How to raise a successful retail RE fund

Despite headwinds affecting the sector, Sterling Organization has exceeded the $450m target on its latest vehicle.

The Sterling Organization’s $495 million value-add retail real estate fund challenges the notion that e-commerce has killed brick and mortar retail.

The Florida-based real estate firm closed its fourth discretionary closed-end fund, Sterling Value Add Partners III, last week. Raising $495 million in capital commitments over 10 months, the firm exceeded its $450 million target and has nearly reached its $500 million hard-cap.

The firm invests capital from the value-add retail fund series in most retail properties, other than enclosed malls. Fund investments will include grocery-anchored shopping centers, street retail, power centers and mixed-use properties located in densely populated areas around the US. The firm has not deployed any of the Sterling Value Add Partners III capital yet but expects to complete the fund’s first three deals in the next 30 days.

“Our fundraise is an example that there’s definitely investors putting capital into retail with the belief that now is the time to be buying,” Adam Munder, Sterling’s principal and chief marketing officer, told PERE.

The fund’s investor base comprises institutional investors that range from public pension funds to family offices, with particularly strong interest from college endowments. Investors include the University of Michigan and the Teachers’ Retirement System of Louisiana, according to meeting minutes from those institutions. New investors accounted for one-third of the capital commitments in Sterling Value Add Partners III, a handful of which reached out to Sterling proactively. Such investors saw retail as a contrarian play at a time when many other institutional investors and consultants have shied away from the sector for the foreseeable future, according to Munder.

In meeting documents, the University of Michigan highlighted the firm’s ability to both acquire quality real estate in prime locations at opportunistic prices, as well as maintain lower operating costs, likely due to its vertically integrated structure. More than 50 percent of Sterling’s deals have been sourced off-market, which results in more favorable pricing, Munder said.

Munder noted that the latest fund may have stood out to investors because few other managers are currently raising retail funds. Indeed, as of June 30, only three other retail focused funds have closed this year, bringing in a combined $1.6 billion, and just four funds closed on a total of $0.79 billion in 2017, according to PERE data. The last two years have seen a significant drop from 2016, when 23 retailed funds closed, raising a total of $4.84 billion.

Munder added that most institutional investors are generally underweight in retail, so those looking to diversify by allocating capital to the property type would look to a retail-focused firm like Sterling.

Sterling, through its value-add fund series, looks to convert class B properties into class A properties. The firm primarily invests in broken properties or those that need to be repositioned.

“Some of these class B properties that are coming to market are jewels in the rough,” said Cushman & Wakefield retail real estate analyst Garrick Brown. “It’s really the perfect time for this kind of contrarian play if you know what you’re doing.”

Brown sees growth and decreasing vacancies for suburban neighborhood and community centers that are grocery or drug store anchored. Most Americans still frequent such centers to buy groceries and personal care items in person rather than depending on Amazon or other internet retailers for delivery, he said.

Approximately 30 percent of Sterling’s properties are grocery-anchored. In meeting documents, the University of Michigan specifically singled out such properties, as well as power centers, for solid income production. Additionally, Sterling often brings on new tenants, such as fitness centers, to its retail locations to provide experiences consumers cannot find online.

“The reason why vacancy is shrinking in these [types of] anchored shopping centers is because almost all of the tenant categories that take space there are e-commerce resistant, at least so far,” Brown said. E-groceries only account for 2 percent of the market, and of that 2 percent, 80 percent of the deliveries take place in dense and urban markets like New York City, Washington, DC and San Francisco, he added.

Founded in 2007, Sterling also manages one core fund that focuses on grocery-anchored shopping centers. The firm’s previous value-add funds, Sterling Value Add Partners I and Sterling Value Add Partners II, closed on $138 million in December 2012 and $311 million in December 2014, respectively.