Bill Rose
VP & Director, National Retail Group and Net Leased Properties Group
Marcus & Millichap
San Diego

Joe Dykstra
Executive Vice President
Westwood Financial Corp.
Los Angeles

Joseph McKeska
Outgoing Group VP, Real Estate and Market Development
SuperValu
Chicago

Thomas W. Roberts
Executive Vice President & Head, Real Estate Investments
Cole Real Estate Investments
Phoenix

MODERATOR

Ian Ritter
New Media Editor
ALM's Real Estate Media Group
New York City

IAN RITTER: Are any certain regions of the country performing better than others, or are we in a property-by-property world right now?

BILL ROSE: I think 2012 was that earmark of tertiary markets being back and financing is supportive of those trades. Certainly yield was more enticing in tertiary markets. When we look at the United States, the coasts, Northeast and Southwest remain dominant markets. With investment sales of shopping centers, the West dominates investor activity with about $15 billion of sales occurring last year, followed by the Northeast corridor. Chicagoland is also very solid with $4 billion in trades. This wasn't the case two years ago. Many investors weren't sure about the middle parts of the country, and today I think that's changed dramatically. We're seeing very positive activity not just on the coasts, but also now in the mid-section of the country, those major NFL cities.

THOMAS W. ROBERTS: We're more product-driven than region-driven. We think great real estate can be located in primary and secondary markets, as well as tertiary markets. We buy a lot of single-tenant retail assets, so a great retailer in a good location in any market can be good. We've been very active in Texas during the past few years, as well as Atlanta, the Carolinas and in Florida. We've been buying in markets like New York and California as well. For example, we closed on major shopping center transactions in San Jose and Southern California and recently completed the acquisition of two corporate headquarters facilities outside of New York. We're seeing activity from coast to coast.

JOE DYKSTRA: Like Cole, Westwood Financial is more product driven than region driven. At the risk of oversimplifying, the ability to buy in secondary and tertiary markets is a result of the resurgence of the CMBS market. Two and three years ago, it was a life-company-driven loan business, and it was very difficult to finance a non-core property or any property not located in a top 50 market. So, as the CMBS market continues to offer historically cheap, attractive financing, the investment market will follow.

ROSE: That's a very good point because prior to the CMBS era, financing was done with life companies and bank debt and, as we know, one needs to be pretty much a gilded investor to transact with the life companies. I think CMBS is so important, given the symbiotic relationship between debt and equity, to the health and growth of our industry.

RITTER: Let's talk about the OfficeMax/Office Depot merger. As a landlord, are you worried to have them in your portfolio and do you think those types of vacancies can be replaced in this climate?

DYKSTRA: Yes, we have OfficeMax and Office Depot locations. However, when we invest in a property, it's rare that we focus on credit-driven decisions. Our acquisitions are based on the quality of the real estate and the site plan in which the tenants merchandise. We look at the specific characteristics that make a space tenantable in today's environment, including the rent being paid and the dimension of the space because we take the position that nothing will last forever. Whether it's a grocery store, soft-goods retailer or one of the office supply stores, we want to make sure that the rent can be replaceable and the characteristics of the space and quality of the real estate will be attractive as-is, or if divided for alternative uses.

ROBERTS: Good real estate is good real estate. If you're underwriting and buying at market rents, you're certainly hopeful that the tenants survive. I think the space is probably big enough to have two major competitors, both Staples and the merged entity. Obviously, I think that the office supply category has adapted relatively well to the Internet. Hopefully the combined entity will be a strong competitor and be a viable, long-term competitor to Staples.

ROSE: There are concepts that have come and gone. There's always this reinvention of retail and there are always these cool new concepts that surface. For example, at Oakbrook Terrace in Chicago, it's kind of sad to see Sears go away, but what's happening? The site is being backfilled by Williams-Sonoma and West Elm. Great real estate is always of the highest value. If you invest today in a dominant market, and you buy a Best Buy property, you're probably going to get a bargain, because if and when they downsize, or if they ever do give the space back, you've got a winner. You're going to be able to backfill that with a new concept that we don't even know about yet. It's always about the real estate.

JOSEPH McKESKA: If one were to look at the current environment for retail space from a landlord's perspective, this is a much better situation than some of the past examples where there were retailers that, at the depth of the economic recession, went belly up like Circuit City. This will be a merged entity that will be stronger. They've already adapted fairly well to the Internet. Therefore, even though they'll downsize and close stores and that won't necessarily be good for the shopping centers in which they're located, they'll obviously continue to be obligated to pay rent and pass-through charges, which will provide landlords with some flexibility with regard to what they do, and how and when they ultimately re-let that space.

RITTER: Can we predict which retailers are going to be able to fill this space?

ROSE: From my experience, you've got to have a merchandising lead that stays in tune with what we're all interested in consuming, and if you don't have a merchandiser leading any retailer, the enterprise seems to slip. I think with Sears/Kmart, they've struggled in saying “who are we” and “what are we?” That's going to prove, I think, to be problematic.

For Penney's, they've changed the helm and I think Myron Ullman is one of those really strong, talented merchandisers in this industry, so I'm pretty bullish that Penney's is likely going to rebound and do quite well, but that's still yet to be seen. In terms of new retailer concepts that are cooking, it seems like fast food is still blossoming new concepts everywhere you go and, of late, it's this whole trend of eating healthy.

ROBERTS: There are obviously new retail concepts being started. I think the past two or three years with the economy was probably a slow period, but going forward, I think there will be new retailers that will come into existence and be in expansion mode across America. Some of these boxes could be replaced with existing concepts. We've had some Circuit City and Linens 'N Things in the past that have been replaced by Dick's Sporting Goods or other retailers of that size. You can always break-up the space for smaller users and re-lease it that way, which we've done with concepts like Five Below.

ROSE: Academy Sports is a concept that's going to start to emerge across the country. You see Big 5 maybe sort of falter and then you see this cool concept, Academy Sports, surface.

ROBERTS: The other thing that's happening in the market is retailers that want to downsize. It's a partnership between the landlord and the tenant, where the existing tenant tries to find a smaller tenant and share in the cost of demising the space. At the end of the day you can make lemonade out of lemons and downsize space from 40,000 square feet to 30,000 feet, and bring a new retailer and new synergies into the center.

RITTER: Grocer competition is crazy. What do you see as the main ingredient to survive in this retail segment?

McKESKA: You have to have a differentiated business model. The traditional grocers aren't going to be as differentiated as others, but the customer expectations, in terms of what they want to buy from grocery stores, have broadened so significantly, even in the past 10 years. It's made it possible for customers to have learned that there are many more choices based upon the retailers that have come along. The shopping patterns have changed, and people will shop in two, three, four different grocery stores today versus their having had a primary grocery store and a distant second 10 years ago. That's through the advent of specialists, the Trader Joe's or the Aldis, as well as large discounters such as Walmart. You need to know who you are and who your customer is.

RITTER: Are retailers finding the types of sites that they want right now?

McKESKA: There's still ample opportunity out there for those people who have the types of business models that are flexible in the spaces they want. For retailers who have very stringent site requirements and who are trying to do a lot of ground-up development, it continues to be a somewhat challenging environment because it's not as if the result of the Great Recession is that real estate values, land values or the cost of construction have gone down dramatically.

RITTER: Are tenants happy with the sites that are available to them?

ROBERTS: Our portfolio is about 98% leased. We're primarily leasing up smaller shop space, but a few of our centers have big boxes that are available and I believe we're seeing very strong demand.

We're certainly seeing development programs roll out with certain retailers. The dollar store space is probably the most active. The tenants are starting to think about expansion. These centers are generally smaller, at about 100,000 square feet with three boxes. But I think over the next two or three years we'll see more development of the traditional power-center space and maybe larger centers, where you put together 300,000 to 500,000 square feet. That kind of development is a sign of the economy improving and retailers looking at their expansion plans long term.

RITTER: Are you getting the rental rates you're aiming for in this climate?

ROBERTS: I think it's certainly better today than it was two or three years ago. The rents have stabilized. In some cases we're achieving or beating our projections as far as rents, and overall it's much more positive than it was at the bottom of the market.

DYKSTRA: Our portfolio occupancy is very good and we are seeing rents continue to improve. However, we believe tenants as a whole are much more sophisticated and much more disciplined when negotiating and renting space. It seemed that prior to the Great Recession, cheap small business financing and expansion plans made it possible for tenants to pay the huge rents the landlord demanded. Now we are seeing tenants being much more disciplined with their business plans and expectations for occupancy costs and gross sales.

RITTER: We have seen more investment transactions this year. What kinds of deals are out there and what's the buyer profile?

ROSE: Retail investments flow in three segments. The first is net lease, the largest segment of retail investments in the country, not only by dollar volume but also by the number of properties traded every year, period. The second is moderate-sized shopping centers, priced sub-$10 million is the sweet spot, roughly $21 billion in trades last year. The last segment is the larger, say over $10 million, but in certain markets it's really over $20 million. There were 655 deals that traded last year, with about $22 billion worth of volume.

ROBERTS: So far, the activity is greater than the prior few years. We completed $3 billion of acquisitions last year and we are already approaching $2 billion either closed or in the pipeline in mid-April, so the activity has been very strong. Cap rates have been pretty stable over the past couple of years, so we're not seeing a lot of compression, but deal volume is very strong.

RITTER: Whom are you facing competition-wise when you go out to look for an acquisition now?

DYKSTRA: Our focus is to invest in $10-million to $20-million necessity-based retail shopping centers in the top 50 markets in the country. Our preference is grocery-anchored retail; however, we work very hard at identifying the best B-quality properties in the marketplace that we can improve into A quality.

ROBERTS: In our world we have different competitors and different spaces. The single-tenant Walgreens and smaller transactions have a lot of competition from the 1031-exchange buyers. In the big sale-leaseback arena, we compete with others looking at $100-million-plus portfolios. On the larger opportunities we're seeing competition from institutional investors, publicly traded REITs, non-traded REITS, and pension-fund advisors.

RITTER: Overall, how is consumer confidence holding up?

McKESKA: It's a little touch-and-go and one important point is that it's bifurcated. There's a certain portion of the country, mainly upper-middle and upper-class consumers, which obviously hit some bumps along the road relative to what happened economically over the past five years. But now that things have stabilized and we have some level of consistent, albeit low growth, and people have reduced their fear factor a little bit relative to their decision making, that strata of our society continues to do well and, frankly, spends very well. When you get into the middle, particularly lower-middle-class, and those that are on the lower rungs from a socioeconomic standpoint, they continue to struggle on a day-to-day basis. There is a lot of fear and uncertainty with regard to job loss and the like. That's the arena in the country that continues to be tough from a consumer-spending standpoint.

DYKSTRA: It's the best and worst of times. There continues to be a growing investor confidence for those with access to equity and debt financing. For those without access to capital, it's been very difficult. For those that have access to equity and debt, we believe there needs to be caution in the marketplace to not overpay for properties because of the historically low interest rates.

ROBERTS: Consumer confidence has improved during the past few years, but is probably still at relatively low levels. Clearly the uncertainty in the economy and the government causes people to be a little more cautious, but I think generally the outlook is better today than it was in 2009 and 2010. We're going in the right direction; probably slow growth, and it's going to take time to get back to a strong, confident consumer.

ROSE: Corporate balance sheets in this country are exceptional. There's an enormous amount of cash sitting on the sidelines waiting to invest. Blackstone is one example. Retailer balance sheets and inventory levels are healthy too. That, coupled with virtually no new development since 2009, and 2013 projecting something like 40 million square feet of new deliveries, suggests a really healthy future for the industry. However, we've got to be very smart and learn from the past. The liquidity trap that caught some investors in 2006 and 2007 happened because of taking full loans at that point in time and not underwriting and budgeting for a potential vacancy; what then happens to my ratios?

Everyone in the market today who sees these opportunities, be very mindful of the liquidity trap and know that in 2023 you've got a maturity coming, and manage it. If you do that, you're going to be pretty successful in this business.