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FEATURE: Shopping for deals

With retailers in the West taking a beating, GPs are eyeing recession-resistant investments. The outlook is less bleak in the emerging markets. And distressed retail is in fashion for those with cash in their wallets. PERE Magazine December 2008/January 2009

New York City's Fifth Avenue may be ringing in the holidays with a little less lustre this year, with retail sales at an all-time low and consumer confidence showing no signs of picking up.

In fact, retail as a sector isn't expected to be decking the halls with bows of holly anytime soon. Regular headlines of national retail chain bankruptcies – including the plight of private-equity backed shops Mervyns and Linens 'n Things in the US – and depressed consumer sentiment has left a bad taste in the mouths of many GPs in recent months. (One veteran real estate investor recently told PERE he wouldn't touch retail “with a ten-foot barge pole”.)

High St sale

The latest data has given them only greater cause for concern. Retail sales in the US have plummeted over recent months, with October 2008 hitting a 16-year low.

Outside the US, the story is not much brighter. Retail sales are down and consumer confidence is very low in many parts of Europe, according to Scott O'Donnell, senior managing director in the UK office of Harbert Management Corporation: “We are seeing the same things as in the US. It's happening at different paces across all of Europe. That has led retailers to re-evaluate their expansion plans with some shutting them down altogether, and others weaning out those stores that they can that aren't high producers for them.”

However for some real estate GPs, there is some glimmer of hope, particularly among those taking a more focused, sectorspecific strategy, targeting community-based shopping centres and grocery-anchored retail properties. This play, they argue, is more recession-resistant than most.

Sigrid Campbell, vice president of PECO Capital at private equity real estate firm Phillips Edison, says that even with an economic downturn, people still need their every-day groceries and goods.

Consumer spending on staples is proving to be robust. Between January and July this year, all US retail subsectors saw a slowdown in terms of expansion, according to construction researcher McGraw-Hill Construction, with new space falling by more than a third in the first half of 2008 compared to the same period in 2007.

When times are bad, people still need to eat. Grocers usually see an uptick because people tend to be more family-oriented. Family means cooking and cooking means going to the grocery store, in the most simplistic sense.

Retail developments in mixeduse properties were also down this year by more than 40 percent, while the only retail subsectors in the US to see any expansion were freestanding drug stores, which grew by 18.5 percent over the six months to July 2008, and supermarkets, which grew by 0.9 percent in the first half of 2008 compared to a year earlier.

Grocery-anchored properties have not taken the same hit as other retail properties, adds Susan Rorison, president of Santa Monica, California-based Watt Commercial Properties. “When times are bad, people still need to eat. Grocers usually see an uptick because people tend to be more family-oriented. Family means cooking and cooking means going to the grocery store, in the most simplistic sense.”

“Usually when you're coming out of a down market – and certainly in the kind of down market we're in right now – I think the focus will always initially be in the bread-and-butter and value/off-price retail,” argues Arthur Milston, managing director at real estate investment bank, Savills US. “And that's grocery-anchored shopping centres and discount departmentstore anchored properties, such as Wal-Mart and Target.”

Emerging opportunity

There are some retail opportunities that are defying the trend being seen in mature markets, such as the US and UK. In the Middle East, where many believe luxury retailing to have set a new standard, retail is still seeing fairer skies.

Some investors are still bullish on the sector. In its November sector outlook for the Middle East, North Africa and Gulf Cooperation Council region, Global Capital Management – the private equity group of Kuwait-based asset management firm Global Investment House – said retail was still an “attractive play”, owing to growing consumer spending in the region. Notably, it said, per capita consumer spending in GCC countries increased at a compound annual growth rate of more than 10 percent between 2002 and 2007.

Factors including population growth, lifestyle improvements, brand consciousness and the emergence of retail malls, were all expected to benefit the retail sector, especially in Saudi Arabia, the United Arab Emirates and Egypt. And almost to prove the point, Global Capital Management acquired this year a controlling stake in Saudi Arabia's third-largest retail player, Al Sawani.

In the emerging Eastern European markets, retail is also an extremely viable investment option. RREEF, the alternative investment management division of Deutsche Bank, is currently completing the second phase of its retail development in Nitra, Slovakia, comprising mostly apparel retailers with some service retail shops. With little to no properties like it in the area, RREEF is looking to capitalise on the fact that it was there first.

The latest research report from international property consultants King Sturge, entitled European Retail Property Market 2009, also argues that despite continental European retail markets expecting to be squeezed in 2009, emerging economies – such as Bulgaria, the Czech Republic, Poland, Romania, Slovenia and Slovakia – are forecast to see growth in consumer spending. Retail rents are set to increase by up to 10 percent in cities such as Bucharest, Prague and Warsaw, according to its research.

Distressed for the holidays

Of course, the distress being seen in the retail sector in the mature economies in the US and Europe is providing some element of good news for private equity real estate firms eyeing retail investments. In Europe, retail property values are expected to fall by more than 30 percent from their peak in early 2007 to a low in 2010, according to the King Sturge report, setting the stage for “extraordinary” investment opportunities to open up for “cash-rich players”.

As we get through the Christmas season and begin the first quarter, by February I absolutely think that the people sitting on the sidelines waiting to see what's out there will pick the best products first, which is normal.

On the US side, the number of struggling REITs expected to be unloading retail assets onto the market is setting the stage for private equity real estate investors to scoop up properties at high discounts, and even to cherry-pick among assets.

What the retail market in the US looks like at the moment could be quite different from what it looks like in the next few months, says Greg Maloney, president and chief executive of Jones Lang LaSalle Retail. “As we get through the Christmas season and begin the first quarter, by February I absolutely think that the people sitting on the sidelines waiting to see what's out there will pick the best products first, which is normal. Plus, because of the troubles with some of the owners and the REITs, I think there will be a good deal of that type of product on the market.”

Chicago-based General Growth Properties is one such real estate investment trust which could pump product into the market. At the time of press, the US' second-largest owner and operator of shopping malls said it could file for bankruptcy protection from its creditors as it struggles to refinance debt. The company has $958 million in debt due 1 December and another $3 billion of debt that matures in 2009. In November, the REIT reported a quarterly loss of $15.4 million.

“There are various opinions of where the cap rates are,” says Maloney. “If August was the high benchmark for values of shopping centres of all sizes in the US, it's safe to say that the cap rate has increased from 100 to 250 basis points depending on the type of product you have. Obviously if the cap rates go up, sellers are going to have to determine if they want to recapitalise and hold the property or sell, which is where you'll see a lot of opportunity.”

But when those opportunities might emerge is anyone's guess. As O'Donnell explains: “You need to have darkness before you have sunlight.”

You need to have darkness before you have sunlight.

The sooner we get to the bottom the better, he adds, although O'Donnell doesn't expect it to be anytime soon. “I don't think 2009 will be the turning point,” he says. “I think maybe towards the end of it you'll start to see people have enough confidence to start going into the market a little bit more. I think the first quarter will still be very slow. This is not a V-shaped recovery unfortunately; it will be more of a U. It's just a matter of how long we're going to sail along the bottom before the wind picks us back up.”

As for the overall recovery of the retail market, confidence will first have to be restored in the consumer market, argues O'Donnell, which will be shown through retail sales. “If you're looking at recoveries I think you're going to see it in the retail sector first,” he says. Investors who took a position at some point in the downturn, before the full recovery comes through, could still see positive benefits, O'Donnell adds. However, they should be prepared for more pain ahead before they see the light at the end of the tunnel.

AT A GLANCE

Retail players
These firms have all invested in the retail sector in the past year.

Firm Headquarters Retail investment
The Carlyle Group Washington DC Acquired controlling interest in retail portion of NYC's 666 Fifth
Avenue building for $525m in July. Also purchased portfolio
of three shopping centres in the UK in June.
Coventry Real Estate Advisors New York Raising third retail-focused fund targeting $400m for retail
properties, including redevelopment, ground-up development with
JV partners and acquiring stores from retailers.
Curzon Global Partners / London Acquired 28 properties – 60% retail – from UK fund manager
Mountgrange Capital PRUPIM in August for £139m.
GPT Halverton London Acquired 11 retail park properties in Germany, totaling almost
19,000 sq. m. Investment made through €136m retail fund, GRP,
which targets food-anchored retail properties.
Harbert Management Corporation Birmingham, Developing retail warehouse in Malaga, southern Spain in
Alabama partnership with JV partner Doric Malaga. Invested out of
Harbert's European Real Estate Fund II.
Henderson Global Investors London Purchased three retail properties in the UK for £365m in August.
Raised £181m in equity for UK Outlet Mall Fund, which will
own the properties.
Horizon Capital Kiev, Invested $15m in growing Ukrainian supermarket chain, Fresh,
Ukraine in October.
ING Real Estate The Hague, Acquired retail complex in Pilsen, Czech Repuhlic for
Netherlands approximately €16m. Investment made through ING Property
Fund Central Europe.
Meyer Bergman London Targeting €600m for value-added retail fund focused on
Eastern Europe. It has acquired more than 20 retail stores
in Turkey over the past two years.
Pradera London Started capital raising for China-focused retail fund in February.
It is the firm's first fund outside of Europe.
RREEF New York Raising retail complex in Nitra, Slovakia, currently completing
fnal phase of development. Total capital investment of €45m.