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LOW CAP RATES? WHO CARES? SAY BUYERS

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General Growth Properties raised eyebrows in October when it paid $550 million for three malls at a combined cap rate of 7.1 percent, especially because the malls were considered ‘B’ quality.

But General Growth stood fast, maintaining that the properties - Glenbrook Square, Fort Wayne, Ind.; Maine Mall, South Portland, Maine; and Sikes Center, Wichita Falls, Texas - are good ones and worthy of the company’s ongoing drive to expand its portfolio.

Like many in retail real estate, General Growth is taking the current sellers’ market in stride. Retail real estate has picked up momentum over the past 18 months at least, thanks to competitive investment yields that continue to fuel demand for shopping centers.

“This is a unique time in the market,” said James Koury, senior vice president at Spaulding & Slye Colliers, a Boston-based real estate brokerage. Up to now, sellers have been holding on to properties in hopes that cap rates will keep plunging. But Koury says he is expecting acquisitions to pick up. “If they want to get out, this is the time to get out.”

One reason real estate looks attractive is that other investments don’t. Interest rates are paying skimpy long- and short-term yields. At press time the 30-year Treasury yielded slightly more than 6 percent; the 10-year was even lower, at 4.41 percent. Meanwhile, investors seeking yield continue to reap healthy cash-on-cash returns (a property’s profits after debt payments) for shopping center investments, according to market participants. Low interest rates have helped cash-on-cash returns to hover around 9.5 to 10 percent for solid tenants in open-air centers, says Koury. This, too, is helping keep the retail real estate market hot.

When interest rates were higher, cap rates needed to be in the 8.5 to 9 percent range to make a shopping center investment worthwhile, says Koury. But thanks to low lending rates, buyers can achieve healthy returns on properties selling at cap rates below 8 percent, such as those recent General Growth purchases.

“This will be the new standard for a long time,” said Koury.

Southern California is a prime example of a superheated market. Despite being one of the most active regions for new construction in recent years, its costly and time-consuming property entitlement process keeps retail real estate development in check. This, of course, keeps supply tight and prices high. Buyers will continue to line up for grocery-anchored shopping centers as long as returns exceed 6 percent. The result: Recent transactions have yielded cap rates of 7 and 8 percent, says Gary Mozer, CEO of George Smith Partners, a Los Angeles-based real estate financing and consulting firm.

At the end of the day, says Bernard Freibaum, General Growth’s CFO and executive vice president, mall companies and other shopping center owners have to judge market conditions based on their strategy for long-term growth. More important, he says, whenever market professionals think the market is adjusting to a new paradigm, conditions change.

For its part, General Growth says it is trying to get a healthy share of mall-based retailers’ business. “The more centers we buy that satisfy their expansion criteria, the more of a share of the stores we can get,” said Freibaum.

Therefore, General Growth’s decision to buy or pass on a mall does not hinge on a single internal rate-of-return calculation, says Freibaum.

“We’re thinking 10, 20 and 25 years [ahead] and make the determination that the shopping centers are worth what we paid for them,” he said. Further, sellers of hot real estate can capture low cap rates in almost any environment. Case in point: The Woodfield Mall sold in the early 1990s at a cap rate of 4.9 percent - at a time when interest rates were about 8 percent.

So how long do real estate professionals have to work with such a high-priced retail real estate market? At least another 12 to 14 months, says Mozer. Most market professionals do not expect interest rates to increase significantly before the 2004 presidential election. Further, the 7.2 percent economic growth that the U.S. Commerce Department reported for the third quarter of 2003 (later revised to 8.2 percent) was unsustainable, says Mozer, who expects the economy to improve slowly, keeping up demand for high-yielding investments such as retail real estate.

The run might stretch beyond that, says Howard Sipzner, CFO of North Miami Beach, Fla.-based Equity One, a REIT that focuses on grocery-anchored neighborhood centers. For the year to date, Equity One has purchased about $160 million worth of grocery-anchored centers, including the 451,587-square-foot Sheridan Plaza, Hollywood, Fla., for $75 million. At press time the company was working on a further $100 million in purchases and hoped to exceed its 2003 acquisition totals in the coming year, according to Sipzner. “Properties are healthy,” he said. “The market is healthy, and a recovering economy will add to their health.”

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