Faris Lee director, Joe Chichester, examines the seller’s perspective, while senior managing director, Shaun Riley, speaks from the buyer’s standpoint on how pricing looks for retail assets in today’s market.
The Sell Side: Joe Chichester
What is the current environment for sellers? Are they typically pricing assets at or above market rates?
The current environment for sellers has changed dramatically over the course of this year, coming off a cap rated compressed market with demand outweighing supply, to a market that has begun to stabilize and now has more supply than demand. Sellers are beginning to recognize this shift and the importance of selecting a firm that doesn’t treat assets as a commodity, but that recognizes and can speak to the uniqueness of each property to maximize value.
The market is still allowing sellers to price their assets aggressively, but it takes the right positioning of an asset and the ability to differentiate it from the general market to transact at more aggressive prices/cap rates.
How do you advise sellers on determining a price/cap rate?
Advising a seller on the price/cap rate of a property is by far the biggest challenge as financial advisors for many reasons, including: the competitive nature of brokerage, economic shifts, and seller and market expectations, to list a few. When advising a seller on the value of their asset it is important to not let the aforementioned challenges overly influence the value of an asset. It is important to focus on the unique characteristics of each property individually. For example, there are more than 150 drugstores actively being listed for sale, so when an owner asks you to give them the value of their property, it takes a diligent review to differentiate it from the competition. Without spending the time to do this, a property gets lost in the market. And yet, there are a lot of brokers and firms that will view it as “just another drugstore” and apply generic valuation metrics that may not do justice to the owner or the property.
What are the main motivations for owners to sell in this market?
Real estate owners sell for a variety of reasons. Some of the main drivers are: looking to capitalize on the favorable market conditions (high demand, low cap rates and availability of strong financing), having a loan coming due, seeking better long-term rental growth by trading into a new property, partnership dissolution, generational planning, portfolio reorganization… and sometimes they simply need or want the money for other life events.
The Buy Side: Shaun Riley:
What is the current environment for buyers? Is the general sentiment that assets are priced to market or over market?
Generally speaking, the current environment for investors is one of stringent underwriting and having more conservative assumptions than at any time in recent years. The comment we frequently hear from more sophisticated value-oriented investors is that there is considerable inventory on the market, though after underwriting the assets, they cannot make sense of current pricing given their risk tolerance and future projections. The general sentiment is that valuations are priced at a level where most investors would not be able to hit their targeted returns. With that said, the abundance of capital and debt available at historically low levels have provided the platform needed for continually strong transaction volume.
For what reasons do buyers justify low cap rates? How low will they go?
The low cap rate environment has sustained as long as it has because the alternative investments to real estate are typically lower yielding than real estate and don’t offer income growth or tax benefits. The availability of interest rates on acquisition loans in the high 3% to low 4% range has helped investors justify low cap rates as long as cash-on-cash returns are met. While it’s difficult to tell how long this low cap rate environment will prevail, it’s really difficult to see cap rates going lower. With headwinds such as rising interest rates and the continual evolving of the retail industry, investors will need to obtain higher cap rates going forward to justify uncertainties on the horizon.
What are the main motivations for buyers to acquire assets in this market?
The needs investors have to justify transacting in this environment are similar to what they have always been and are mostly based around event-driven situations such as a 1031 Exchange, managing risk, or the need to restructure their portfolios either through changes in desired product type, geography, or property management responsibilities. At the end of the day, the acquisition needs to be driven by a real need.