Retail Investment Market Reaches Equilibrium

IRVINE, CA—The retail-investment market’s temperature varies according to property type and location, but single-tenant retail is one of the hottest sub-sectors, Nicholas Coo, senior managing director of Faris Lee Investments, tells We spoke with Coo about the various property types and how his firm advises investors and sellers to get the most out of an asset. Nick, tell us about the retail property market right now. Is it a buyer’s or a seller’s market, in your opinion?
Coo: There’s a multifaceted answer to that question. Some segments of the market are at unprecedented highs in pricing. Other segments are in equilibrium where benefits are strong for both parties. The seller’s market is at its strongest in the single-tenant category, largely within the ultra-urban core MSAs and also across the country for NNN assets with credit tenants. For example, an Apple store on the iconic Third Street Promenade in Santa Monica, CA sold for a 3% cap rate recently. That trade blows away all conventional retail cap-rate thresholds for an asset of its size. With other property types—anchored or unanchored retail outside of what we would consider a top-tier urban location—we are seeing more equilibrium where both parties stand to benefit.
Lease rates play an important role in the equalization happening in non-core markets. In the “boom years” of the last cycle, rents were over-inflated rents across the board—there was minimal difference between rent rates in core urban markets and secondary and tertiary markets. The urban and core locations are still a seller’s market—they can command premium rents and trade at historically low cap rates like the Apple example above. But in today’s post-recession environment, lease rates within non-core multi-tenant properties have “right-sized.” A buyer can acquire a property with the confidence that their tenants pay sustainable or replaceable rents. Tenant stability is obviously a key factor in garnering a favorable return, particularly over a long-term hold. So, in these types of markets, there is more of a “fair trade” environment among buyers and sellers. How does Faris Lee advise investors seeking out an asset?
Coo: We get to know the investor, and we work through their goals and objectives first. We treat every investor differently based on their needs. Some are more security driven; others are looking at assets for a generational purchase, while others are looking for value-add investments. How do you advise sellers on getting the most out of their asset?
Coo: We look at the whole market. Our retail-brokerage platform is one dimension of Faris Lee. If it makes sense strategically, we will place investors into other property segments. We take a global market perspective on reinvestment and filter that back to the investors’ goals and objectives.
For example, we were engaged to advise a private real estate investment client on their retail asset in Orange County. We devised a reinvestment strategy which considered all asset types. We then identified a 20-unit apartment asset located in Northern California prior to the close of their Orange County sale. We designed a reverse 1031 exchange which accommodated the acquisition of the asset prior to selling their Orange County retail center. In this case, the apartment asset stood to provide a 20% IRR utilizing conservative underwriting. It was a better use of capital to sell the Orange County retail asset and buy an apartment asset in Northern California. The relinquished asset at the time had eight tenants and two suites vacated during escrow. It was a great price for the seller because of the upside and redeployment of equity. And it was a good investment for the buyer as well due to the ultimate return upon stabilization.
Ultimately, if we can execute with certainty for the seller and develop a business plan for the buyer, we’re benefiting both parties. What types of properties are the most sought after and why?
Coo: I’ve personally witnessed that the industry has been hitting record levels in demand and acquisition volumes. Demand is coming from the same two segments we have historically witnessed drive the market—the security-driven buyer and those seeking value-add opportunities who are willing to take higher levels of risk. The security-driven buyer wants a new product with solid tenants—in which case they’re buying into low management and lower risk due to the tenant’s credit—and that includes single-tenant buyers. Then, there are those investing in real estate who have a business plan and are looking to accentuate returns. This second type of buyer is seeking a property with vacancy or with a difficult configuration where existing rental rates are below market, and they’re looking to add value.


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