It is clear that the vast majority of dollars invested in 2010 were chasing stable shopping center product, with quality tenants, low vacancy and ample lease terms. Cap rates have improved because this type of product is in high demand and there is a limited supply of these stable assets. Centers that are distressed, in default of their loans, with high vacancy and short tenant terms are not of interest to investment capital unless they are purchased at low cap rates with significant upside in both rental rate and lease-up potential.
As of this date, there are still more than $15 Billion worth of retail CMBS loans, that are either REO or in default in the US, across more than 1,500 shopping centers. These properties have not been resolved or sold at whatever cap rate is appropriate. These figures do not include all of the CMBS loans that have been modified or sold over the past 3 years. They also do not include the bank loans that are more difficult to track, but are estimated to at least match these figures. Further, lenders anticipate more delinquency in 2011 due to maturity defaults. These loans will be significant problems due to a gap in loan to value ratios, requiring a struggling owner to find more equity.
In order for retail rents to begin upward momentum, we need more movement in the clean-up of retail real estate loans. Most investors have been anxiously waiting for this to happen because a write-down of the loans and subsequent sales of distressed centers will allow leases to be signed at today’s market rates, reducing the supply of quality vacant boxes, and forcing retailers to pay reasonable rents for good space in the nearer term. Until that happens, bottom feeders will continue to wait for cheap deals … because they can. Furthermore, lowering overall vacancy should convince retailers that are sitting on piles of cash to get back in the game, or miss the game altogether.
Therefore, while cap rates improved in 2010 for the product that did trade, the pricing was heavily weighted toward quality centers, and yet the overall fundamentals of rental rates, term and credit have not improved so dramatically. And, although it might give the impression that investor appetites for retail have improved significantly, a closer look shows that the real health of this class of assets is far from cured.