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ARTICLE
RE: GLOBE STREET RETAIL ADVISOR
HOW CAN A SMALL DEVELOPER COMPETE
IN THE RETAIL ACQUISITIONS GAME?
by Scott Goldman
Today’s retail investors are faced
with a complexity of capital markets dynamics. It is difficult
to avoid picking up a real estate publication without reading
commentary about these dynamics. Long-term interest rates
continue to remain at historical lows and capitalization rates
and yields seem to be moving lower on a daily basis. The retail
sector continues to draw increased demand from a variety of
sources, REITs who have benefited from investors making real
estate a greater portion of their portfolios; international
investors who have discovered that because of the weak dollar,
real estate provides an above average rate of return, and
private investors searching for stability and low-risk cash
flow opportunities. In support of all these factors, lenders
are providing capital at ever shrinking spreads with ever
increasing loan to value ratios.
As developers, we’ve been blessed
by this aggressive cap rate environment, allowing us to dispose
of assets at figures we could have never justified factoring
into our original development proformas.
As private retail investors, however, the
market has been quite challenging and seems to show no likelihood
of slowing down. Core and core-plus investments appear to
be trading at lower cap rates with every deal, and yields
continue to drop to levels that defy fundamentals. The retail
sector has been the recipient of unprecedented demand that
is fueled by the economy’s perfect storm. Shopping centers
are viewed as an alternative to investments in multi-family
apartments and office product as both are challenged with
historically low interest rates and a lackluster economy,
respectively. As the economy improves, interest rates may
rise and the dollar may strengthen, which may cause capital
to flow out of retail investments into other sectors of real
estate, relieving the level of demand that has been driving
retail prices lower. Investors purchasing core deals without
upside potential will be facing cap rate risk as they try
to sell their investments at current cap rates.
The competitiveness of the market has extended
to investors compromising long established underwriting standards
in the pursuit of justifying purchase prices. Vacancy factors
on non-credit tenants have been reduced or even eliminated
in some cases while non-credit tenants are being categorized
as credit tenants and being removed from the vacancy calculation
altogether. In addition to extraordinarily short due diligence
periods, the market has been ignoring reserves for structural
improvements and physical issues associated with properties.
Many sellers are using master leases for challenged space
that may be difficult to lease at expiration. These actions
create an arbitrarily inflated net operating figure, making
it even more difficult to rationalize the prices the market
is paying.
Despite these challenges, Pine Tree purchased
14 shopping centers valued at over $100 million last year
and we hope to continue that trend in 2005. Three key factors
to consider for navigating through the turbulent market and
achieving success in retail acquisitions are:
1. Capitalize
on relationships - Each of the assets we purchased
last year were sourced through long-term business relationships
and included off-market assets in markets in which the company
has built a foundation.
2. Think outside
the big box – Consider properties encumbered
by a value-added or redevelopment component that might deter
larger investors. Through the use of higher leverage levels,
you can maximize the assets’ return on equity.
3. Recognize
and use your advantages – A boutique company
that has developed property throughout a specific region has
the advantage of being able to make quick decisions in markets
larger investors may need time to become familiar with. It
is in these markets where smaller development companies are
ever more reliable on their long-term relationships to provide
proprietary opportunities.
Scott Goldman
is Manager of Acquisitions for Pine
Tree Commercial Realty, LLC, a full-service real estate
development company headquartered in Lake Bluff, Illinois,
with branch offices in Indianapolis, Minneapolis, and Kansas
City.
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