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When Acadia Realty Trust, a publicly-traded REIT that invests in both shopping centers and street retail, released its annual report for 2022 earlier this year, the document noted what would, to some, seem like a counterintuitive trend. The street retail in Acadia’ portfolio, which includes locations in major shopping corridors in New York City, Chicago, Los Angeles and Washington, D.C., among other places, was performing better than it did before the COVID pandemic in terms of market rents and tenant health. What’s more, according to Acadia, “since we are still in the early stages of a rebound in these locations, we see several years of above-trend growth.”
Acadia executives noted that occupancy for the REIT’s street retail portfolio reached 87% during the year. And on a long-term basis, they expect higher rent growth from the street tenants than from tenants in their shopping center portfolio. Leases for street retail typically feature annual rent increases that are 100 to 150 basis points higher than the increases for other types of open-air retail properties. Over a 10-year period, that structure already results in a roughly 30% internal growth for street retail leases compared to 14% for leases in suburban shopping centers, they wrote.
But Acadia also reported that market rents for street retail, while definitely on the upswing, still trail below peak levels reached five to 10 years ago. Its stores in the SoHo shopping district of New York City, for example, posted 10% year-over-year growth in rents in 2022, but are still from 30% to 50% below their prior peaks. As a result, the company expects multi-year, above-trend growth for those types of locations, with its core portfolio (including both street and shopping center locations) expected to deliver NOI growth from 5% to 10% over the 2023 to 2026 period.
In fact, in 2022, before the cost of debt went up, Acadia added a few more street locations to its portfolio. It acquired 11 storefronts on Bedford Avenue in the Williamsburg section of Brooklyn; a corner property on Spring and Greene Streets in SoHo; properties in the retail corridor on Beverly Boulevard in Los Angeles and a portfolio of shops on Henderson Avenue in Dallas.
And while the company stayed on the sidelines with acquisitions in the second half of 2022, some other buyers were still out purchasing street retail assets. In the fourth quarter, for example, Acadia sold an urban retail asset in Boston at a sub-5% cap rate.
Acadia didn’t not return calls for comment.
Regal Ventures, a New York City-based investment management firm that launched three years ago and that primarily focuses on retail assets, completed the acquisition of a retail and parking condo at 897 Eighth Ave. in New York City from Prudential Financial in October of last year, for $35.25 million. The retail portion of the property contains 15,893 sq. ft. of space and is anchored by Gristedes supermarket, in addition to featuring an Italian restaurant, a dry cleaner, a coffee shop, a nail salon and a bagel shop.
While the firm targets street retail in major markets, it prefers multi-tenant properties leased to non-discretionary and experiential tenants rather than stores leased to purely discretionary retailers, according to Sean Dainese, managing partner with Regal Ventures. It’s hard to know whether any given clothing brand will be around in a few years’ time, he noted. But “I do know that you and I will want to go out and eat with our families, grab a coffee on the way to work, stop by for a sandwich at lunch. And when that’s coupled with the foot traffic you find in urban areas, that for us is a perfect asset.”
Today, Regal Ventures’ retail portfolio has an occupancy of approximately 98%. And the firm is looking at additional acquisitions similar to its recent buy in New York, including at a portfolio of properties in high foot traffic areas in a major city.
“We are a relatively newer, growing firm, so in addition to having the motivation to grow, we also think it’s a very good time to be acquiring,” Dainese said. “While [sales] velocity is down, we see this time as a good opportunity, when private equity groups and other firms similar to us think it’s a good time to sit it out. We are definitely in acquisition mode but trying to be very selective.”
One of the main factors Regal Ventures is focusing on right now is the stabilized unlevered yield it can achieve, which on value-add assets in more urban areas needs to reach 8% or higher, or an approximately 200-basis-point spread on the cap rates these types of urban street assets are currently selling for.
“Historically, we like to look at IRR, but we are having difficulty in understanding what the exit cap rates are going to be three to five years from now, which is our typical hold,” Dainese noted.
What the numbers show
While rising interest rates and a muddier economic outlook have definitely put a damper on investment sales of street retail assets in recent months, for much of 2022 the sector registered a steady growth in demand. Sales growth stayed positive for six consecutive quarters, through the third quarter of last year, when it went up by 14% compared to the third quarter of 2021, to roughly $2.1 billion, according to data from research firm MSCI Real Assets. In the fourth quarter, however, investment sales volume declined by 53% to $1.9 billion. (Investment sales for all types of retail declined by 57% during the same period, to $16.2 billion).
The trend likely continued in the first quarter of 2023, when MSCI noted that sales volume for shop space—defined as retail spaces occupied by a single tenant and/or measuring under 30,000 sq. ft. in any type of location—declined by 43% year-over-year when the entity-level buyout of STORE Capital was taken out of the equation. The Commercial Property Price Index for shops also declined by 9.4% year-over-year and 6.0% quarter-over-quarter, though cap rates on closed transactions expanded by just 20 basis points compared to a year ago, to 5.7%.
In Dainese’s view, the slowdown in sales has been due to the same issues affecting most of commercial real estate—the uncertainty sparked by still rising interest rates and concerns about troubles in the regional bank sector—rather than to any doubts about the performance of street retail specifically.
“Street retail has had a strong rebound since COVID, our tenants have performed extremely well over the last year,” he noted. “So, I really do think it’s just because the rise in interest rates has made it more difficult to have certainty in underwriting for both buyers and sellers.”
In addition, would-be investors might be finding that opportunities to acquire retail assets on urban streets are few and far between, according to Chris Decoufle, managing director of U.S. retail capital markets with real estate services firm CBRE. That’s particularly true in an environment in which owners who don’t face any pressure to sell might not want to bring assets to market just to sell at a discount.
Some transactions involving street retail have continued to go through even in this year’s tougher climate. For example, in March, U.K.-based Weybourne Investments bought a 14,600-sq.-ft. retail building on 155 Mercer Street in New York City from a joint venture of Thor Equities and ASB Real Estate Investments for $60 million or $4,110 per sq. ft. The property last traded hands in 2016, when Thor Equities bought it for $90 million. Thor Equities did not return a request for comment in time for the publication of this article.
When it comes to property fundamentals, however, the urban street retail sector is unique in that it features a different population of shoppers than other retail types, and these shoppers, including international tourists, tend to be less vulnerable to uncertainty in the economy, according to Chad Littell, national director, capital markets, with real estate data firm CoStar. That’s being reflected in street retail rents in major cities. For example, in Miami, which saw a 129% increase in domestic tourists from September 2021 to September 2022, retail rents rose by 9.5% in the third quarter of last year, according to a recent report from real estate services firm JLL.
Investor profile
In the few years since the COVID pandemic, the composition of buyer groups actively engaged in street retail acquisitions has undergone an evolution, according to MSCI data. In 2022, there were far fewer cross-border investors in the mix, with 3% market share, vs. 11% in 2019 and 10% in 2021. There were fewer institutional investors too—they were behind just 6% of deals last year vs. 17% immediately pre-COVID.
On the other hand, the share of private capital in the space went up—to 84% of volume vs. 76% in 2021 and 61% in 2019. The share of buyers representing publicly-traded REITs, end-users and other entities stayed roughly the same, with under 7% of volume in total across all three categories.
This is happening at a time when fundraising earmarked for retail in general in North America has taken a dip. According to London-based research firm Preqin, in the first quarter of 2023, there were only three such funds raised globally with a total of $180 million, compared to 19 funds totaling $12.86 billion closed during all of 2022.
But the tide on institutional investors’ attitude toward retail real estate, including street retail, might be changing, according to Regal Ventures’ Dainese. The firm, which is GP-owned and operated, has been raising money from a variety of equity sources, from high-net-worth investors to private equity groups. But selling institutional investors on the idea of street retail assets has been tough because many of their mandates over the past two years excluded retail in general, he noted. In addition, many institutional investors are currently looking for opportunistic returns, which can reach 10% or higher.
“However, we are starting to see that trend in a more positive direction on retail. We are starting to see the more institutional clients become more responsive to us,” Dainese said. “It’s not always easy, but the sentiment on retail is definitely more positive than it was a couple of years ago.”
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