5 retail commercial real estate investor sentiments and trends to watch

Retail real estate continues to feel the impacts of negative headlines and shifts in consumer trends as the ever-changing landscape works to find a stable footing. In 2017 there was an 18.2 percent decrease in total retail investment sales volume as compared to 2016, according to Real Capital Analytics (“RCA”). This follows a 13.7-percent decrease in volume from levels in 2015. The decrease in sales volume is not solely in retail, but has been felt across most asset types including office and multifamily. The year-over-year decreases are reflective of a shift in investor sentiment. This also signals an opportunity for those groups willing to wade against the current and dive head first into investing in retail real estate.

The retail industry continues to evolve as the needs and desires of consumers change. This is the cycle of retail. The current shifting of retail is similar to the introduction of the regional mall in the 1950s or the emergence of the discount department store in the 1980s. Within the current shifts are healthy and positive statistics on actual store openings and closings:

• For every company closing a store, 2.7 are opening one.
• There were more than 4,000 net store openings in 2017, and another 5,000 are projected to open in 2018.

Financial markets have largely started to price the associated negative retail risk into individual asset valuations, and investors are still attracted to well-conceived, well-positioned retail real estate assets. Through discussions with investors of retail real estate, we have compiled a few sentiments and trends of note.

Buyer-Seller Reconciliation

Compared to a decade ago, commercial real estate prices are now 20 percent higher for all property types nationally, according to RCA. The gap between sellers’ expectations of pricing and what buyers were willing to pay for their perceived risk gradually lessened throughout 2017. Retail properties remained on the market longer, as the two views began to gravitate toward each other. Well-located retail, value-add and grocery-anchored retail were in highest demand, not as subject to longer marketing periods. In the coming year, the bid-ask gap is anticipated to continue to shrink as the market gains more comfort with retail real estate headline risk and the changing retail environment.

Capital Formation

Advisors and equity funds continue to raise capital for retail real estate and many are forming strategies to pursue out of favor retail assets such as power centers with big box exposure, and shopping centers in secondary markets. The deployment of this capital has been slow to occur but is expected to pick up over the first half of 2018. Experts within the commercial real estate industry are in broad agreement that private capital will be a principal driver of new investment in real estate in 2018, according to a recent report from PWC. As a percentage of total retail transaction volume in the United States, private capital, consisting of equity fund advisors, operators with capital sources and high net worth individuals, has increased every year since 2014, reaching 57 percent in 2017, according to RCA. In Denver, private capital accounted for approximately 80 percent of all retail transaction volume in the metro area, for transactions over $5 million, according to HFF research. With record amounts of capital to deploy, and a growing appetite for real estate as an asset class, the private equity sector is set to be the lead player of real estate investment in 2018.

REITs

Retail REITs have maintained high occupancy rates, despite retailer bankruptcies and store closures, by attracting new tenants including those providing services and offering experiences, according to NAREIT’s 2018 Economic Outlook. Overall occupancy rates of properties owned by retail REITs were 95.7 percent as of third quarter 2017, and has remained above 95 percent since 2013. With healthy retail fundamentals, REITs’ focus in 2018 will be strategic portfolio optimization through identifying and disposing of non-core assets. Portfolio optimization will focus largely on dispositions of lower quality assets or assets with low growth profiles. These disposition strategies represent additional opportunity for private capital to enter certain markets and deploy value-add or repositioning strategies for retail properties as mentioned above.

Operations & Leasing

Out-of-market equity investors continue to seek out local operating partnerships with best-in-class retail operators in order to enter a desirable market, such as Denver, without the need to establish an office. The ability to attract and maintain tenants in this rapidly changing retail landscape is more important than ever, so high-quality management and leasing teams are in high demand. 

Financing

Sellers of retail real estate in 2018 are asking the question of how prospective buyers will finance acquisitions, in the midst of the challenges of retail. Well-conceived mixed-use, high-density, in-fill, “internet proof” tenancy and grocery-anchored centers with quality sponsorship continue to generate attractive financing from traditional banks, life insurance companies and CMBS lenders. These lending sources are under-allocated in retail and will compete aggressively to finance the best centers. Riskier retail centers with box risk, lack of credit tenants or significant rollover is being underwritten with those risks in mind, limiting leverage and requiring additional capital from the sponsor. Capital to finance retail real estate remains for those able to obtain the best quality assets and those with equity to lessen the risk to the lender.