Impressive market fundamentals strengthen investment activity

One notable transaction that traded in late 2018 was the $30 million sale of the Cherry Creek Retail Center, a two-tenant power center. This was noteworthy because power center assets have been impacted the most by evolving retail trends, however they typically command desirable real estate fundamentals and offer the entrepreneurial investor an opportunity for higher relative returns that are not readily available in alternative investment products. Courtesy CBRE

Parker Brown
Associate, capital markets, national retail partners, CBRE

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Record-low unemployment levels, increased consumer spending and robust residential development have continued to bolster a high-performing retail landscape across the Colorado Front Range. These factors certainly boded well for the region’s retail investment market throughout 2018, and will continue to do so in 2019, as the region remains a preferred market for commercial real estate investors across the capital spectrum due to its proven resiliency.

Matthew Henrichs
Senior vice president, capital markets, national retail partners, CBRE

Denver’s retail investment market recorded total 2018 sales volume that exceeded $782.3 million, a 2.9 percent increase year over year. Although a relatively modest increase, this is particularly impressive given macroeconomic threats that have disrupted the retail environment and caused choppiness in the capital markets.

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Last year saw strong demand from commercial real estate investors across the capital spectrum for retail assets all along the Colorado Front Range. Investors in the private capital space, which typically consist of high-net-worth individuals, family trusts and private opportunity funds, remained focused on acquiring small-format strip centers and single-tenant net-leased assets that feature service-oriented, investment-grade tenants with locations that possess irreplaceable real estate fundamentals. These investors often utilize debt financing in their purchases, typically provided by relationship-based lenders such as banks and credit unions.

While ample capital allocations existed for these small-format retail investment properties, a supply shortage persisted throughout the year. This imbalance buoyed strong pricing levels due to fierce competition for best-in-class assets, and also resulted in an increase in the number of local and out-of-market investors pursuing opportunity in Colorado’s secondary markets such as Colorado Springs, Fort Collins and Pueblo. The sale of the Shops at Northern, a Class A strip center in Pueblo shadow anchored by a leading global discount retailer, for $2.7 million to a Denver-based 1031 exchange investor embodied this trend.

In contrast to private capital investors, institutional and middle-market investors set their sights on pursuing retail centers that offer experiential components, opportunities to immediately create value through lease-up or management, and even well-located centers in need of revitalization. These well-capitalized investors also pursued larger-format opportunities, such as power centers, with a discerning eye due to the potential for opportunistic returns.

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Two highly notable transactions that traded in late 2018 were the $30 million sale of the Cherry Creek Retail Center, a two-tenant power center, and the $10.15 million sale of Denver West, a value-add power center. These are of note because power center assets have been most impacted by evolving retail trends, however they typically command desirable real estate fundamentals and offer the entrepreneurial investor an opportunity for higher relative returns that are not readily available in alternative investment products.

Last year’s success within the region’s retail market is proof of Colorado’s resiliency in the face of national trends and headlines centered around retailer bankruptcies, store closures and e-commerce disruptions. To that end, the metro Denver retail market recorded positive net absorption of 709,869 square feet in 2018, more than double 2017.

Over 1.3 million sf of new retail space was delivered to the Denver market in 2018, up roughly 18.9 percent year over year, which no doubt positively impacted 2018’s impressive absorption levels. Notable development projects that delivered in 2018 were Candelas Marketplace, a 123,000-sf King Soopers-anchored center, and Denver Premium Outlets, a 328,000-sf outlet mall.

2018 leasing activity remained robust, driven by retailers focused in the entertainment, service, and food and beverage sectors. The market’s direct vacancy rate ended the fourth quarter at roughly 7.2 percent with a direct asking lease rate of $19.34 per sf triple net, an all-time high. Strip/in-line centers command the highest direct asking lease rate of $20.86 per sf triple net, signaling the increased demand for efficient floor plans as tenants continue to right-size their footprint while focusing on omnichannel opportunities.

In 2019, investors from across the nation and capital spectrum will continue to allocate capital to Colorado as the area has solidified itself as a safe-haven growth market for real estate investment. While demand from capital sources will sustain, perhaps the largest threat to the retail investment market over the next year will be the rising cost of capital for investors. Both debt financing and pricing will continue to be impacted by the rising benchmark 10-year Treasury yield, which experienced an increase of roughly 20 basis points in 2018.

As we progress into 2019, the fundamental strength of the region’s economy and retail market should provide viable market conditions for continued transaction velocity. There will be continued demand from aggressive capital sources, and many property owners will seek to capitalize on the favorable metrics that have impacted pricing across the Colorado Front Range over the current real estate cycle. However, we will witness significant pricing disparity across retail investment opportunities in 2019 as investors exercise increased discipline and scrutiny in committing their investment dollars. Assets that possess irreplaceable real estate fundamentals with investment-grade tenants or a value-enhancement opportunity will garner the greatest attention from available capital in the marketplace.

Featured in CREJ’s February 2019 Retail Properties Quarterly

Edited by the Colorado Real Estate Journal staff.