May Issue: Retail—A Market ‘Awash with Cash’

The retail sector is picking up, even if in a bifurcated manner.
The Palms

JLL manages premier Miami retail center The Palms at Town & Country

By Anna Spiewak, Senior News Editor

So far, Simon Property Group Inc. has not succeeded in its quest to snap up Macerich Co. and make its already massive footprint even bigger.

But the mere prospect of that blockbuster deal foreshadows more of the same in the nearest future.

“Macerich has a strong, independent streak, and they like doing their own thing,” Garrick Brown, vice president of research at DTZ, told CPE. “They’re very successful at it. They don’t have to merge with anyone at the end of the day, they don’t have to sell, so they’ll hold out for the top dollar.”

Brown added, however, that he does predict more M&A activity from private investment groups and mall REITs alike—“none as big as Simon and Westfield, but there’s other players out there. I’m sure they’re scouring the market already.”

According to Real Capital Analytics Inc., the pace of investment activity last year was brisker than at the height of the market in 2007. Sales of retail assets topped $82.6 billion in 2014, surpassing the pre-recession peak of $81.4 billion.

This activity is attributed mainly to pent-up investor demand and the improving economy.

“There are some retailers that haven’t been deploying that capital to grow like they were four or five years ago. As a result, there are retailers who are sitting on a lot of cash,” Wally Wahlfeldt, executive vice president for national retail corporate services at JLL, told CPE. “There’s also investor cash, private equity firms that are looking to invest in retail, and we’re seeing a lot of that activity, as well.”

Retail net absorption totaled 109.8 million square feet nationally in 2014. Deliveries tracked comfortably below absorption at 60.6 million, helping push down vacancy 60 basis points since the end of 2013. Average rents rose 2.1 percent last year, and further increases are almost certain as long as new supply remains constrained. Nevertheless, rents are unlikely to reach their previous peak until 2018, according to JLL’s fourth quarter 2014 retail forecast.

Observers say that foreign capital drawn to the stable U.S. economy is boosting a lot of these numbers, particularly those for gateway markets.

“Global money is coming here, because we’re the only country where GDP is increasing right now,” Brown explained. “There’s uncertainty in Europe, a declining GDP in Asia—you’ve got all these investors trying to funnel their money here because we’re the only place where the economy is appearing to grow at levels that are close to robust.”

Avoid the Middle
So what sorts of retail assets are investors chasing?
Analysts report that the hot sellers are luxury high-end malls, fast-casual dining, single-tenant properties (especially drugstores) and grocery-anchored centers.

Rosedale Center, a 1.1 million-square-foot regional mall in Rosedale, Minn., is managed by JLL.

Rosedale Center, a 1.1 million-square-foot regional mall in Rosedale, Minn., is managed by JLL.

“The common trend is you don’t want to be in the middle,” said Brown. “The luxury shopper came back after the recession, (but) the middle class downsized and went into frugality mode, and hasn’t returned.”
With that in mind, investors favor high-end malls in urban clusters.

Grocery-anchored centers offer the evergreen appeal of necessity retail. Restaurants are enjoying robust expansion and face relatively little competition from e-commerce. That helps explain why the restaurant sector has accounted for 45 percent of retail growth in units over the last five years, Brown noted.
Office supply retailers, on the other hand, got hit hard by competition from online sales. That led to the merger of the top three: Staples, Office Max and Office Depot.
“You’re going to see consolidations like that, where retailers at mid-price are really hammered by the middle class’s frugality, so some of them will merge with each other as a matter of survival,” Brown concluded.
Another factor making more consolidations likely is investor interest in turning around troubled retailers.

That is widely expected to be the fate of Sears, JC Penney or both. Sears is planning to close between 130 and 235 Sears and Kmart stores this year, while JC Penney is trimming about 39 stores, according to JLL.

“The toughest asset to trade is the unanchored strip center,” said Michael Lagazo, senior retail advisor with Sperry Van Ness. “The investor has to pay the mortgage, so they take on these self-funded mom-and-pop leases. But when you lock in these leases, it’s not as attractive to lenders and institutional investors.”
Transactions involving urban/High Street locations also stand out. Investment volume for those assets jumped 60 percent to $13 billion, according to RCA.

Pricing for retail properties suggests that investors are still willing to pay top dollar for premium assets in the six major metro markets. Cap rates for all retail acquisitions fell 30 basis points nationally, to 6.7 percent, last year, only a hair above the 6.5 percent rate recorded in 2007, according to RCA.

While retail construction is generally ramping up across the country, favored product types vary considerably by market. In Miami, Washington, D.C., and New York City, urban storefronts dominated last year. Broward County/Fort Lauderdale and Orange County have mostly mall-focused construction. And all of Palm Beach’s construction was for neighborhood centers, community centers and strip malls, while Orlando’s was all about power centers, according to JLL’s latest retail report.

“You’ll see a lot of acquisitions in grocery-anchored centers. Last week, Publix announced acquiring a handful of grocery-anchored centers, even though they’re a grocery operator,” Lagazo said, adding that Walgreen’s also announced plans for expansions.

T-Mobile, a JLL client, recently bought out Metro PCS, but is now itself a target for acquisition by AT&T and Sprint. This scenario is likely to crop up repeatedly in the next few years.

“If you’re a healthy retailer and you’re only growing 10 to 12 stores a year, you’re just not showing your shareholders the growth that they want to see,” Wahlfeldt concluded. “So if you sit on your hands and you start to see sales pick up again, you’ve got to do something—you’ve got to start growing again, either organically or through acquisition.”