While interest rates continue to play an integral role in the overall capital markets, investor appetite for acquisitions has not shown many signs of a slowdown. The stock market remains extremely volatile, and investors want hard assets. Buyers remain active and engaged, but sellers of single-tenant assets have been slow to respond to the current market environment. However, activity for shopping centers has remained strong. Sellers for multi-tenant assets have done a better job of meeting the market and understanding the shift in the capital markets.
By now, everyone is familiar with the Fed increasing interest rates to curb inflation. Investors tend to flock to hard assets in high inflationary periods, which is why there is still so much buyer demand within commercial real estate. Investor appetite for shopping centers has not slowed since these assets still have cap rates above interest rates. Additionally, buyers understand that leasing activity has remained strong, and with limited new supply coming to the market, shopping center owners are signing new leases at increased rental rates.
Typical retail leases have annual increases or increase every 5-years. These increases are an incredible tool to hedge against inflation, and why real estate has remained such a powerful investment during high inflationary periods. Typically, in the single-tenant space, an investor can expect a Tenant to have 10% increases every 5 years. While attractive, it’s more typical to find annual increases of 2-3% within shopping centers. Increases that compound on an annual basis, coupled with the fact that owners are leasing up their shopping center vacancies, has caused many investors to re-evaluate neighborhood centers and add these assets to their portfolio.
Per CoStar, “Chicagoland demand for retail space increased by 3.6 million square feet in Chicago over the last 12 months, despite Chicago’s population losses.” An increase in demand for retail space means an increase in rent growth, which Chicago also “saw over a 3% increase for the trailing 12 months.”
With rents continuing to increase and interest rates also rising, buyers realize that now is a good time to put their money to work in multi-tenant retail shopping centers. A buyer can get in at a lower basis now than in the previous 3 years. While their cash-on-cash returns might be sluggish for the next few years due to the increase in debt service payments, many buyers are taking on traditional bank debt and plan to refinance in a few years once the capital markets have settled.
We recently listed a deal in Auburn Hills, MI. It’s a 48,000 SF shopping center, with 20% vacancy- the market vacancy sits right around 1.1% (CoStar) for retail. The submarket is home to a high-performing Costco, Home Depot, and Great Lakes Mall- a 1.2 million square foot mall that is 100% leased. The market has seen a steady rise in market rents, population, and a decline in market vacancy, key indicators for an investor that a market is healthy. Within 48 hours of going live with the listing, we received multiple competitive offers. Buyers are very bullish on value-add deals due to market fundamentals such as increased demand for retail space, higher rent growth, and limited new supply coming online.
Alternatively, developers and owners of single-tenant assets, and 2-3 tenant new construction developments, have been slower to move pricing and meet the market. Unless you’re a cash buyer, investors who need to place debt on single-tenant assets are having a hard time making the numbers work. The days of the 6% cap deals trading are unfortunately behind us unless you’re a 1031 exchange buyer. Investors today are looking for higher-yielding assets, 7.5% cap or higher, or value add deals. It is really the only way a buyer can make sense to transact in today’s market.
Overall, buyers still have certain returns to achieve for themselves and their investors. While there has been an increase in cap rates, the overall market still has not fully adjusted to the new interest rate environment. Thus, there has been a massive drop in transaction volume. Sellers in general have not met the market and currently, there is an under-supply of shopping center product on the market.
At Quantum, we understand buyers’ needs to navigate the current market environment. We have a plethora of on and off-market deals, that check many of the boxes for the retail investor in today’s world.