The Scanlon Report: Misery, opportunity: opposite sides of the same coin


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My practice includes tracking what is going on in the private real estate investment world, especially retail. In broad terms, privately held investment real estate includes properties with a value of between $1 million and $10 million. These days, I have a long list of investors who have access to cash and financing, and who are waiting for “opportunities” to acquire investment properties.

For them, opportunity comes in the form of multi-tenant retail centers that are experiencing high vacancy, deferred maintenance, unpaid property taxes and owners who might even be “upside down” with their lender.

Owners in this situation are obviously experiencing misery, with nowhere to turn as we ride out the current economic roller coaster. It’s a dose of market reality that has been played out in the past, most notably

in the early 1990s in southern New Hampshire, when the Federal Deposit Insurance Corp. marched down Elm Street in Manchester closing banks that had been around for nearly a century and then proceeded to foreclose on and sell off numerous properties at cents on the dollar to investors who had some cash to invest.

However, I haven’t seen the “misery index” climb very high thus far, and conversations with commercial lenders have confirmed that they have very few troubled assets.

I have heard stories of landlords who are concerned about the ability of their tenants to hang in there, but have not seen a mass exodus of tenants. Perhaps it’s too soon after the holidays, and the worst is yet to come. I also think that some landlords will be able to weather the storm better than others.

My take is that private investors are not over-leveraged the way several institutional investors are. This is probably due in part to the lessons that New Hampshire commercial lenders learned in the early ‘90s.

As an extreme example, I was talking with the owner of a retail strip center the other day who has no mortgage. He has one vacancy at the moment, and says that some of his tenants are telling him that they are having a hard time. He won’t be happy if he loses more tenants and can’t find replacements, but he will more than cover all of his expenses and not be faced with the need to sell.

On the tenant side, some businesses are doing well while others have been clearly affected by the economic downturn. Dollar General announced recently that it has seen an increase in sales and profits and plans to open 450 new stores in 2009. It also plans to grow, remodel or relocate 400 existing stores.

McDonald’s is reporting increases in sales, as is Wal-Mart. The Demoulas family, owner of the Market Basket supermarket chain, recently bought land in Pelham and is rumored to be looking for a Manchester site. Hannaford’s recently opened a new store in Bedford on Route 101, and out-of-state grocers like Aldi are now looking at southern New Hampshire locations.

Hit to retail landlords

On the downside, Desjardins Jewelers in Manchester is closing its Elm Street store after being in business since 1944 and a local furniture store on Hooksett Road in Hooksett is having a going out of business sale. Ritz Camera recently filed for Chapter 11 protection, and it is unclear which stores it will keep open. The Wall Street Journal also reported recently that many franchisees are in default on SBA-backed loans. The Circuit City, CompUSA, Linens ‘n Things and Tweeter stories are well-known. These closings are leaving gaps in larger retail centers, and there will likely be more store closures by retailers whose names we all recognize.

One of the noted hits to some retail landlords is the closure of Advance America’s 24 stores throughout the state as a result of changes in the law relative to interest rates. These stores were often located in strip centers, leaving significant gaps for landlords to fill. The leases were often long-term as well.

Why have retail centers not traded as much over the last couple of years? I don’t think that the normal rules of supply and demand are in effect.

One of the biggest reasons for a lack of activity is the bid-ask gap. Owners will only sell at prices buyers are unwilling to pay. This could be translated to read that owners have not experienced enough misery to create the type of opportunity that buyers are looking for. So owners are riding it out. Also, with so few properties trading, sellers who might be willing to sell, and who want to defer their capital gains taxes and do a 1031 exchange, are not finding properties to trade up to.

The third issue, to some extent, is financing. It’s fairly clear from my discussions with local lenders that they have the money to lend and want to do deals, but I think underwriting standards have tightened somewhat, and the cash flow from these properties is being looked at more critically than it has in recent years.

And since the cash flow is tied directly to the quality of the tenants and the terms of their leases, the centers with marginal tenants with short leases probably can’t get financed.

None of us has a crystal ball, and we will all have to ride this out. My hope is that as we go through 2009, we will begin to have a clearer picture of where we are going.

My sense is that the opportunities that investors are looking for might come up in a few cases, but not the way it was in the early 1990s.

TARP funds and stimulus money aside, we need, and are probably going through, a market correction that is long overdue.

Dan Scanlon is a retail investment adviser with Grubb & Ellis|Coldstream Real Estate Advisors Inc., Bedford. He can be reached at 603-206-9605, or dscanlon@coldstreamre.com.

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