GlobeSt.com: Overall commercial real estate transaction volume has taken a nosedive this year, but single-tenant properties are accounting for a large slice of the pie. How is Marcus & Millichap's single-tenant business doing so far this year?

Haddigan: It's one of the real bright spots in our business. I think it goes to the broader idea that it's very hard to assess risk in this marketplace in terms of how rents are trending, how store sales are trending, how financing is trend. So what's trading is what I'm terming to be the 'safe bets.'

GlobeSt.com: And on the net lease side of things?

Haddigan:On the net lease side, I would say that even within net lease, buyers have become much more analytic and/or much more careful about what they are buying. It has suffered the least, so if you're using double negatives, it's the least bad in terms of transactional velocity, because it's a lot easier to quantify or assess a net lease deal. You've got contract rent that's stated for a period of time, and so to the extent that you understand the credit of the tenant, an investment grade deal is a no brainer and there still is a lot of activity. A non-investment grade deal, you're going to want to know store sales, how are your rents and are the rents replaceable.

Year to date, Marcus & Millichap's net lease business has been off about 33% from a year ago. A few years ago, I'd say the sky is falling, but when you look at multi-tenant deals being off 50% and or/or hospitality or other fringe types being off 80% or 90%, it's still relatively active.

GlobeSt.com: This has to have negatively impacted lending, right?

Haddigan: We've had a lot of disruption in the lending markets. The lenders have become much more cautious in terms of how they underwrite properties. So for example, in 2006/2007, if you were to sell a McDonald's ground lease, or a Rite Aid that's not investment grade, you could still look at contract rent and the lenders would pretty much underwrite with a debt coverage ratio of 1 to 1, or 1.01 to 1, or 1.05 to 1. Well now, even with some of the safest net lease deals, the investment grade drugstores of Walgreens and CVS, ground leases, they're putting vacancies in, they're putting reserves in, they're putting management fees in. So even though you've got contract rent, they're only taking a smaller part of it, 90%, 91%, 92% of the contract rent and using that and then backing into it with a debt coverage ratio. So the net result is the loan-to-values are typically in the 50% to 60% range.

GlobeSt.com: What else are you seeing in the market?

Haddigan: Rents in retail net lease deals should really correlate to the store sales of the unit, because you want to make sure you've got a tenant that sustains themselves. But for much of the new construction from 2002 through 2007, we saw a huge run up in land costs and construction costs. The rent for many of the properties built was a function of construction costs, FF&E and the developers' capitalized return; 'okay Mr. Tenant, here's your rent.' But the rent didn't correlate to store sales, and we're seeing a lot of situations now where lenders say, 'you may be collecting X amount of rent, but we believe that if that tenant went out, you could only get X minus 20% or 40% or 50%.'

An extreme example of that might be a Starbucks. It might have had a $45 rent completed four years ago; that rent today might be $22. That's an issue. Another example would be, say you put two different CVS (stores) on the market; they're investment grade, but one might have $24 rent and one might have $44 rent. Buyers are much more careful about that, looking at the one that's safer or more likely to sustain itself. And on non-investment grade, that becomes very, very important, in terms of what your rent levels are.

GlobeSt.com: In terms of retail where are you seeing the most demand?

Haddigan:I think that necessity-based retail, on the net lease side, is still more in demand. That includes dollar stores, auto parts stores, drugstores, grocery stores. Whereas some of the fringe stuff, department stores, non-necessity, it's just not as exciting. We're just not getting the same traction. If you're taking a single-tenant furniture store to market, which we would have been able to easily trade a few years ago, those are being met with big yawns today.

GlobeSt.com: Talk more about what is trading most easily, and what deals in the current market environment are impossible to get done.

Haddigan: If you look at analyzing it three different ways—one is by quality of location, two is quality of credit and three is quality of the physical asset itself - what is most likely to trade is your primary location, infill and/or part of a larger MSA. A lot of the secondary market product that might have traded because people were chasing yield, it's a lot more difficult to trade today. Secondary markets meaning Montgomery, AL, Wichita, KS, Cheyenne, WY. We could trade that stuff all day long a few years back; today, unless it's Main and Main within that small town and its investment grade credit, it's going to be very difficult to trade.

If you're within the New York MSA or Chicago or inside another MSA, that's definitely a leg up. People want the better sites, and part of the metrics for determining a better site would be traffic counts, household income etc. People are much more focused on that, as are the lenders. Lower risk positions are what's a lot easier to trade. If there's uncertainty, if there's less than 10 years left on the lease, if the rents appear to be at or above market, if it appears that whatever the sector that tenant is in is weak, it's very difficult for us to trade.

Furniture stores, some of the department stores, dry goods, even electronics, we're just not seeing the traffic there that we did in the past, because some of these commodity items, people are just very nervous about what the long term business model is. Whereas necessity—grocery store, pharmacy, even auto parts—people seem to believe in. Plus it's the price point on those things; the $1 million to $5 million market is where most of the activity is. There are some large deals happening—large being $20-million-plus net lease deals—but they're rare or there has to be some reason to it.

GlobeSt.com: Is there a particular smaller segment that you are watching closely?

Haddigan: The drugstore world is interesting right now. There are three main products out there, Walgreens, CVS and Rite Aid. Walgreens and CVS still trade, they're probably of the more desired product types even though they're trading at yields quite a bit above where they were a few years ago. We could trade a Walgreens, generally, in the 8.25 cap rate range; that might have traded at 6.5 to 6.75 three years ago. A Rite Aid right now is very challenging. We have Rite Aids on the market in great trade areas at 10.25 caps and there's no interest. Part of that is that you cannot get a loan, generally, on a Rite Aid. If someone tells you, 'hey, I got a loan,' the lender underwrote the borrower and said, 'okay, the borrower is gold plated, it's recourse to the borrower, it's not about the real estate.' And a lot of the Rite Aids are in good locations. They've got 5,000 or 6,000 stores; arguably they're not all struggling, but I think right now the market is very, very wary of assessing risk on a Rite Aid. And that's even though the drugstore sector keeps growing and is very popular and all of us would intuitively believe with the aging of the population and the growing of the population, the convenience-oriented pharmacy is a viable long-term model. I think part of Rite Aid's issue is their balance sheet, and a lot of people seemed to think that when they bought Brooks they really overleveraged the company. So if you're buying a Rite Aid today, you're pretty much looking at it from the point of view of, if they were to go out, how do I replace those rents.

GlobeSt.com: You noted sellers don't want to sell right now if they don't have to. Is the bid-ask gap still wide, or are there signs it's narrowing?

Haddigan: It's getting a little more narrow. I think more owners are realizing, 'hey, I've got to deal with the reality of what's out there.' And I'm also seeing that if someone has to raise capital, they're typically selling their better quality real estate. When you're living the business all day long, when you look at the numbers, the numbers don't necessarily line up with what we experience. Meaning, from a cap rate point of view, while cap rates are rising, they're not rising as rapidly as one would think. I think the reason for that is what's trading is the better quality assets. In 2006-2007, when everything traded, you aggregated the numbers and averaged them out. But it you separated the 2006 numbers into infill/primary market, top-tier credit asset quality and compared it to today, that might be a more meaningful analysis. Most of what's trading today on the net lease side is primary. We're not trading the quick service restaurant in Loredo, TX, because people just aren't buying that stuff. And so the numbers, on average, really reflect the fact that it's better quality deals that are trading right now. In general, yields are absolutely going up, cap rates are going up. If you don't have income stream, it's almost not saleable unless it's in a primo location.

Right now, I would say I don't see this turning around anytime soon. It's difficult, because you've got to be an optimist in this business, but as a forecaster, I can see this market continuing throughout 2010. Because until we get consumer spending back to a level of confidence where it's stable and increasing and where there's reliable debt in the marketplace, people are not going to take risky positions. I think there's also a concern that there's a tremendous amount of distress out there, and going into 2010 and 2011, there's probably $400 billion or $500 billion of debt maturities. And what we've seen so far this year is that lenders are not foreclosing. And so I think the buyers are saying, 'if I take an aggressive position on a property and all of a sudden we start seeing a flood of distress coming through, it's going to depress prices. I'm going to sit back and wait. Unless I can buy something that's absolutely prime and/or easily assessed, I'm not doing anything.' This disconnect, I think, is going to continue for a while.

GlobeSt.com: I was going to ask what your expectations are for the few remaining months of this year and as we head into next year, but it sounds like you don't think a whole lot is going to change.

Haddigan: I don't. We're active as a firm. What we're trying to do is making sure that our agents are out talking to as many people as they can. We're trying to maintain relationships, cultivate relationships. People are dying for information. We're out there, we're active, and we're really try to work with our agents to make sure they're being disciplined in thinking about sustaining themselves for another year. I just don't know when this is going to turn. I think when the market turns, it's going to take off very quickly; I think brokers and debt providers are going to be super, super busy facilitating transactions.

But it's really a strange time right now. Brokering in a situation where people are stressed is much more challenging than brokering in a situation where someone just made a huge fortune by buying a deal two years ago and flipping it today. The stress right now is, 'if I don't selling something, I've got two loans coming due.' Our mainstream client could have five to 25 properties and what typically happens is there's one or two or three that's a thorn in their sides; it's those that create the problems and they have to raise capital or their investors want money back. I think 2010 is going to be problem solving as opposed to profit taking in the marketplace. I don't think things are going to get way worse, I just don't see it getting much better. But notwithstanding economic cycles, there are still people that for non-economic reasons need to transact—death, divorces, partnership breakups, life changes, things of that nature. There is always is a threshold level of activity out there. But problem solving, problem avoidance, minimizing risk and deleveraging are still themes that are significant out there.

Instant Insights /

Marcus & Millichap's Bernard Haddigan

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