Retail and restaurant expansion plans are perking up for the first time in two years.
The National Restaurant Association is reporting that its Restaurant Performance Index (RPI) index rose to its highest level in 27 months in February and capital expenditures and expansion plans are also in the rise. Given that we have lost more than 280,000 eating and drinking place jobs during the recession, and an untold number of restaurant locations, this is a welcome sign for the industry (read the full press release).
At the same time, Retail Lease Trac is reporting an increase in projected store openings for the first time in a year. Their tracking of 2,000 leading retail companies indicates plans to open over 65,000 stores in the next 24 months.
All of this bodes well for net lease investment which is leading the charge as one of the few bright spots on the commercial real estate horizon. Many restaurants and a large number of expanding retailers are single tenant entities and often look to investors as landlords and to assist with their expansion plans. Net lease investments have long had the attraction of very limited property management duties and maintenance compared to other real estate investments. In addition,with banks paying a paltry .25% on money market accounts, the opportunity to receive an 8% or better return on that same cash, and limit investment risk, is a compelling opportunity in current environment.
As reported here earlier, FDIC bank regulators were recently in the process of re-writing the guidelines for commercial real estate loan workouts. Well they did. These new guidelines were released on Friday just in time for Halloween. The end result is a 33 page policy statement on prudent commercial loan workouts (emphasis added). In a nutshell, this policy statement calls for a continuation of the so-called “extend and pretend” practice of extending loans upon maturity even while the value of the property has fallen below the loan amount. The FDIC is obviously concerned about bank failures which have cost the FDIC’s fund that insures deposits an estimated $25 billion so far this year and are expected to cost another $100 billion through 2013.
Regulators have now provided more explicit guidelines for commercial banks dealing with troubled commercial real estate loans. It appears likely that if the property is producing income sufficient to cover the debt and the borrower shows a strong likelihood of continuing ability to pay, the loan will be extended or re-worked. In fact, in the introduction on page one of the policy statement, the FDIC says “financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers’ financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications.” In other words loans made to creditworthy borrowers that have been extended or restructured won’t be classified as high risk by bank regulators when the assets backing them have declined to a value that is below the loan balance. This is the strongest indication we have seen to date that the floodgates are not ready to be unleashed as far as OREO properties are concerned. However, delinquent loans still comprise around 9% of total commercial real estate loans outstanding and some 16% of all construction and development loans were considered delinquent at the end of the second quarter of 2009. This places delinquent commercial real estate loans at some $150 billion out of a total loan pool of $1.7 trillion held by commercial banks. If the loan is delinquent, what does this say about the borrowers ability to repay? And this says nothing of the $900 billion in securitized real estate loans, many of which will be seeking a new home over the next several years. I don’t see special servicers and hundreds of individual bondholders being willing to employ the same strategy as commercial banks. Regardless, it appears we may have to wait a bit longer for some significant OREO opportunities and there is so much dry powder out there sitting on the sidelines that some REITs are now talking about using it to pay down debt in 2010 if buying opportunities do not emerge.
This whole process sets up another dilemma just down the road. Valuations are actually coming back down to historical norms. Too many people have forgotten that cap rates were 10% earlier in this decade. At the same time as these loans are being extended, both occupancy and rents are continuing to drop. This trend is set to continue throughout 2010 for most real estate asset classes. The fact is we still have too much office space, too many apartments and too many shopping centers for the demand. Until we see some serious and sustained job growth this trend will not reverse. And then interest rates are expect to start rising soon…I still see someone eating OREO’s in the future.
There are over 1,400 retail properties in distress totaling some $31 billion according to Real Capital Analytics. Retail is the leading distressed property type by almost double the value when compared to every other property type. Even without the General Growth Properties (GGP) bankruptcy, retail still led the distress pack in 1Q 2009 with over $16 billion of properties in distress and the highest number number of properties. Even so, where does it hurt? “Everywhere”, states Real Capital Analytics.
There is more news each and every day, and most of it not good.
Well, the shoe is already dropping and set to drop further. This kind of talk is a genuine disservice to those in and outside of the industry. It is all about jobs, jobs, jobs. Commercial Real Estate 101 goes like this:
Job Creation –> Demand for Office and Industrial space –>
Demand for Housing –> Demand for Retail Space
This is not rocket science, just simply economics. Job losses continue to mount and the political uncertainty is not helping. Small businesses are the greatest job creators of our economy and they are paralyzed due to mounting costs, looming taxation, a health care fiasco, lack of credit and a host of other issues — none of which are being address on any serious level by any branch of government. Until we are able to start creating some serious jobs things are going to get worse, not better in commercial real estate.
And now we have the Capmark bankruptcy to contend with brought on in part by the fact that commercial real estate properties are not worth a sufficient amount to cover or service debt.
Here is a slide from my latest Retail Real Estate Presentation to investors that subjectively shows where we are right now in the Retail Real Estate. My biggest concern is about underestimating where we are in the cycle.
Yet, what does this mean for savvy investors in the future? Perhaps the greatest opportunity in our life time to acquire real estate assets below replacement cost, below net asset value, below ridiculous debt levels, and basically below everything that matters. This will require due diligence and patience. Things are not going to turn around quickly but the buying opportunity over the next several years will be unprecedented for well located, cash flowing properties that have unique qualities and characteristics that stand the test of time. In short, places where people want to be. As we have seen, ridiculous debt levels combined with places that people really don’t want to be — like commodity tract housing and commodity big box retail — have little lasting value. The true value is in the places where people do want to be, now and in the future. Well-conceived and well-located mixed-use projects that offer unique characteristics such as water views, water access, higher education and the like continue to be the places where people DO want to live, work, play and learn. This bodes well for the coasts, and university towns. Now, let’s do some due diligence and seek out those opportunities.
Here’s a tale of excitement and shoppers flocking to get the goods and services they want amidst this retailing climate plagued by gloom and doom.
Providence Town Center is a “power town” shopping center that recently opened in Collegeville, PA – a Philadelphia suburb. The project is intended to be a hybrid power center/lifestyle center. A 132,000 sq. ft. Wegman’s opened on Sunday to a throng of shoppers, including 1,500 who lined up at the door at 7AM. (Wegman’s is a good story in and of itself. They are quite well known in the mid-Atlantic for high quality stores and a loyal customer following.) The twist is this particular Wegman’s includes The Pub, a full-service restaurant located inside the store’s Market Café.
The enthusiasm and excitement of the shoppers is a bright spot and a testament to delivering what the people want and where they want it.
Providence Town Center also includes Best Buy, LA Fitness, Dick’s Sporting Goods, DSW Shoes, Ulta Cosmetics, Five Below, Staples, PetsMart, Michaels’, Raymour & Flanigan, PNC Bank, PF Chang’s, Eastern Mountain Sport (EMS), and Olive Garden. This is one of the larger retail projects to open this year (about 500,000 sq. ft.). Private developer Brandolini Companies also envisions a lifestyle center as part of the project in the future, adding another 200,000 sq. ft. or so. As one might expect, this component has been delayed for the time being. I have seen many hybrid centers around the country but few with full-line grocery stores. Power center developers, take note.
The reality is that we do have too much space for the given market conditions. Too much or too little space is relative to the demand for this space.
The demand for retail space is highly correlated to population/population growth and income levels. In this decade the industry built retail space that took the per capita shopping center square footage from 21 in 2000 to 23.5 today. This is a compound annual growth rate of 1.3%. Given that, the population was growing at about 1% per year in the U.S. and income/wealth was also growing, this seems appropriate on the surface. However, in the current economy, incomes and wealth are down substantially and we have lost most of the jobs created in this decade. We are now over-stored and retail stores are closing and many shopping centers are in distress as a result. The supply of space now far exceeds demand. Roughly half of the space that was built in this decade was off-mall, big box. We are seeing the direct fallout from this trend with the bankruptcies of Circuit City and Linens ‘N Things and store closings by other box retailers.
Virtually no enclosed malls were built in this decade. Enclosed malls are facing another challenge and that is the slow grinding obsolescence of the department store format–which is largely responsible for decline of some regional malls and the related emergence of the so-called lifestyle center (essentially an open-air mall without department stores). Good quality A & B malls are holding their own in the current environment and will continue to do so. However, poorer quality malls are being impacted across several fronts: by quality malls they compete with, as well as all other formats from off-mall boxes, to lifestyle centers to internet retail. This trend will continue and many C & D malls are going to slowly die as a result of this trend. Retail contraction is underway and it is largely the result of decreased demand. Overactive lending did not help and created some poorly underwritten shopping centers that should not have been built. Regardless, supply now far exceeds demand and this is going to take several years to work itself out.
