Real Estate Watch: Retail Market
Retail Market Faces Key Swings
By PHIL VOORHEES
Two major factors,dramatic swings in treasury yields and the continued decrease in retail vacancy rates,will shape the Orange County retail landscape in the months to come.
Remember back in June when brokers were urging you to sell because insanely low treasury yields were driving the cost of money down and property values through the roof? Hindsight shows they were probably right.
In a two-month period to the middle of June, the typically stable 10-year treasury yield, the benchmark of commercial loans, plummeted to just over 3%.
For some time prior, the yield had been holding between 4% and 4.25%,still several percentage points below the historical average.
If that’s not enough to raise an eyebrow, the rate today is about 4.5%. These dramatic swings have captured the attention of buyers, sellers and brokers as the feasibility of expensive real estate deals hang in the balance.
What does this mean to OC retail property owners?
Loans for commercial properties are based on spreads above the 10-year treasury ranging from 1.5% for class A buildings to 2.75% or more for properties of lesser quality.
Let’s say 2% above the 10-year treasury is the normal lender spread. Back in June, the best loans were being made just above a 5% fixed rate (3.1% treasury yield plus 2% spread equals 5.1%). Today, the same loan would bear interest at about 6.5%.
Most buyers want a spread of at least 2% between their purchasing cap rate and the rate of their loan to achieve positive leverage.
Accordingly, market cap rates will adjust upward with interest rates. Those contemplating selling in the next year who believe interest rates will rise,as many pundits do,should strongly consider selling or refinancing immediately.
On the leasing front, a 30% decrease in the amount of retail space under development since the fourth quarter should continue driving vacancy rates down and lease rates higher.
OC rates have increased nearly 6% in the past year for all retail product types. Small-shop tenants seem to be returning to the market after a hiatus triggered by the terrorist events of Sept. 11, 2001, the second war in Iraq and general economic uncertainty.
Large national tenants are aggressively competing for the few spaces available in desirable markets. Lowe’s Cos. reportedly leased about 135,000 square feet on a former Kmart Corp. site in Aliso Viejo where the San Joaquin Hills (73) Toll Road meets Aliso Creek Road for a stunning $20 per square foot per year, or $225,000 per month,an almost unheard of rate for space of this size.
In the months ahead, keep an eye on the activity of the national grocery chains. Wal-Mart Stores Inc.’s anticipated arrival into Southern California, for instance, has the major grocers on guard.
Voorhees is a senior associate specializing in retail investments with the CB Richard Ellis Private Client Group in Newport Beach.
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