Stages of Grief Fade, Retail Sector Adjusting to New Normal – Connect CRE

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A mixed bag of expectations and projections highlighted the discussion among investment and finance professionals, mortgage brokers, and lenders at Connect Retail West. The outlook for 2024 could easily be categorized as sunny, with a chance of rain.

The Capital Markets panel was moderated by Chicago Title’s Shauna Smith and included Red Oak Capital Holdings’ Gary Bechtel, Progressive Real Estate Partners’ Greg Bedell and Newmark’s Glenn Rudy. The overarching theme that emerged was one of high volatility, yet opportunities persist.

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Rudy noted that challenges remain, yet there’s an effort underway to “be bullish.” He said, “People are trying to be bullish and excited about opportunities, that the market is going to be is going to present as we move forward next year. I think it will continue to be volatile.”

That said, Rudy was quick to remind the audience not to get mired down by the negativity surrounding the retail sector, economy, or capital markets. He encouraged the retail sector to “stay in the moment” and understand that “there will be opportunities. There is going to be transaction volume back, period. There’s just too much capital in the markets,” said Rudy.

That sentiment was echoed by Bedell, who said, “What it feels like right now, especially with retail really being one of the darlings of the asset classes, [is], we’re really no longer [hearing] the retail apocalypse stories, with the exception of Class B and C malls.” He says, capital players, “especially on the private capital side, are sitting or standing at the edge of the pool. They want to jump in, but the water’s still murky and they’re just not sure where to jump in yet, especially for retailers.”

Bedell noted, “broadly speaking, everything is down volume wise, but [once] you start diving into specific product types, specific markets, and specific dollar ranges, you do start to see different stories. And there’s no doubt that there’s going to be some opportunity out there, assuming retail fundamentals remain strong.”

Bechtel pointed out the large and looming amount of debt maturities on the horizon – especially involving bank debt, which is causing banks to contract. “There’s a big void in the market. There’s a lot of capital to lend and a great amount sitting on the sidelines,” he said, noting many prefer not “to catch a falling knife not knowing where the market is. The waters are murky,” he said.

“We expect to see higher rates for the foreseeable future and that results in conditions that deals don’t pencil today,” he said, predicting that 2024 will be a “difficult time,” especially for the office sector and potentially the retail sector where degradation of NOI has occurred that’s set against the backdrop of increased capitalization rates, which has worked to drive the value of assets lower and caused lenders to become more conservative. Borrowers can either add more capital themselves, look for a lender discount, return the keys to the lender or seek more money in the form of private equity, White Knight, or rescue capital.

Bechtel predicted, “There’s going to be some great opportunities for those guys to come in and solve some of the holes. But unfortunately, there’s also going to be a lot of keys handed back to the lenders, and the lenders are going to dump that, which therein lies an opportunity for them to resell a property at a lower basis and restart the cycle all over again. So, 2024 is going to be really interesting.”

Fundamentals remain solid for the retail sector, with panelists agreeing they see healthy conditions, low vacancies, and resilient performance across the retail segments, with few exceptions. Rudy is optimistic that no “blood baths” are on the horizon. Though he is keenly watching institutional investors because once they give the keys back to an asset, that means they’ve exhausted every strategy they know to implement. But, Rudy added, “from a retail perspective, the West Coast, particularly in California, is always going to be a darling. It’s always attracting institutional capital. Period.”

Bedell pointed out that “sellers have been going through the five stages of grief throughout the course of this year. It feels like most are hitting the last three stages where they’re at the depression, bargaining and acceptance [stage.],” though “different sellers are at different stages. I think we’re starting to sense more and getting towards acceptance or some sense that some buyers [are] wanting to jump into the pool,” though it can still be challenging, he says.

That is a view Bechtel also holds. At the beginning of the year the market refused to accept that the interest rate environment and the availability of capital had changed. Bechtel said, “That kind of played out from Q2 and Q3. And then all of a sudden in August, September, they got the memo, ‘okay, rates aren’t going down. There’s not going to be a significant amount of capital coming into the market. If I want to transact, I better transact and just swallow it and move forward.’” It wasn’t a position they were happy to be in even as rates continued to changed. “But I think they’ve finally gotten the same memo that ‘I need to transact. It’s not going to change.’”

One type of retail assets where transactions are occurring is second generation retail space, which is in demand, though “cooling is occurring market-by-market and product type-by-product type,” said Bedell. One of the biggest challenges that Bechtel pointed out when underwriting deals is securing insurance, and borrowers are wise to disclose any skeletons early on because when they invariably arise lenders have fewer options to structure deals through an issue later. He noted that rising wages had been a challenge though that is largely been accounted for.

The optimism about 2024 is largely based on the large number of opportunities expected to emerge in the marketplace, predicted Rudy, though he cautions that the large amount of capital “that wants to get out, that wants to be placed” will be challenged to adjust to a different market, especially surrounding deal pricing, which is expected to drive transaction volume going forward.

“I’m going to remain absolutely bullish that we see an uptick of activity if we can all acquiesce to the new normal,” said Rudy. He believes once that stabilization is achieved with indices, the lending community and an election, deals will pick up in 2024, though not likely a flood. Once the retail industry gets past those future issues and emotions, Rudy believes “we’re going to want to get back to the business of real estate. And we’re not in a bad spot right now, historically speaking. So, I think we remain bullish.”

Bechtel is realistic and optimistically expects conditions to remain with similar capital constraints through 2024, and the same interest rate environment. “There is a lot of capital on the market and in the system at a higher price than borrowers have wanted to pay because they’ve been spoiled with ten years of extremely low interest rates. But historically, this is a pretty good time from an interest rate standpoint.”

Regardless, Bechtel said, it is “still a pretty good environment. But everybody has been spoiled by a historically low interest rate environment.”

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