Is the Time Right to Invest in Retail? Some Say No

By Keat Foong, Finance Editor

While demand seems to exceed supply for investment sales transactions, not everyone thinks this is the time to acquire retail real estate.

Josh Scoville, director of U.S. research with Property and Portfolio Research, a CoStar company, says that investors with higher risk tolerance may step back into the market currently, but otherwise “it is still a bit early” to invest. “If you are a traditional investor, you would be looking for more recovery. We are probably (10) months away from (a good time to) wander back into the investment waters,” he said.

Occupancy should bottom this summer, said Scoville, but rents are still 18 to 24 months away from the bottom in most markets. Retail vacancies, at 7.5 percent in the fourth quarter, will peak at just under 8 percent, no earlier than summer, he noted. Scoville forecast retail rents will continue to fall, although the rate of decrease will drop from 5.5 percent this year to less than 2.2 percent next year, stabilizing in the first half of 2011. 

“A lot of retailers are still struggling. We are not out of the woods in terms of retailers announcing store closings. There is still a bit more shakeout to work itself out,” he said.

Like occupancies, though, retail property prices are “very, very close to bottoming,” he observed. Retail prices have fallen from $178 per square foot at the peak in the second quarter of 2007 to $95 per square foot as of the fourth quarter of 2009. PPR forecast prices will stabilize this year and increase by 3 percent in 2011 and 5.5 percent in 2012. 

Scoville’s recommendation that most investors may not want to invest yet is borne out by the investment strategy of NewMark Merill Cos. NewMark specializes in acquiring shopping centers, often older centers in need of remodeling and located in densely populated or infill locations on intersections in blue-collar neighborhoods. NewMark views prices as potentially already too high.

Jim Patton, director of acquisitions, said the company is “treading very cautiously” and generally still “holding off” on investing to see how the next six months will shake out. “If values fall, we’d be a player; if values remain stagnant, we would rethink our strategies,” he said.

Patton thinks many players are overpaying for properties. “I have not heard of many deals that have gone through where I’d kick myself and say, ‘I missed out on that,’” he said. “On some deals, even with very reputable buyers, you would say, ‘They know something the rest of us don’t. The deal appears to burn a hole in the pocket, and from what I know, they overpaid.’”  

Patton is waiting for a possible wave of product coming on the market from banks and special servicers starting this year, which would ease the current retail property supply crunch and by implication moderate prices. Lenders, he said, are telling him that the days of loan extensions are coming to an end for many borrowers, as lenders are deciding that some loans are just not going to work out. Many of these properties will be put on the market. “Brokers have also been telling me that they are busy writing opinions for banks” that are getting ready to foreclose on their properties and put them on the market, he said.

For more on the retail property investment market, see “Retail Returns” in the May 2010 issue of Commercial Property Executive.