ICSC RECon 2010

Net Lease Insider asked Patrick Nutt to contribute his analysis of the 2010 ICSC convention.

It is as follows:

In the weeks and months leading up to this years ICSC convention in Las Vegas, everyone I spoke with had uncertainty about the overall turnout and value in attending the conference this year. Well, as I sit in my office fresh off a 72 hour session of networking, deal making, and walking (lots and lots of walking), I can emphatically say that once again it was a great event and well worth attending. While we can all work effectively through the use of emails and phone calls, the opportunity to sit down face to face with clients and discuss existing business and future plans is always time well spent. I am still revisiting all the conversations I had and observations I made, but here’s a glimpse of what I took away from the show.

Attendance:

I heard various numbers mentioned from a variety of sources, but I would say that attendance was about even with last year, however activity was up. It seemed as though most attendees this year had pretty busy schedules and were discussing real activity that will occur over the next 12 months, rather than casually discussing hopes and plans like the 2009 version of RECon.

Prettiest girl at prom award goes to: Dollar General.

All aspects of the net lease world were feverishly talking about Dollar General and their aggressive expansion to include 600 new stores a year. We’ve seen merchant developers that formerly focused on power center and grocery anchored locations now shifting their resources toward building 20-60 new dollar general stores in the coming months. REITs and private funds alike are looking to this retailer to fill their need to place capital. This is purely a numbers game for all parties, as Dollar General needs to open these stores to keep Wall Street happy, merchant developers need volume to create efficiencies to make this a profitable program, and the institutions need this same volume and a pretty yield to make sense of acquiring assets generally priced in the $850k to $1.5M range. This could be a winning combination for all, but we’ll be keeping a watchful eye on this program to see if everyone can execute on these plans.

Biggest Question: What do I do with all this money?

That was basically the continuing theme from the institutional groups. With the rebound in the REIT sector, they are all flush with capital and need to put that money to work. They are paying their investors a return from the day they receive it, so money not spent is worse than accepting a slightly lower cap rate. With the lack of product on the market, acquisitions are in short supply and has everyone searching for quality assets. With the dead pipeline from the past few years, very little new development is coming out of the ground, forcing buyers to chase existing properties, but owners are repeating the same question…..if I sell today, what do I then do with the money??

Retailer Activity:

If you are a net lease player, the next 12-24 months should be exciting as the typical single tenant retailers were discussing new stores, relocating old locations, reasonable growth in strong markets, etc. For those in the shopping center, power center, or regional mall world, recovery is still a long ways off. The big box tenants are still waiting patiently for more signs of recovery in the global economy before moving forward with new locations. 2010 and 2011 will see the smaller retailers continue their slow growth plans, while big boxes will begin to move forward in 2012-2013…..that is if the economy and job markets continue to stabilize and improve.

Phrase least heard: “Distressed Properties”

What seemed like the mantra of the 2009 RECon was almost never brought up this year. Much of the capital raised over the past two years has yet to be deployed, and would-be vultures have accepted the reality that lenders and servicers simply don’t have the need or ability to flood the market with distressed assets. They have proven that they would prefer to work with existing borrowers and renegotiate the debt terms or extend maturities rather than take a greater loss by selling into a market filled with bottom feeders.

Overall, it was a good show with great activity from all participants. While we are still a long way from being out of the commercial real estate mess of the past several years, people in every aspect of the industry have learned a new reality for deal flow and real estate fundamentals. The industry is very different today than in previous years, the reckless have wrecked themselves, while the experienced and diligent have found a way to stay alive and do another deal.

Opportunities on the Cutting Floor

A Landlords primary responsibility is to ensure the presence of a paying tenant. Unfortunately for many “big box” owners, the recession has left plenty of space empty; with slim chances of new tenants filling it. There is simply little interest in the cavernous lots so many feared would dominate the landscape. Retailers are demanding tighter, more economic space and landlords are responding by cutting up their “big boxes”, meeting the needs of retailers and creating new opportunities for net lease investors.

It is no secret that retail has suffered heavily since the recession. In its wake, a movement has emerged known as “right-sizing” which places a focus on frugality and sustainability. This trend has traditionally been popular with smaller retailers such as Dollar General but is now even catching on with retail giants such as Wal-Mart and Target. Both are testing smaller floor plans as they move into more urban locations and cater to scaled back consumer demands. Such developments slim the chances that vacant big-box space will fill quickly and has forced landlords to “de-box”.

Net lease investors should be intrigued by this trend because many of the tenants positioned to make use of these smaller lots are usually triple net leased. Dollar stores, such as Dollar General, Family Dollar and Dollar Tree, all have plans for expansion this year and are prime candidates to occupy the de-boxed space. Other possibilities include auto-part stores such as Advance Auto and AutoZone and certain restaurant tenants. Though not the ideal of full market recovery, this development highlights market movement and movement is a good thing.

Are Cap Rates Going Down?

A recent article by M.P. McQueen in the Wall Street Journal stated that cap rates for investment grade triple net lease properties were falling. Specifically it said “in recent months, cap rates have been falling because property prices nationally are rebounding. More investors are going after fewer high-quality properties, driving prices up.” In order to gain a wider perspective on this topic, we asked two industry experts, who have capital available and are active in the market, their opinions on cap rate trends today and by years end.

Here are their responses:

Jon Adamo, National Retail Properties.

I would agree that over the last few months we’ve seen a decrease in cap rates of higher quality net lease investments in the range of 25 to 50bps from pricing we experienced in 2009. There’s definitely a supply and demand issue at the root of the adjustment along with an improvement in the ability of buyers to get the better tenants/deals financed. The scarcity of new deals hitting the market will continue to keep cap rates low for the remainder of the year and may cause them to go even a little lower but not significantly. The cost of financing is still very much a factor for many deals and although banks are doing very safe deals at very safe rates and terms they have certainly not opened their doors all the way.

If you look out past the next 6 months and into the next year I think caps will be moving up with rising interest rates. I also see more product reaching the market as developers begin to reemerge and M&A activity picks up thus producing some sale-leaseback opportunities for buyers that might look to dispose of some assets. For now it seems there’s a glut of capital for good Walgreens and McDonald’s-type NNN investments and not enough to go around putting stress on cap rates but higher rates and lower ltv’s of the new financing “norm” will cause the cap rates to rise eventually.

George Rerat, Senior Vice President of Acquisitions, AEI Fund Management, Inc.

We’ve seen cap rates for high quality NNN properties decrease from around 9.5% to 9.0% today. This drop is a reflection of the dwindling supply of high quality NNN properties on the market. Construction has been at a relative standstill and as such the pool of these assets has been shrinking, forcing cap rates down. By years end we could possibly see cap rates drop by another 50 basis points. Furthermore, it may take a while for construction to pick up again, prolonging the supply imbalance for the next 1-2 years.

So the question becomes whether or not the window is still open, as supply continues to constrict and the laws of economics take hold.

Springtime for Retail, Sale Leasebacks, and Urban Investments

As spring unfolds, key areas of the net lease market such as retail, sale leasebacks and urban investments seem set to grow. Numbers and analysis from the first quarter of 2010 point to better days and more opportunities ahead.

Retail

As of March 2010 consumer spending has increased over the past five months and retail sales have risen the past four. Retail sales in the first quarter 2010 are up 1.9% over the previous quarter and up 5% compared to the same period last year. Retail transaction volume totaled $3.1 billion for the 1Q 2010, which is a steady improvement from $2.2 billion in the same period last year. Furthermore, according to a major commercial real estate magazine “investors are showing strong interest in well-stabilized retail properties that generate consistent cash flows”. This description fits perfectly with net lease investments, which are defined by their stability.

Sale Leasebacks

It has been estimated that there is at least $1 billion in corporate owned essential real estate and according to RW Baird “strong corporate demand for sale-leaseback transactions”. If only a fraction of this $1 trillion were to enter the market, it would be a huge boon for net leases. Sale-leasebacks, which are almost always structured as net leases, offer corporations a chance to pull vital equity out of their real estate and enhance current operations. The real estate is sold and a long term lease is signed which leases back the property. Sale leasebacks have already provided the basis for many net lease transactions in the last two years and that trend looks to continue to pick up steam.

Urban Investments

There has been a lot of talk about the upward trend in urban investments. Walgreens purchased Duane Reade and their 258 New York metro area locations for $1 billion and those leases have been recently valued at $74 million. The German group, GLL Real Estate Partners also entered the urban market by purchasing 14,000 sq. ft. of New York retail condominiums from Hines. The urban market is one the most attractive today because it ensures a properties close proximity to large populations. As a result, net lease urban properties have increasingly been in demand.