LAS VEGAS — Bill Rose, director of Marcus & Millichap’s National Retail Group, doesn’t hesitate to use the word “awesome” when discussing recent trends in the 10-year Treasury yield, which dropped last Friday to 1.7 percent. It was the lowest closing level ever for the benchmark yield, and the ninth consecutive weekly drop. In contrast, the 10-year yield hovered around 5 percent at the peak of the last real estate cycle in 2007.
“This low interest rate has been extraordinarily favorable for commercial real estate,” says Rose. “This is awesome to have sub-2 percent Treasury rates. We’ve never seen that before. How long do we get it?”
That is one of the burning questions on the minds of many attendees of RECon 2012 hosted by the International Council of Shopping Centers. The show, which runs through Wednesday, kicked off Sunday afternoon at the Las Vegas Convention Center. More than 30,000 professionals from different disciplines across the retail real estate industry will participate in educational sessions, network and establish deals.
Godsend for borrowers
The persistently low interest rate environment is enabling property owners with maturing loans to breathe a little easier because their loan constant, or cost of capital, has dropped. In 2009, Rose says that many borrowers were looking on the horizon and saying, “I’ve got a note maturing in 2013. What am I going to do?”
Today’s borrowers, Rose explains, are looking at that same horizon and saying, “I’m in good shape because I can refinance that note maturing in 2013 in the fourth quarter of 2012 at a loan constant in the mid-5 percent range. My current constant is [more than 6 percent].”
The high demand for U.S. Treasuries, which has caused yields to fall, is partly the result of a flight to safety by foreign investors amid the growing sovereign debt crisis in Europe. The extremely low 10-year yield is also a signal that the U.S. economy is still not firing on all cylinders. In April, employers added 115,000 jobs, falling well short of expectations, according to the Bureau of Labor Statistics.
Against that backdrop, Rose will moderate a panel discussion focusing on investment strategies as part of Marcus & MIllichap’s Retail Trends 2012. The 90-minute reception and program, held in conjunction with RECon 2012, will kick off at 5 p.m. Pacific Time on Monday at the Renaissance Las Vegas Hotel.
Rose’s panel will include Wayne Brandt, managing director of real estate capital markets for Wells Fargo; Paul Freddo, senior executive vice president of leasing and development for DDR; Mark Miller, vice president of real estate for CVS/pharmacy; and George Tomlin, president and CEO for GBT Realty Corp. Hessam Nadji, managing director of research and advisory services for Marcus & Millichap, will provide an economic outlook.
In the net lease arena, Rose says that Encino, Calif.-based Marcus & Millichap has observed huge investor demand for retail assets occupied by tenants with strong credit ratings. Examples include Walgreens and CVS/pharmacy drugstores, Wells Fargo, McDonald’s and Burger King.
Mom and pop real estate investors have a special affinity for those types of tenants because they are household names with a proven track record of success, emphasizes Rose. “They may say, ‘I don’t know anything about Cisco or Facebook, but I do know that McDonald’s down the street from me has been operating for 20 years, and I’m going to buy that kind of property.’”
Retail vital signs improve
The vacancy rate for neighborhood and community centers fell from 11 percent in the fourth quarter of 2011 to 10.9 percent in the first quarter of 2012, according to Reis, which tracks the country’s top 80 markets. Both asking and effective rents both rose by 0.1 percent in the first quarter over the prior quarter.
Meanwhile, the vacancy rate for regional malls in the first quarter was 9 percent, down from 9.4 percent in the third quarter of 2011.
Much of that vacancy decline is the result of constrained supply growth, says Victor Calanog, director of research for New York-based Reis. For example, until the opening of City Creek Center in Salt Lake City, Utah, during the first quarter of 2012, there had been no new U.S. regional mall openings for 6 years.
“Once again, in 2012 we’ve had record-low construction figures for neighborhood and community shopping centers and almost no growth for regional malls,” he says.
The key issue for the retail sector is that the economic pie is not expanding fast enough to stimulate demand for space in an appreciably robust fashion, emphasizes Calanog. “If economic growth does register at or around 2.2 to 2.4 percent [annually], this should be sufficient to push vacancies down by a measured amount, about 20 basis points year over year.”
Net absorption totaled 3.1 million square feet nationally in the first quarter, the second largest gain in net absorption since the retail sector began losing occupied space in the first quarter of 2008, according to Reis.
Still, announcements of store closures “stream in” as retailers rationalize their space needs, says Calanog. “Expect demand to be choppy for the rest of the year.” Even in the healthier mall sector a bifurcation exists in demand for space as Class A malls continue to maintain the lowest vacancy rates in the subsector.
Buyer activity heats up
The average cap rate for retail properties was 7.3 percent nationally in the first quarter, down by more than 30 basis points during the past two quarters as investor enthusiasm for the retail sector builds momentum, according to Real Capital Analytics (RCA). The New York-based research firm notes that regional malls have become especially popular.
Source: Real Capital Analytics
Sales of retail properties and portfolios valued at $2.5 million and above totaled $12.5 billion in the first quarter of 2012, up 87 percent from a year earlier. Portfolio transactions were largely responsible for the big gain, reports RCA. Individual property sales increased only 16 percent compared to a year earlier.
In fact, portfolio transactions accounted for $6.6 billion of first-quarter volume with 30 transactions involving 173 properties. Two large portfolios accounted for much of the total, including Simon Property Group’s buyout of its partners’ interest in what had been the Mills Corp. for approximately $3.85 billion, reports RCA.
The other transaction was Canada Pension Plan Investment Board’s acquisition of a 45 percent interest in 10 regional malls plus two redevelopment sites in the United States owned by Westfield Group. At the time of the sale, the properties had a total gross value of $4.8 billion.
Source: Real Capital Analytics
Distress overhang
The retail real estate industry still faces significant headwinds on the distress front. Loan defaults and transfers to special servicing in the retail sector totaled $1.9 billion in the first quarter of 2012, a reduction from the prior quarter but higher than inflows in the third quarter of 2011, according to RCA. “Increasingly, newly distressed situations are resulting from [loan] maturity defaults of CMBS loans,” wrote the RCA researchers in their U.S. Capital Trends Retail Report released in April.
A total of $63.9 billion in loans on retail properties has become distressed in this real estate cycle, according to RCA. Approximately 55 percent of that total has been resolved via loan modifications or restructurings. “The recovery rate on liquidations of distressed retail properties has declined during the past year,” points out RCA. “In [the first quarter of 2012], lenders recouped an average of 61 percent of outstanding balances before costs and fees, the lowest among the main property types.”
Sound bites from the floor
In the trenches of the Trade Mall — which features more than 300 product suppliers and service companies — the mood was decidedly upbeat on the opening day of the convention. Stuart Wiston, president and CEO of New Wind LLC, a Nashville-based distributor of vertical-axis wind turbines and hybrid wind/solar LED lighting solutions, was busy all afternoon in his booth fielding questions on the company’s energy-saving products.
“Most people we spoke with were considering capital improvements to their properties,” said Wiston. “Several we met with were involved with new developments — something I truly did not expect.”
Hybrid light poles are generating plenty of interest, says Wiston. “Sustainability is still of interest to many of the participants from the standpoint of ROI (return on investment), rather than for its own sake. We spoke with people from Hawaii and Argentina, and from California to Massachusetts.”
— Matt Valley