for multi-tenant centers is becoming more difficult to obtain, and fewer would-be investors are physically getting out to visit properties to even consider an asset’s potential.
Rents for tenants such as gyms, bars and movie theaters have declined, adding an element of financial disruption. Rents at centers such as these have typically climbed 2 percent year over year but declined 16 percent from Q1 to Q2, with average asking rents in Phoenix at just under $15 per square foot. But single-tenant properties are faring much better. “The perception is that the retail sector is in trouble across the board, but the decline in transactional velocity is consistent with almost every other product type and essential, pandemic-proof single-tenant retailers are still viewed as one of the strongest investments for potential buyers”, says Baratz.
In Phoenix, population growth plays a role in the single-tenant space. Chauthani says a majority (68 percent) of Taylor Street’s buyers are 1031 exchange buyers from the multifamily sector, an investor pool that is flush in the Phoenix area. According to the U.S. Census Bureau, Maricopa County has been the fastest growing county in the United States for the past three years in a row.
Taylor Street reports double-digit increases in transactional velocity for assets with retailers deemed essential. Especially essential have been QSRs. “They have been a really positive note in a wave of negative news, experiencing increased optimism over the past two to three months,” says Chauthani. “QSRs are one of the most heavily targeted sectors of single-tenant real estate.”
Nationally, drive-thru properties have remained open and are typically generating anywhere from 60 percent to 80 percent of pre-coronavirus sales, Taylor Street reports. “So they’re still hanging in and doing pretty well,” says Chauthani. “Initial yields for QSR drive-thru assets are actually still in the mid-3-percent range for the strongest tenants, such as McDonald’s or Chick-Fil-A, and up to the mid 6% range for tenants with weaker credit profiles.
Other sectors still thriving during the pandemic include essential businesses that have kept their doors open, including dollar stores, drugstores and auto parts stores. “We’ve seen particularly strong interest from buyers on those deals,” says Baratz. “We see a lot of interest on pretty much anything we list that’s essential, well located and typically newer construction.”
Poised for the Future
Baratz says there is a groundswell of pent-up demand waiting to enter the Phoenix market. “As we talk to institutional investors and out-of-state private capital investors alike, there is a lot of money on the sidelines that is waiting to be deployed,” he says. “There are a lot of institutional clients that we have spoken to that are excited for the opportunity to potentially enter the Phoenix market or grow their portfolio because there are still strong investment drivers. Maricopa County has been named the fastest-growing county in the U.S. for three straight years, which is a testament to job growth and demand in the Phoenix MSA right now.
And that is what will differentiate this period from the financial crisis of 2008. “We have a drastically larger and more diverse workforce than in 2008, with a major increase in the fields of technology, medical and financial services, so our economy isn’t as reliant on construction” explains Baratz. “There weren’t as many people entering the market. Inventory is going to remain relatively stable, which is going to keep pricing from bottoming out like it did in the 2007/2008 financial crisis.”
The Election Effect
“If history is an indicator of the ‘election effect,’ then, like investors in the stock market, buyers and sellers of real estate prefer to lie low heading into an election cycle. There is typically a lot of uncertainty about what’s ahead, so owners and investors will likely adopt the position of ‘wait and see.’ That uncertainty is because of a potentially new administration, which may affect trade policies, interest rates and tax law,” says Baratz.
Chauthani says when it comes to the election, key factors to pay attention to are cap rate fluctuation and the number of transactions happening, along with trade policy, tax deductions and tax credits.
“As we get closer to November and the election, it’s incredibly important that investors in all asset classes, across the country understand the potential implications that a new administration can have on their real estate portfolio.
In the midst of the coronavirus pandemic and a hotly contested election cycle, there is still a lot of activity, though lenders are taking as much care as possible with potential clients and underwriting assets. “In March when the pandemic started to become more prevalent, we experienced buyers and borrowers starting to hunker down and completely shut everything down rather than managing their existing portfolios,” says Chauthani. In saying that, there is still uncertainty over the short-term, even as the economy continues to open, but looking forward, the drivers that underpin real estate demand remain sound. There are unique, compelling opportunities that have been sparked by the health crisis and many investors could be positioned to capitalize on these. The spread between cap rates and interest rates are at their second widest on record — this yield premium represents a unique situation for potential investors.
— By Lynn Peisner. This article was written in conjunction with Phoenix-headquartered Taylor Street.