January 14, 2018

Andy Little


by Andrew Little, Special Correspondent

David Bowie probably wasn’t thinking about Amazon and retail properties when he penned the “The Man Who Sold the World” lyrics back in 1970, but it would be hard to find a retailer or lender today who doesn’t worry about the behemoth online store and its impact on the retail sector.

A recent report by Credit Suisse regarding the outlook for conduit loans secured by retail properties was less than flattering, stating that retailers are “going through a large and undeniable transformation.” The report acknowledged that while the retail sector has been under pressure before and survived, “the current metamorphosis appears to be different, seemingly secular in nature, with larger and more permanent adjustments to the business model.”

With that sort of prelude to a 20-page report, it almost doesn’t matter what the details are. The implication is clear: Lenders and investors should use extreme caution when underwriting retail loans and investments. The problem and opportunity is that with so many lenders and investors effectively writing off the sector, less money is chasing what will certainly produce both winning and losing investments.

As with every dislocation or disruption, there is opportunity for those who can decipher the data and determine how the Amazon effect will play out in the next 10 to 20 years. The report goes into great detail to try to do just that, but solid answers remain elusive.

Fundamentals for retail properties are quite good, meaning there is very little new supply and increasing demand. Completions and new construction continue to bounce along at 35-year lows, and retail sales in physical stores continue to increase. This has enabled rents to grow and vacancies to shrink. Lending pressure on the sector will continue to limit supply, and population trends are in favor of retailers overall.

The problem is that e-commerce continues to grow, which scares everyone who can logically conclude: Why does anyone physically shop anymore when they can do it from home? Also, every year, numerous stores familiar to lenders and investors shut. Most recently, such retailers as Macy’s, Payless ShoeSource, Kmart and Sears are closing stores.

According to the report, about 7,800 stores closed in 2017 through November.  But to counter that, there were more than 3,400 store openings through November, a huge rise over 2016 and a sign of changing consumer habits and tastes.

Changing demographic trends toward millennials has led to an onslaught of new restaurants and more experience-oriented retail that cannot be easily displaced by Amazon.

But there are plenty of other shopping experiences that are hard to duplicate online. Merchandise such as books, electronics and office supplies are easy to research and purchase online. On the other hand, clothing and apparel are harder to buy online as are major pieces of furniture. These sectors still have physical locations and probably will stay that way for a while.

At current cap rates and interest rates, there are a number of solid investments for the discerning retail buyer.

Rates pushed higher over the last month and are currently in the 3.8 to 4 percent range for 5- and 10-year loans offered by life insurance companies, according to the John B. Levy National Mortgage Survey. Conduit pricing is more expensive and now averages 4.55 to 4.75 percent for higher leverage loans.

The annual Real Estate Market Participant Survey, released recently by the Virginia Commonwealth University Kornblau Real Estate Program in association with Knight, Dorin & Rountrey, found that retail had the highest percentage (by 20 percent) of respondents who indicated “worse” when asked about market expectations for the next six months.

The results reflect current sentiment of 769 respondents, the majority of whom are in the Richmond region and Hampton Roads and who were given the option of answering “same,” “better” or “worse.”

The survey also found optimism in the property sectors. Single-family residential and industrial properties topped the scales, both with more than 40 percent of the respondents expecting “better” market conditions in the next six months.

In spite of positive sentiment for the sector, the highest cap rates, with an average of 8.1 percent according to the survey, are available for industrial properties in the Richmond area. Having such a high cap rate is somewhat surprising for industrial properties given the positive sentiment.

On the other hand, with all the negative sentiment toward retail properties, you would think the cap rates would be higher than industrial properties, but that is not the case. The average cap rate for retail properties, according to the survey respondents, was 7.5 percent.

John B. Levy & Co. partner and investment banker Andrew Little can be reached at