Price Check for Centers
Here’s something you may not have heard in a while: Competition from multiple buyers is causing a spike in the price of many shopping centers. This isn’t a minor bubble, either — it has become apparent to me that the extremely competitive nature of the current market has led to some dramatic overpricing. From my perspective, many of the price tags on power centers and grocery-anchored neighborhood centers (and, to a lesser extent, traditional malls and unanchored strip centers) are getting out of touch with reality.
This point was driven home to be recently by an experience I had when performing some due diligence research on behalf of a client interested in investing in a major distressed power center. After looking closer at the property, the tenants, the market and the financials, I ultimately advised the client in no uncertain terms to stay away. I believe the phrase I used was “I wouldn’t touch that with a ten-foot pole.” To my disbelief, I later discovered that the property had 17 competitive bids! In this case, the center is a distressed asset that was built before its time — developed in anticipation of population growth that never materialized. This demographic reality shows no sign of changing anytime soon.
So what’s going on here, exactly? I’m sure that part of it is that there are plenty of prospective buyers out there, including REITs, pension funds, insurance companies and developers. And, with a recovering economy, there is a significant amount of investor money sitting on the sidelines. Mostly, however, it’s a case of a lack of product: there are simply fewer opportunities to invest in new development because there is no new development. At least, new development has slowed considerably in the past few years. The result is that prices for many properties are inflated at the moment.
Also, the success of some redevelopment initiatives has investors assuming that many less-than-desirable centers will be redeveloped or rehabilitated. The reality is quite different, however. Yes, there are high-quality redevelopment opportunities out there, but not every center is a candidate for redevelopment. You still need the basic ingredients for retail success, and not all of those can be controlled. You can shuffle the tenant mix and invest in significant upgrades and new construction, but if the market isn’t there, you are still going to be paddling against the current.
With all of this money out there and no one quite knowing where to put it, the net result is that everyone is chasing the same kind of asset: neighborhood grocery-anchored centers and power centers where investors and developers believe they can add value. The supermarket-anchored neighborhood centers seem like the most active category, with generally the most intense competition over the center(s) in each market with the strongest supermarket brand (either the best sales volumes in the region or the top market share). Power centers, however, are the category of commercial asset where I find the inflated prices to be the most puzzling. There simply are not very many new tenants appearing in this category (with a few exceptions like Sprouts and Total Wine) and, because there are so many current vacancies, the prices are lower.
If I were putting my money down, today, I would try and think very carefully about two things: 1) where I could add the most value, and, 2) where the prices are more realistic. There is nothing earth-shattering about that, of course, it simply goes back to investment basics. Realistic prices are a little difficult to find, these days, however. Maybe the best approach in the current environment would be to focus somewhere where most of the REITs are not looking: the anchorless strip centers. They may not be the “sexiest” of investments, but they make great money if they are positioned correctly, with popular fast-casual and quick serve restaurants as well as professional services such as some of the new massage, chiropractic and medical/dental concepts out there. It’s a much better position than overpaying for one of the other categories.
From a retailer perspective, I’d be a little bit worried that landlords might be asking rents that are beyond what’s affordable. Especially because many retailers are still out there looking for deals, we are starting to see a disconnect between what investors are expecting and what kind of rents retailers are willing to pay. This will be worth watching closely over the next year or two.
The bottom line is this: There is disproportionate investment interest in many commercial development categories at the moment, especially relative to the earning power of those assets. Is that a blip on the radar screen or a trend that will persist going forward? I’d love to hear your thoughts and personal experiences: Is the market out of alignment? If so, what kinds of developments are seeing the highest price spikes? Join the conversation by leaving your comments below or emailing me at Jeff@JeffGreenPartners.com.
Click here for past columns by Jeff Green.