Driving forces behind private capital investment

A high-net-worth individual purchased Country Meadows, a 24,085-sf center completed in early 2019, for $7.7 million. The private investor utilized bank-debt financing in addition to a 1031 exchange in order to capitalize the purchase – a frequent occurrence in this market space.

Parker Brown
Capital markets, national retail partners, Denver, CBRE

Strengthened consumer confidence and unemployment at a 50-year low have materially benefited the continued success of the retail property market across the Colorado Front Range. These factors, in addition to today’s low cost of capital, have fueled the region’s retail investment market throughout 2019, as the market continues to demonstrate its attractiveness to real estate investors.

Amid persistent attention-grabbing headlines that warn of the impending collapse of the retail industry, retail across the Colorado Front Range continues to strengthen. The market has recorded year-to-date positive net absorption of more than 625,000 square feet, nearly double the amount posted though third-quarter 2018, while new development activity remains disciplined with 709,000 sf delivered year to date. Popular growth concepts such as quick-service food, entertainment and boutique fitness have continued their expansion throughout the market while larger, mixed-use developments such as Basecamp at Market Station and McGregor Square begin to enhance the city’s urban retail landscape. Rent growth also has continued, with average triple-net lease rates at $19.56 per sf, up 3.5% year over year.

It is no longer a surprise that private capital real estate investors nationwide are aware of these trends and actively seeking opportunities to capitalize on the region’s strength. As retail property owners evaluate their capacity to take advantage of today’s competitive environment, it is critically important to understand the variable factors and market participants driving investment decisions in Colorado’s retail property market.

•Single-tenant, net-lease and small-format retail. Substantial capital allocation and demand persists for small-format strip centers (two to five tenants) and single tenant net-leased assets. These assets typically feature service-oriented, investment-grade tenants with locations that command irreplaceable real estate fundamentals. These assets tend to carry very little management oversight and responsibilities, offering investors truly passive income, though it is crucial to fully understand the nature of the underlying lease(s).

The overwhelming majority of active buyers in this space are cash-flow and yield-driven, and they consist of high-net-worth individuals and family trusts. Many of these buyers are first time investors to Colorado and often are executing 1031 exchanges across markets and asset classes. Exchange timing requirements often make these investors an appealing option for property owners seeking efficiency of execution. Due to the typical price point for these assets between $1 million and $5 million, investors often possess the ability to close transactions on an all-cash basis, but frequently prefer to utilize debt financing.

Due to significant demand from investors, there is regularly a supply imbalance for best-in-class assets within this market space, resulting in a compressed yield environment. Market cap rates are safely between 4.75%-6.5% for STNL assets and between 6%-7% for small-format strips, though these are heavily driven by tenancy, credit, lease structure and lease length.

A recent example is the sale my partners and I completed of a single tenant 7-Eleven, featuring a 15-year triple-net lease along Colorado Springs’ Powers Boulevard, for $4.4 million to a Los Angeles-based 1031 exchange investor.

•Unanchored strip centers. Unanchored multitenant retail typically features a tenant roster comprising a mix of local and regional service-based retailers with triple-net leases. As the name denotes, these assets are not anchored by a grocer, big-box retailer or otherwise, but rather command highly visible and easily accessible locations. These assets often require additional management oversight when compared with STNL or small format strip centers.

The most active capital sources in this market space include private funds and syndicate groups in addition to high-net worth individuals and partnerships, though institutional investors increasingly are raising funds to enter the space. Investors in the space commonly utilize debt financing in their purchases, primarily provided by relationship-based lenders such as banks and credit unions, though nonrecourse life company and commercial mortgage-backed securities options are available for certain opportunities. This is especially prevalent in today’s low rate environment.

Elevated construction costs have played a large role in limiting new construction starts of these assets over the last 18-24 months, resulting in a moderate slowdown in available for-sale product despite sustained demand from investors. Market cap rates today are within the range of 6.75% to 8%, though these are highly impacted by a variety of factors including tenant mix, lease terms, location and vintage.

One of the few new construction, unanchored strip center sales of 2019 recently occurred, when a high-net- worth individual purchased Country Meadows, a 24,085-sf center we marketed that was completed in early 2019, for $7.7 million. The private investor utilized bank-debt financing in addition to a 1031 exchange in order to capitalize the purchase – a frequent occurrence in this market space.

As 2019 draws to a close, private capital real estate investors will continue to scour the Colorado Front Range for investment opportunity, as Colorado has demonstrated its standing as a safe haven growth market with high-quality underlying fundamentals. A robust local economy, low cost of capital and strong underlying market fundamentals will provide for continued transaction velocity to close out the year.

Understanding the specific participants and factors influencing retail property investment across the region is critical for owners and investors in order to secure a profitable and efficient outcome when pursuing an acquisition or disposition effort.

Featured in CREJ’s November 2019 Retail Properties Quarterly

Edited by the Colorado Real Estate Journal staff.