Retail Cap Rates Trend Lower

Some surprising data released in a report by REIS - an industry leader in providing comprehensive and unbiased data that is used by commercial real estate professionals. Despite the onslaught of negative publicity for the retail sector, cap rates continued to decline in the most recent quarter.

I believe there is a lot of confusion about what, exactly, people are speaking of when they discuss "retail". Are we speaking of single-tenant properties occupied by stores that actually sell things - like a Best Buy or Dicks Sporting Goods? Are we speaking of malls with lots of clothing and shoe stores? Are we speaking of grocery anchored centers? Are we speaking of neighborhood retail strip centers?

At Prudent Growth, we really like the good-old neighborhood retail strip center. We recently closed on two deals - both in greater Greensboro area - with a total square footage of approximately 60,000 square feet and well over 20 different tenants. I don't believe a single one of those actually sells "things". They are all service based: restaurants, small offices, hair and nail salons, finance companies, a military recruiting center, a Spectrum cable store, various small accountants and therapists and counseling services, etc.

The characteristics of these investments are very similar to multifamily investments - another hot sector. With a broad mix of tenants - and without the exposure of a single large "anchor tenant" - there is substantial diversification, especially with staggered lease renewals. If one or two tenants vacate the debt service can still be covered quite easily. The list of future tenants who would take a vacant space is long, and they can be replace quickly. The leasing and upfit costs are much lower than Class-A office, etc.

So, if these kinds of properties can be acquired for cap rates as high as 8 or 9 or even 10, we view them as VERY attractive additions to the portfolio of properties we own.

From the article:

Retail cap rate trends again show somewhat surprising results. Despite the headwinds the industry faces from e-commerce and store closures, Retail cap rates fell in the third quarter of 2017 to 7.5% from 7.7% in the second quarter. At 7.6%, the 12-month rolling average is now 20 basis points below the recent high of 7.8% at the end of 2016, but is still above the low of 7.4% in 2015.

Although Retail fundamentals are arguably weaker, some investors clearly still see opportunities in Retail properties. Both the mean and 12-month rolling averages have stayed below the 10-year average for the last three years. These results are consistent with overall Retail rent trends that have remained positive despite the bad news on store closures. However, a number of metros have seen negative net absorption in Retail space along with declines in Retail employment. A quick look at the data shows that a number of metros with negative net absorption saw the biggest increase in Retail cap rates.​

Yes, it is important to KNOW your market and to be selective in where you buy. The tenant mix has to "fit" the surrounding demographic. The rental rates need to be realistic for these small business owners, and the expectations for future rent increases also need to be realistic. Finally, solid due diligence is important - parking lots, roofs, etc. all need to be carefully inspected and budgeted for.

But, for the investors who do their homework, there is definite upside in retail!

Full Article Here:

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