Repurposing is on the minds of most private real estate managers and investors these days. Indeed, in pwc and the Urban Land Institute’s latest Emerging Trends in Real Estate Europe report, nearly three-quarters of survey respondents said they planned to pursue conversions of assets from one sector to another over the next five years. Tellingly, 41 percent of the report’s interviewees – up from a third last year – expressed concerns about asset obsolescence this year, with nearly half expecting the problem to worsen in the coming half-decade.
Easier said than done, of course. In retail, for example, the feasibility of repurposing an obsolete or vacant retail asset is dependent on numerous factors, running the gamut from zoning laws to financing availability to rental rates, as we revealed in PERE’s May Deep Dive published this week. (You can also listen to our podcast on the topic here.)
In many cases, however, the feasibility of a retail conversion project, particularly for distressed buyers in the sector, can come down to one deciding factor: pricing.
One person who emailed us after reading the Deep Dive was Jim Costello, senior vice president at data provider Real Capital Analytics. For Costello, the key issue with repurposing retail is the ability to buy assets at a price “too cheap to ignore,” citing a quote from Angelo Gordon’s Anuj Mittal in our piece.
What is too cheap to ignore? Anecdotally, examples include a £50 million ($69 million; €58 million) shopping center in the UK being sold for £7 million, and generally, retail property values have plummeted by 50 percent or more, according to Rick Kalvoda, senior vice president at advisory services firm Altus Group. In the US, the bid-ask spread for retail has narrowed to 20 percent, Kalvoda says, while one Asia-focused fund manager told us this week the bid-ask gap for retail in China has fallen from 30 percent in 2020 to zero.
As Costello told us: “Investment in construction is risky and unless prices fall dramatically, developers cannot make a go of converting a building over to a different use.”
In a January report, Costello noted a clear correlation between falling prices and an uptick in redevelopment in the Manhattan office sector, where redevelopment sales have historically risen after prices fall.
In this current crisis, overall property prices are hitting a floor right now, but redevelopment deals are not yet happening in significant numbers. Typically, such transaction activity picks up in the first five years of the recovery, Costello noted.
Retail sales for redevelopment purposes fell from $1.4 billion during Q1 2020 to $460 million in Q1 2021 in the US, according to RCA data. While that decline may be attributed to the general slowdown in real estate investing during the pandemic, what is worth noting is the number of properties that traded during both quarters was exactly the same: 37.
In a prep call this week, one investor noted the market will only see more distressed sales if owners are forced to sell. Banks have held off on forced sales during the pandemic, but that could change after more shopping centers have reopened and been back in operation for several months, he said.
Distressed sales, and in turn the repurposing activity that much of the industry has on the agenda, is therefore just beginning.