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.
There is a report out on Bloomberg that FDIC bank regulators are in the process of issuing guidelines on commercial real estate loan workouts for banks. Is this the moment we’ve all been waiting for? Probably so, and I am looking for 2010 to be the year of commercial real estate REO as there was a lot of talk about REO in 2009 but it never really materialized, save some of the single and multi-family residential.
Bridgewater Falls in suburban Cincinnati, Ohio may be a shade of things to come. Bridgewater Falls is a 600,000 sq. ft. “power town” originally developed by the now defunct Premier Properties. The center is basically a hybrid, something of a cross between a traditional power center and a lifestyle center. Believe it or not, this center had an $80 million dollar loan on it and entered foreclosure in early 2009. The lender, Wachovia, sold the property to itself for $33 million, or a whopping 59 percent less than the original loan, after no higher bids emerged at an auction back in March of 2009.
Just last week this center traded hands again. The buyer, a distress/opportunity fund operated by Phillips Edison, paid $43 million for the center in an all cash transaction. My sources tell me the cap rate was in the range of 10%-11%, thereby raising the bar for these types of transactions. The tenants are basically a who’s who of retail survivors that you want in a power center project – JC Penney, Target, Dick’s, TJ Maxx, Best Buy, Bed Bath & Beyond and PetSmart. This type of project could have easily traded in the 8%-9% range just a few short years ago. Clearly this sets a new lower level of value for power/big box centers. This segment is where notable distress exists in retail real estate given the rampant overbuilding throughout this decade (almost 50% of new space constructed was in power center/big box retail), and the fallout from the bankruptcies of Circuit City, Linen’s N Things. I look for many more of these opportunities to become available and I strongly feel 10% is the new cap rate floor in these types of transactions. REO buyers take heed.
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.
There is a lot of talk about rent relief and rent concessions in the current environment and how this is impacting shopping center landlords and publicly traded REITs. Hardly a day goes by without another article or news report talking about retail tenants asking for and in some cases getting rent relief. Is this happening? In fact it is happening. It is completely a function of the local market situation, the particular tenant and the level of pain for the landlord (or lender in some cases). Is it widespread? No, it is not. Some landlords who are strapped themselves are telling tenants to pound salt. While retail sales are down almost everywhere, quality shopping centers and malls won’t even consider rent relief. Consider a typical A class mall with pre-recession sales of $500 PSF. If sales are down 10% right now from peak to trough, the average sales $PSF is still $450 and tenants are absorbing some of the resulting higher occupancy costs and also dealing with it by cutting expenses. There was a great deal of “fat” that built up for landlords and tenants alike in this decade and much of it has now been trimmed off. If sales drop precipitously from this point, we are going to have a problem, but the economic and retail signs are pointing towards a bottoming out and leveling off.
Rent relief is taking several different forms:
Early renewal at the existing rent or in some cases even a slightly lower rent, to lock in the rate for the tenant and get more term for the landlord (a popular strategy with private companies with little access to capital themselves).
Rent deferral – reducing current rent but backloading it onto the end of the lease (a popular strategy with publicly traded REITs). While this reduces cash flow in the present, it attempts to preserve the income stream over the life of the lease.
Reduced rent in exchange for little or no tenant allowance. Landlords are willing to exchange rent for tenant improvement dollars and this is happening in some instances. However, the tenant needs to then be in a position to fund their own store build out and this does not work for many tenants because of credit availability – especially mom and pop’s in the current environment.
Asking rents are simply down, almost universally and especially in the off-mall environment. There are some tenants active in new store development that are getting rent relief in the form of reduced market rents and landlords are willing to do deals at ~25% less (than peak rents) in some cases for the right situation.
Move down the road. Anecdotally, I have seen some tenants move down the road from their existing location and get “rent relief” by simply dealing with a more aggressive landlord in another shopping center.
Rent relief is going to be with us for some time and it will continue to be a renters market in the foreseeable future . Tenants with a smaller footprint have the best opportunity to exploit the current market by significantly reducing their occupancy costs in new store locations. Existing leases are best reduced when the end of term is close at hand.
