LAS VEGAS—Retail commercial real estate transaction momentum won't be impacted by the threat of rising interest rates as severely as many believe, according to Nicholas Coo, senior managing director and a founding member of Faris Lee Investments. But it's not because of the obvious reasons, suggests Coo. GlobeSt.com spoke with him in advance of the ICSC RECon event taking place here, to get his full reasoning behind the sector's resiliency, and where and how investors are spending their money in this retail real estate market.
GlobeSt.com: How is the threat of interest rates rising impacting the trading of retail real estate assets?
Nicholas Coo: In most cases, we believe the threat of rising interest rates is priced within investor underwriting we are seeing today. Lenders have widened their spreads (above the base index) to adjust for the market's view on yields required to transact loans and this ultimately filters back to the stated coupon rates quoted by various debt sources we are seeing today. In cases where investors are assuming low interest rate loans with less than 5 years remaining, the NOI growth and interest rate tolerance is considered when determining the ultimate value. With yields compressed to historical lows in the bond market and fears of sensitivity to interest rates in the stock market, the global view places real estate as the best hedge against the pending interest rate hikes.
GlobeSt.com: How is this sector different?
What makes retail real estate investments different is the fact that the lease structures for higher quality tenants feature fixed increases which don't consider changes in inflation or the cost of funds. Unlike other product types where rent appreciation is subject to annual changes in the rental market conditions, retail property owners are required to carefully underwrite rent growth against perceived future market conditions due to the “locked in” terms of their lease escalations. Based on our company's pipeline of recent closings and offer activity, the market is continuing to bet on the stability offered in retail real estate.
GlobeSt.com: What yields are investors searching for today?
Coo: in the single-tenant category we are seeing bidding on portfolios becoming increasingly aggressive, from institutional and professional investors. The one-off single-tenant property sales are garnering unprecedented interest, so investors focusing on yield are being increasingly pushed into the portfolio arena in order to maintain yield in trade for bulk purchases where the individual 1031 buyer hasn't been as active. We believe that yield requirements for professional and institutional investors have compressed further in recent months.
GlobeSt.com: What are transaction negotiations looking like?
Our bidding and selling on behalf of clients has surfaced new lows for cap rates in the portfolio space. As an example, we are currently selling a STNL property in the Pacific Northwest where the buyer adjusted its bid by 50 basis points compared to the cap rate floor it communicated a little over one month ago. We are also bidding on a portfolio of net leased QSRs where the activity is 100 basis points more aggressive than the cap rates produced for the same credit in 2007. In some ways, we're seeing a replay of the peak in 2007 as investors are raising capital which continues to place downward pressure on cap rates. Our current market conditions provide investors with the ideal opportunity for taking profits through a sale, that are even more aggressive than the pre-recession boom.
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