I speak with a lot of property owners and investors daily and I find frequently in conversations with retail property investors I’m told they have a strong interest in either opportunistic or value-add properties. This is a logical investment strategy as it’s clearly an advantage for the buyer to seek and invest in properties that do not have their future potential value already priced in. Real estate behaves something like the stock market in that, if the market thinks the future will have growth, that is priced into the stock before the growth actually happens. If you’ve been investing for a while you’ve likely become accustomed to that. Sometimes, though it’s more difficult to accept that real estate would have the future priced in, although that happens in the market place sometimes. We’re all looking for those exceptions where we can achieve greater gains over the period of our ownership. Basically, there are three categories of real estate investment assets that are preferred by an investment group depending upon their objectives, or the objectives of the particular fund they are managing, and these are known as, Core, Value-Add and Opportunistic.
A Core property meets the needs of conservative investors looking for stable income flows that are low risk. These properties require little hand holding and can be compared to bonds. These properties are occupied by strong covenant tenants with long term leases. In Canada some examples of core tenants are grocery stores like Sobeys, Loblaws, Costco or Walmart or even smaller yet still core tenants like A&W, or MacDonalds, or established dental and medical groups. The cap rate on this type of asset traditionally has been low but like all other asset classes could come under pressure with rising interest rates. Core investors tend to use about 45 to 50% leverage. We have seen these assets trading at a 4 cap often and in the last quarters of 2021 and early 2022 we even observed 3 cap and below on trading properties in Toronto.
Value-add real estate assets are synonymous with growth, just as in the stock market. These assets are considered moderate to high risk. The properties have a high vacancy rate, deferred maintenance issues, or management problems or all three. Perhaps the property has underutilized land or parking that can be developed by adding more buildings.
An example of a Value-add property is that of 4099 Erin Mills Parkway Mississauga, which sold October 2021 for $31M or $494 per square foot, 10% below the average sale price for the GTA. The plaza is anchored by Iqbal’s Foods halal grocery store, an independent grocer. Iqbal Foods replaced Michael-Angelo’s Market grocery store in 2018, owned by the property vendor. The property is fully leased and appears to be reasonably maintained, however it maybe that the parking ratio is constrained at 1.24 per 1000 square feet which likely constrains sales in this vehicle driven trade area. The property had been held for more than 20 years and by the former operator of the anchor, Michael-Angelo’s, and likely there is an opportunity to increase lease rates upon renewals. For these reasons and perhaps others that we are unaware of, the property traded a little below average. In general though, this seems like a solid investment with low to moderate risk.
But a word about comparing property investments….It’s difficult to compare retail investment transactions as cap rates and building conditions are hard to determine from data supplied publicly. The price per square foot as one measurement to gauge relative pricing doesn’t tell the whole story but it is useful when assessing relative property values. Looking over the retail investment transactions of the last year, single tenant buildings where rents are low, such as a building occupied by Giant Tiger, tend to trade below the average price – that is an example of where the lower price is reflective of the cap rate and not reflective of a medium term Value-add opportunity.
Value-add investors tend to use between 60 and 75% leverage to generate returns.
Opportunistic properties often have little to no cash flow but have potential to produce tremendous cash flow once the value has been added. Opportunistic investors often cannot leverage more than 50% but expect higher than average returns.
A recent example of a retail property sale that was an Opportunistic investment is 1635 Lawrence Ave W., Toronto, which sold on April 21, 2022 for $30.7M or $452 per square foot. This was 18% lower than the Toronto average price per square foot of $548. The anchor tenant in this shopping centre, Superking Supermarket occupied 25,000 square feet and was owned by the same group that owned the property. It’s unknown what the lease rate would have been in place for this owner-occupied anchor space. The buyer was Spotlight Development Inc., and the intention according to the buyer’s website is to build 4 condo towers of approximately 1M square feet targeted at the affordable housing market. Clearly the lower than average price was due to the fact that the anchor tenant was the owner, the property is large enough to accommodate high density, and is near to communities that include low income families. There is tremendous upside for Spotlight here, but also the significant development risk that comes along with embarking on an ambitious, long term capital intensive project.
Investors need to understand the risks of each situation and if they are a conservative investor, the focus should likely be on Core properties with minimal Value-add characteristics. A long or even multi-generational time horizon may nudge the newer investor towards Value-add properties, with time on their side to help smooth out market ups and downs and other risks. On the other hand, the investment groups with deep experience with repositioning and re-developing properties are almost always looking for the opportunistic investment. Without a doubt for the Opportunistic investment, patience is the name of the game, but with great patience, and great risk often come great reward. We help clients understand the risk and reward potential of investment properties, positioning properties for sellers such that the opportunity is well understood and analyzing the potential risks for buyers that we work with. Call us to discuss your needs further. We love talking about retail real estate.
