Shopping Center Investments in the Pacific Northwest
After a stagnant two years, the Puget Sound retail investment market is experiencing increasing volumes and decreasing cap rates for A-quality shopping centers. Although overall volume remains significantly down from the height of the market, the increased retail investment activity should continue due to aggressive capital and pricing. Institutional investors are leading the way with pent-up demand for quality, anchored product. Debt is also aggressive for quality product, but standards have changed with stricter underwriting, lower loan-to-value ratios, and a flight to quality. These tighter lending standards have limited the private investor and made the institutional investor the dominant player. The following is a snapshot of pricing, financing, and volume for retail investments in the Puget Sound region.
The aggressive appetite of institutional investors for core, A-quality grocery-anchored centers, coupled with a lack of supply, has created a scarcity premium and compressed cap rates. Cap rates for A-quality core product are in the low-to-mid 6% range, a mere 25 to 50 basis points higher than where the same product was trading at the peak of the market. The spread between A and B product has widened significantly since the peak of the market with cap rates for B product trading 150 to 250 basis points higher than A product.
The declining yield on the 10-year treasury, tightening lending spreads, and loosening of capital have lead to attractive interest rates for investors. The yield on the 10-year treasury declined through 2010 from 3.85% in January to 2.54% as of October 25th. Lending spreads on A-quality product are around 200 basis points, providing mid-4% to mid-5% interest rates. Although capital is loosening up, lenders remain extremely conservative, cherry-picking A-product, following tight underwriting standards, and keeping loan-to-value ratios below 65%. We are still in a difficult lending environment for B product with lower loan-to-value ratios, shorter amortization periods, and spreads in the 350 to 400 basis-point range. Debt for B product is typically available only for strong borrowers, most of whom have existing banking relationships.
After declining nearly 90% from 2007 to 2009, retail investment sales volume in the Puget Sound region is beginning to climb. Over $800 million of retail investment properties traded hands in 2007, dropping to approximately $100 million in 2008 and 2009. As of October 2010, volume has reached $100 million* with an additional $100 million set to close by year-end. The uptick in volume has been driven by six individual sales of grocery-anchored assets totaling approximately $70 million, all acquired by institutional investors.
Demand for institutional-quality shopping centers is high and interest rates are low, driving cap rates within 25 basis points of market highs. Underwriting however is stricter, with vacancy and structural reserves much higher and little credit given to vacant space. Weak tenants are vetted, rents are marked down to market, and projected rental escalations are viewed cautiously. The risk spread between A, B, and C product has dramatically widened. Loans for A product are plentiful, B product difficult, C product impossible. 2010 has shown some stabilization. 2011 should be interesting.
*These numbers do not include the recapitalization of a three-property portfolio in Puget Sound totaling approximately $90 million.