Fundamentals “So Strong” for Outlet Centers

Now is the time to buy outlet centers. The fundamentals are so strong, and consumers are showing fervent interest in the off-priced retail market, and as a result, there is strong upside for investment capital. Last week, we sat down with Phil Voorhees and Richard Frolik, both EVPs at CBRE, to talk about the outlet center market. Now, we sit down with them again to get a deeper look at the investment activity for outlet centers, how capital is responding and where the market is heading.

GlobeSt.com: Why is this a good time to buy outlet/off-price anchored properties? Frolik: Fundamentals are so strong. Consumer demand and occupancy are up. Tenants’ cost to operate and profitability are the best out of any retail format. Outlet centers typically have a very low health ratio compared to other retail offerings. A health ratio, also known as an occupancy cost ratio, is the relationship between a retailer’s sales and total occupancy costs. A retailer’s health ratio for a given location is calculated using the formula of total annual rent (inclusive of reimbursements and marketing costs) divided by its gross annual sales. Higher sales and/or lower occupancy costs drive a low ratio and normally infer higher profitability. Voorhees: Presently, the definition of “core” retail is tighter than it’s ever been. From an institutional perspective, it’s “fortress” malls with exceptional tenant gross sales production in primary or coastal markets, and the top several grocery-anchored centers in the same markets. Cap rates for non-grocery-anchored centers generally expand 75-125 basis points without an owned grocer. For example, if a Whole Foods-anchored center in coastal San Diego County would sell for a 4.50% cap rate, the best non-grocery-anchored open-air center would likely trade between a 5.25-5.75%; a generalization, but nonetheless true. For outlet centers, location is less important than tenant sales production. In fact, using the Southern California market as an example, some of the best performing outlet centers are in locations like Barstow, Cabazon, and San Ysidro at the US/Mexico border.

GlobeSt.com: How is capital responding to this sector?

Frolik: Overall, very well. On the debt side, the CMBS world is open to assets that are well performing (low health ratio, good sales trends, and strong national tenancy). On the equity side, both institutional and private equity have started to either invest directly or joint invest with operators. Also, foreign money is looking to the US for outlets. Capital views this sector as a growth opportunity due to the supply constraint of outlet centers and the change in consumer behavior toward value. Outlets make up approximately 1% of the total US retail GLA but attract nearly 11% of total brick and mortar shopper visits. GlobeSt.com: Who are the buyers? Frolik: All types: institutional buyers (i.e., REITs, pension funds and advisors), private equity and private equity funds, and foreign capital are current investors or are seeking investments in the sector. There are typically two categories of investors: those who want the best of the best (best market and asset performance) and are long-term holders; and those in pursuit of value and want to redevelop or re-tenant and grow NOI. The latter typically has a three to five-year hold and exits after the value creation. GlobeSt.com: What do you see on the horizon for this category?

Frolik: Due to the sensitivity of brands competing with their own full-price offering at department stores or regional malls, traditional outlets centers in the past were built approximately 30-plus-miles away in more secondary or tertiary markets. The formula has completely changed; both retailers and consumers are demanding more infill locations and sensitivity is nearly nonexistent today. This means more outlet offerings in denser areas, although probably smaller or repurposed assets. These are very exciting times and, though new development is on hold for the most part, many opportunities will be available through acquisitions and redevelopment. GlobeSt.com: Anything else that you would like to add?

Voorhees: If our National Retail Partners’ pipeline and closings thus far in 2018 are indicative of market activity in general, 2018 will be a high-volume year for retail transactions. Lower loan-to-value, long-term financing remains at historically low rates, providing excellent leveraged cash-on-cash returns in most retail formats, superior to the cash-on-cash yields in other investments. Outlet, neighborhood and strip center formats all adapted well to increased consumer activity online. It’s been said that retail is experiencing an evolution, not a revolution. At this point in the cycle, evolution has created excellent acquisition opportunities for investors in all retail formats, across the spectrum of risk and return. CBRE expects strong transaction volumes during the second half of 2018.