Retail Development Continues to Lag

LOS ANGELES—Retail development has continued to lag over the past year, but Bob Peterson, VP of investments at Passco, tells GlobeSt.com that may be good news for investors. As pricing continues to increase and a lot of the “low hanging” opportunities have been scooped up, some investors are heading to secondary markets and finding value-add opportunities to increase their yields. In this exclusive Q&A, Peterson sits down with us to talk about the challenges in the market, how and where investors are finding better yields and what is happening on the development front. 

GlobeSt.com: As the retail sector picks up, what are some of the new challenges that are surfacing for investors?

Bob Peterson: There are several different areas where you have to be careful. One is that we have seen a variety of corporate mergers occurring. We are also seeing the downsizing of tenant footprints because they are able to function more efficiently in smaller spaces. In addition some sectors are completely disappearing. We have seen that with movie rentals and bookstores. You also can't forget what is going on with ecommerce; consumers are really taking advantage of that, and retailers have to be flexible and move to a platform that is conducive to both brick and mortar and ecommerce. These are a few of the challenges we are facing in addition to the usual challenges of tenant mix, location and the prospect of new development.

GlobeSt.com: How are investors finding good yields in this competitive market?

Peterson: That really depends on what you define as attractive yields based on the capital that you are representing. There are foreign investors and core institutional investors that are very comfortable getting a 5% to 6% cap rate, depending on the market. Money is coming in to America for safe and reliable returns. Institutional investors struggle to find yield in today's market for many traditional investments and therefore look to real estate to enhance overall yields. More buyers are also buying on a longer-term horizon, and solving for lower overall returns. On the flip side of that, some value-add investors are willing to accept lower initial yields, but they are really underwriting to a total return and by repositioning the asset, they are hoping to achieve something in the low- to mid-teens on a total return. So, it really depends on the capital.

GlobeSt.com: Which geographic markets are investors finding the best yields?

Peterson: Secondary and tertiary markets offer more attractive initial yields vs. the primary (and especially coastal) markets where significant capital has driven cap rates to extremely low levels. You have to be very thoughtful in choosing secondary markets and look closely at such items as economic drivers, barriers to entry and liquidity. In the end, investors are looking at total return, including appreciation, and different investor groups have different philosophies. It is usually best to diversify across multiple markets when building a balanced portfolio.

GlobeSt.com: What property characteristics should investors look for in identifying a retail investment asset?

Peterson: First, we focus on overall market demographics, like job growth and population growth. As you get down to the specific location, you look at the competitive set and how they compare. Then, you get into the property itself, looking at the tenant sales and the tenant mix, making sure that they complement each other and fill the needs of the people in the area. Lastly, you look at the repositioning opportunities, whether it is re-tenanting or reconfiguring the property.

GlobeSt.com: How does development fit into this picture? Last year, development had not yet picked up for retail properties. Has that changed, and if so, how has that additional supply affected the market.

Peterson: From my perspective, compared to the other product types, it has definitely been kept in check. Industrial and multifamily are both deep into the development cycle, and office and retail have been kept more in check. Capital is plentiful but remains disciplined when it comes to new development. But, it is coming. I know people that are looking at different sites, but we still haven't seen enough growth in those two sectors to justify development. You always have to be aware of that, and watch for what is planned in the area, what sites are available in the area and where someone can come in and rezone. In today's world, you are also seeing an offset to new development with older projects that have become obsolete. Those are either going to a higher better use, or being reconfigured significantly. In lieu of ground-up development, you are still seeing a lot more repositioning.