Retail Property Assets: An ‘Alternative’ Goes Mainstream

Fact: Ten thousand Baby Boomers will retire every single day over the next 19 years, according to Pew Research.

Fact: Ten thousand Baby Boomers will retire every single day over the next 19 years, according to Pew Research. That is a powerful demographic trend, and one that all commercial real estate investors must keep in mind when considering the context of their future property investments.

Today’s investors—both institutional and individual in nature—continue to live through turbulent times. The traditional universe of investment alternatives—stocks, bonds, private equity, debt—has exhibited volatile tendencies for the better part of the past five years now. The beneficiary of this uncertainty is commercial real estate, which is becoming much more of a mainstream asset class rather than one alternative in a larger investing universe.

In many ways, real estate is the perfect fit, given the times. In general, it provides steady monthly income, low correlation to publicly traded equities and significant portfolio diversification. The demand for income has never been greater, based on the changing face of demographics.

The Baby Boomers—those born between 1946 and 1964—will turn 65 in the period between 2011 and 2029; on average, each of those years will see an increase of 1.6 million people in the 65-and-over cohort, and by 2029 people older than 65 will represent 19 percent of the U.S. population. In 2011, the Baby Boom generation started becoming the “Golden Boom” generation, retiring and beginning to receive their main income stream from savings instead of jobs.

This fact has put more pressure on institutional investors to produce sustained, healthy income flows, which will become more important than ever but also increasingly difficult to find.

As an asset class, commercial real estate has historically delivered attractive income returns relative to other asset classes. From 1978 through 2011, income returns from commercial real estate averaged 7.6 percent annually, second only to corporate bonds, a more volatile asset class that had a very strong decade in the 1980s but slipped below real estate in the last decade.

One of my favorite expressions, “loyalty is the absence of something better,” rings true when it comes to describing the current investment climate. In the absence of something better, investors instead have gravitated to U.S. Treasuries as a safe haven. The problem is that T-bills continue to generate a low return, hovering in the 2 percent range, and rates are expected to remain low for quite some time, as the Federal Reserve shows few signs of tightening its monetary policy.

Another familiar alternative, the public equity markets, rose to new highs earlier this year, but stock trading remains a day-to-day, quarter-to-quarter grind, which speaks to anything but surety and low volatility.
This challenging investment landscape, coupled with the continued drive to find higher-yielding investments, has led many institutional and individual investors directly to something better—and that is retail real estate.

All of which means now is an excellent time to revisit the investment opportunities available in shopping centers and other retail properties, which remain a proven safe-haven investment when compared to the yields on Treasuries. According to the National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index, the retail property sector returned 11.1 percent in 2012 and 13.1 percent in 2011. In fact, the NPI shows that the quarterly return for retail properties is actually higher than the annual return for U.S. Treasuries. The NPI index includes analysis of more than 7,000 institutional-quality commercial properties across the United States.

In particular, net-leased retail properties with creditworthy tenants on long-term leases are in much higher demand in 2013. This is for good reason, as these properties will provide the most consistent and predictable income streams over time.

Not surprisingly, the attractiveness of these assets is driving down cap rates on quality properties. Cap rates on net-leased retail properties dropped to 7.1 percent in 2012 from 7.8 percent in 2010, according to Real Capital Analytics Inc.

Given the sustainable nature of the long-term demographic trends coupled with investors’ continued appetite for steady, predictable income streams, retail properties present a far better alternative compared to investment strategies based on loyalty or the absence of something better. Perhaps it will not be long before real estate is viewed as the mainstream asset class over stock and bond alternatives.

Bill Rose is the national director of Marcus & Millichap’s National Retail Group. Contact him at bill.rose@marcusmillichap.com or (858) 373-3132.