REAL ESTATE NEWS

Rising yields are now becoming a reality for commercial real estate lending — but that's leading to new opportunities in retail — specifically for equity-rich investors.

In fact, panelists at the ICSC@Western deal-making event, taking place this week, said an influx of capital is helping drive competition for assets even as higher interest rates and a widening gap between buyer and seller expectations complicate transactions.

Speaking during the session "Capital in Motion: Where is the Momentum in Today's Market," industry executives said retail has emerged from years of restructuring and stress-testing as an attractive investment opportunity.

The panel was moderated by Caitlin Zirpolo, vice president of investment sales at Colliers, and featured Andrew Lundahl, vice president of private real estate at CenterSquare Investment Management; Sumeet Parekh, managing partner of HP Investors and Jeffrey Sause, senior managing director and capital markets office co-head at JLL.

Post-2008 Survivors Get Stronger

Lundahl said the shift toward retail represents one of the most significant changes in institutional investment sentiment since the 2008 financial crisis.

"Retail has still right-sized itself," Lundahl said, pointing to the sector's experience with the disruption caused by e-commerce and the "Amazon effect."

The retailers that have survived and emerged from that economic downfall period, he said, are now much stronger.

While institutional capital previously favored other CRE sectors, retail is now attracting investors who are competing for properties occupied by strong retail operators.

"The pricing aggressiveness that was in the other food groups never got there for retail," Lundahl said. "Institutional capital is fighting over good retail operators right now."

Momentum Spreads To Lending

The renewed interest is also extending to the lending side of the market, according to Sause. He said the credit box has opened considerably over the past two years across different types of lenders, creating additional sources of capital for retail acquisitions.

"On the equity side, what you are seeing, you are also seeing on the debt side," Sause said.

Retail remains an asset class where many institutional lenders have relatively limited exposure, he added, creating an opportunity for them to put more capital to work.

Institutional Shows Appetite for Smaller Assets

For private investors, the influx of institutional capital is apparent in the value-add segment.

Parekh said his firm has historically completed retail transactions using a mix of private capital and institutional partners. More recently, however, institutional investors have approached the firm seeking opportunities to generate value-add returns.

He said HP Investors has been contacted by six to eight institutional partners that were looking to deploy capital, including in smaller deals and portfolios of smaller properties that historically may not have attracted institutional attention.

"They are underallocated," Parekh said of institutional investors. "It is hard for them to buy value-add retail without a partner."

Local market knowledge and relationships with brokers can give private operators an advantage in sourcing and executing those deals, he said.

Yield Spike Forces Change In Underwriting

At the same time, higher interest rates are forcing investors to rethink how they underwrite acquisitions.

With the 10-year Treasury yield around 5%, getting transactions across the finish line has become more challenging as financing costs, seller expectations and uncertainty collide, according to moderator Zirpolo. But Sause said the higher-rate environment has not significantly diminished investor appetite for retail.

Many investors remain eager to deploy capital after missing opportunities in 2024 and 2025, he said. Some are adjusting their underwriting by moving exit-cap assumptions outward to reflect the changed rate environment, but they continue to pursue retail because of the sector's comparatively high yields.

Parekh said the disconnect between buyers and sellers typically becomes more pronounced when interest rates rise sharply.

He noted that this can lead to lower property values that "sellers don't want to believe that right away." As a result, this can create a temporary pause in transaction activity as the market waits for pricing to reset.

For buyers, the response has been to underwrite more conservatively and seek different types of opportunities. Parekh said his firm is now underwriting larger spreads and higher interest rates and has moved away from certain vacant properties that are difficult to finance with debt in the current environment.

Instead, investors are increasingly looking toward secondary markets, including opportunities outside California, while paying closer attention to tenant-improvement costs.

Tenant improvements can become particularly important in a higher-rate environment because the cost of capital makes large upfront expenditures tougher to absorb, Parekh said.

Liquidity-Rich Buyers Get Opportunity

The changing financing environment is also creating opportunities for buyers with greater access to cash.

"In the tighter markets, more cash buyers are coming to the table who are willing to add leverage later," Parekh said.

Despite the challenges, Lundahl remains bullish on the sector.

He said investors should continue to rely on fundamental underwriting rather than dramatically changing their approach every time market conditions shift. Sellers, meanwhile, are still adjusting to the reality that the extraordinary cap-rate compression of recent years may not return in the short term.

Slowdown May Occur, But Investment Cycle Remains Young

But the amount of capital seeking retail investments could ultimately prove difficult to ignore.

"The macro pressures of the amount of capital that is looking to get into this space will continue to drive deal flow and transactions," Lundahl warned.

While he expects some slowdown as the market adjusts to higher rates and new pricing expectations, Lundahl said he believes the retail investment cycle remains in its early stages.

"I am bullish," he said. "There will be a slowdown as the market adjusts, but we are still in a very early inning for the retail run that is taking place."

Check back in the coming days for more from GlobeSt.com from the ICSC@Western event here in San Diego.

Source: GlobeSt/ALM