Factors impacting the investment property market
Hindsight is classically 20-20, but it’s difficult to imagine that on Jan. 1, 2020, any participant in Colorado’s retail investment market could’ve accurately predicted the dramatic shift we encountered overnight on March 15. An unfamiliar and unwelcomed reality rapidly established itself that hardly resembled anything we’ve ever known. The potential for rent growth, cap rate compression or tenant expansion plans quickly became immaterial as market uncertainty ensued. Decisions surrounding rent deferrals or forbearance programs took center stage while fiscal stimulus and tax extension programs provided by the federal government became critical and necessary.
It is no surprise that COVID-19’s dramatic arrival and related public policy responses quickly and materially impacted the retail investment property market throughout the Colorado Front Range. As retail property owners and investors evaluate investment decisions in today’s variable environment, it is critically important to understand the variable factors influencing Colorado’s retail property market.
Paycheck Protection Program and 1031 exchange extension. In response to the pandemic, the federal government signed into law the Coronavirus Aid, Relief, and Economic Security Act on March 27. Two programs proved particularly impactful to the retail property market:
- The Paycheck Protection Program: Following the implementation of Colorado’s stay-at-home order, retailers of all types and sizes quite literally overnight lost their ability to generate the revenues necessary to meet obligations and turn a profit. Despite a fairly tumultuous rollout, the Paycheck Protection Program provided a significant lifeline to retailers and small-business owners. Eligible recipients of PPP funds were permitted to utilize these funds for rents obligated under a lease, thereby benefitting both retail tenants and landlords in a time period of uncertainty. Rent payment burden between tenants and landlords was mitigated temporarily but certainly not eliminated as significant choppiness persisted across many retail assets.
- IRS extends Section 1031 exchange deadlines: Commercial real estate investors who were engaged in a 1031 exchange with an identification period on or after April 1 and before July 15 were granted an identification extension to July 15. This is a significant extension beyond the typical 45-day time period allotted for 1031 exchange investors to identify a replacement property. This allowed many would-be time-sensitive 1031 exchange investors some breathing room to exercise patience throughout much of April and May before, ultimately, coming back to the market for acquisitions in late May up to the deadline date of July 15.
Demand drives single-tenant, net-lease investment activity. Active investors in the retail space have demonstrated a significant flight to quality since mid-March, increasingly targeting single-tenant, net-lease for purchase requirements. These assets often feature buyers executing 1031 exchanges on an all-cash basis.
In a time period of uncertainty, STNL assets have commanded substantial investor interest given that they may feature “essential” and investment-grade tenants while often featuring a drive-thru component. Notable single-tenant retail tenant uses that have proved resilient and are in high demand by investors include gas and convenience stores, medical, quick-service restaurants and grocery. Due to significant demand from investors, market pricing for these best-in-class assets remains extremely competitive given the security of cash flow and continued supply imbalance. A recent example is the sale my partners and I completed of a single-tenant Humana Primary Care, featuring a 15-year triple-net lease in the Denver metropolitan statistical area, for $4.48 million to a Los Angeles-based 1031 exchange investor.
According to our research, sales volume in the STNL market segment locally declined roughly 20% year over year in the second quarter, though we expect market transaction data will detail substantial investment volume for this asset class in the coming months following the July 15 identification deadline.
Multitenant and debt market pause. The multitenant retail investment property market has largely ground to a halt since mid-March across Colorado. Temporary store closures and rent-deferral programs led to substantial unpredictability across many shopping center assets across every corner of the market. Rather than positioning assets for a disposition, landlords found themselves negotiating deferred-rent structures while considering the potential of mortgage forbearance programs. In turn, life companies, commercial mortgage-backed securities, banks and credit unions largely hit pause on retail lending activity while closely monitoring the impact of the pandemic on the retail and commercial real estate market. Discretionary leveraged investors found themselves on the sidelines for many of these same reasons. While the market has displayed signs of stress, there have been limited signals of distress. Great clarity into the strength of rent rolls is necessary before lenders and buyers resume transaction velocity in this market space. Opportunities will be reviewed and analyzed at the asset-specific level.
One of the few multitenant shopping center sales since March recently occurred, when a high-net-worth individual purchased Arvada Connection, a 38,711-square-foot center we marketed for $10.6 million. The private investor utilized relationship-based, bank-debt financing in addition to a 1031 exchange in order to capitalize the purchase.
Looking ahead. COVID-19 and the related ripple effects of the pandemic likely will continue to challenge the retail property market throughout the second half of 2020. A resilient local economy, entrepreneurial workforce and accommodative government will propel the Colorado retail property market through current challenges.
Understanding the variable factors influencing the retail property market across the region is more critical than ever for owners and investors as we power through the current market environment. Expertise, perseverance and optimism are key.
Featured in CREJ’s August 2020 Retail Properties Quarterly