For Open-Air Centers, the Money's in the Middle (Markets)

LOS ANGELES—For retail investors looking at acquiring open-air shopping centers, the real value is in the middle. In other words, in mid-priced major markets, rather than either prime markets or the higher-yield and lower-cost secondary ones. That's the topline conclusion of a CBRE report analyzing investment values based on a variety of metrics.

Along with the usual suspects among gateway cities, the top-tier markets in terms of pricing for open-air centers include Austin and San Diego. Typifying the major markets are Atlanta, Dallas/Fort Worth, Northern Virginia and Northern New Jersey, all of which compare favorably in terms of risk premiums, liquidity and improving fundamentals when laid against both higher- and lower-priced markets.

“At this stage in the cycle, there is an abundance of capital chasing a limited number of properties,” says Spencer Levy, CBRE's head of research in the Americas. “Opportunities are scarce and pricing is high in most gateway markets, so investors have to look elsewhere to find value.”

Levy adds that the current spread between cap rates in major and prime markets “has rarely been as high as it stands now.” CBRE's analysis finds that in the fourth quarter of 2014, the cap rate spread premium offered by major markets against prime markets was 44 basis points, compared to the long-term average of 26 bps. “As such, investors in major markets are being unusually well-compensated relative to investors in the nation's prime markets.”

As a rule, grocery-anchored shopping centers see less pricing differential among market tiers, and as a result, the opportunities for investors are not as clear. However, although prices have flattened out noticeably in the prime markets over the past two years, CBRE sees a strong divergence in pricing between the grocery-anchored assets priced at over $20 million market and those priced at under $20 million.

In other words, the cap rate spread between these markets persists at historically high levels. CBRE says. The divergence in pricing might be attributed in part to not only the effect of e-commerce on smaller grocers, but also to the impact on their businesses by non-traditional grocers such as Walmart and Target.

Relative value is more evident across market tiers when talking about power centers. Cap rates for power centers in prime markets just reached a new record-low of 5.9% in Q4 of last year, according to CBRE.

It's unusual to see record-breaking cap rates across retail segments to begin with, but especially so for a segment that has been challenged by economic conditions and exposure to e-commerce. Still, CBRE says, as prime markets reach record pricing, the cap rate spreads between prime markets and major and secondary markets are at cyclical highs, offering investors a value proposition in these other markets.

“As a favorable outlook for the economy boosts commercial real estate fundamentals, investment opportunities for open-air shopping center investors appear to be shifting decidedly to many of the nation's mid-priced, major markets, while the nation's priciest prime markets—most of which are considered gateways—appear to have the fewest options to discover value at this stage in the cycle,” sums up Levy. “On a relative basis, major markets, in particular, offer a clear value proposition to investors of open-air shopping centers: considerable risk premiums, liquidity and improving fundamentals.”