Right now, there is a general feeling that the economy is slowing down. We have been tracking the difference between consumer spending and consumer confidence. Consumer spending has continued to go up, even though confidence is not as high as it has been. This seems to indicate that things perhaps aren1t as bleak as we believe them to be. There is a divergence in opinion as to the future direction of the economy. The economy could go in a number of different directions: it could slow down, it could rebound or it could stay where it is. This really depends on the stock market and what the Fed decides to do with the interest rates.

While it' difficult to accurately predict the ultimate direction, it is important to understand how the retail transaction market will react to these different scenarios. In a recession scenario (and resulting flight to quality), cap. rates for Class A product could go down while those for some Class B and C properties would go up. The resulting net transaction velocity would go down. The real opportunity would be for owners of Class A assets to sell into the momentum. If the economy stabilized, cap. rates for Class A properties should stay where they are, while cap. rates for Class B and C properties could move up slightly, depending on location and other property specific issues. In terms of a rebound scenario, we would expect to see cap. rates for Class A properties remaining stable. The real value would be in cap. rates for Class B and C properties; they would be driven down (as the market sees favorable risk adjusted pricing). The opportunity for owners would be to sell the Class B and C centers into this market. Going forward, the key drivers continue to be the debt market and location. The important thing to remember is that we are on a see-saw and there are opportunities whichever way you look.

We are currently seeing a number of trends affecting retail sales activity in the Southeast. Chief among them is the availability of capital in today' market. The debt market is having a big influence on the flow of deals and deal pricing. Regardless of what the buyer or seller wants to do, ultimate pricing (i.e., at closing) usually comes back to how the lender is underwriting each of the deals. Transaction volume should be up this year due to the favorable debt market and the fact that the cap. gap between seller and buyer expectations is compressing for certain retail assets (there are situations where the cap. gap is increasing). The market divergence continues.

There are also a lot of buyers crossing their traditional lines of expertise. For example, those who would normally buy office properties are buying retail centers.

The 1031 exchange investor is also important to the market today. At times, they are the dominant buyers in the market. It is important for them to receive excellent investment advice. What kind of product should they buy? Should they buy a drugstore where they will have operational requirements? Should they buy an unanchored strip center where there is upside potential? It does come down to the risk/reward parameters of the investor. However, it' important to understand that focusing purely on credit opportunities could be riskier than initial expectations as the credit orientation of the retailers evolve.

While the marketing time line has compressed a little for certain deals, the cycle is still protracted and buyers remain discriminating. Deals are also falling apart because of the seller' inability to control the sale. Unless they can successfully manage the transaction flow - the multiple pieces behind the deal like the appraisal, title, engineering report, estoppels, financing etc. - the likelihood for a deal issue is high.

Pricing Structure

Prices of retail centers in the Southeast have been interesting to watch lately. CB Richard Ellis Retail Investment Advisors has been tracking sales comparisons throughout the Southeast and Mid-Atlantic states and the cap. rates are all over the board. It boils down to lenders and buyers pricing each deal differently, depending on the quality of the anchors, perceived cash flow durability, competitive alignment, location, and, of course, potential upside. The focus is not just on credit anymore. It is difficult to compare cap. rates (and make any generalizations) on any retail sale that is not a simple core grocery-anchored center with minimal shop space or a NNN asset with significant duration remaining on the lease. In addition, we are seeing different cap. rates for the same grocer in different parts of the region. The lowest cap. rates for grocery-anchored centers appear to be achieved in hot markets of Florida and the greater Washington, D.C., area.

Debt Markets

There is a lot of money available to purchase real estate. The CMBS market has returned: 2001 will probably be the best year for CMBS players since 1997. We' also seeing a lot of investors return to the B traunch of the CMBS markets; they' the ones that drive the market. The floating rate structure that was in last year is nearly gone; fixed rate mortgages are now in favor. Since the treasuries have recovered, fixed rate mortgages are popular with the conduits and with the life companies. It is important to remember that as treasuries decrease, borrowers will not necessarily get a better rate. We are seeing a lot of lenders place floors on treasury lending, since it sometimes doesn1t make sense to loan money at extremely low rates.

The life companies are now less flexible. They are using CMBS to create a more liquid portfolio. WhatØs important is how fast things can change. Depending on more favorable economic news (and a decrease in the likelihood of further rate drops), treasuries could go back up in the spring. Also, the current CMBS pipeline is pretty full, which could cause spreads to widen.

Always look at the exit strategy when financing a center in today' climate. Since we don1t know where the market will go, it is important to be able to get out of it at any given time. Even if you want to underwrite a 20-year loan on the property and you plan to own it for 20 years, it is important to think about exiting early. That 20-year amortization is going to hurt the property should you decide to sell. Investors are always looking for yield. Yield is compromised with a shorter amoritization period. Also think about issues like leases that will be rolling over at the end of the loan term, the credit of the grocer and anchor sales. Lenders are getting very competitive. Some lenders are writing 12-year terms and taking out the balloon risk at the end. They are also underwriting creative escrows. If you have to escrow $50,000 or more per year for a CMBS lender, it is going to kill your deal. Investors should think about how they can get out of an asset and what they want to get out of it. You should always make your property sellable, not just financeable.

Transaction Market

Are cap. rate spreads different in smaller markets compared to larger markets? In smaller markets, you can find smaller deals. A grocer and some small shop space in a smaller town is a relatively small deal. Local investors can often buy these pretty aggressively so the cap. rate differential might not be that great with cap. rates being seen in larger markets. A large regional or national owner investing in a small market would have higher cap. rate expectations than those of a local owner. We recently had a case where the owners of a manufacturing business sold their company and were looking to redeploy their gains from that sale in real estate. They ended up purchasing a neighborhood shopping center, among other real estate assets, close to the small town in South Carolina where they lived just because they wanted to own a good asset in their own community. For larger assets, however, the cap. rate spread is larger as the ultimate buyer is most likely a regional or national investor that would require an illiquidity premium.

Challenges For Retailers

The most recent concern for landlord and lender have been the bankruptcy and store closing announcements of several key retailers. Bankruptcies include Service Merchandise, Heilig Meyer, Jitney Jungle, Waccamaw Pottery and Montgomery Ward, not to mention several theater chains that were active in the Southeast. Retailers that have announced store closings include Winn-Dixie, A&P and Uptons. Consolidation among the categories has also been happening.

While there is significant negative press and sentiment regarding retailers, some in each of the retail segments are doing well. Retailers who are performing strongly are focused on what their value proposition is and what it offers to the consumer. They must have an independent segment of the market. Favorites among developers for the discount anchors are Target and Kohl'. There are also retailers that developers feel negatively about and those that developers feel are stable, meaning that they may be operating a great business, but their segment of the retail pie isn1t viable. Our survey illustrated the preferences.

Opportunity Markets

There are several markets in the Southeast that we feel are opportunity markets. In the Carolinas, Charlotte and Raleigh stood out as the most preferred in our recent survey of 30 shopping center owners in the Southeast. Both of these markets can be perceived differently on the supply constraint issue. Raleigh is supply constrained, whereas Charlotte does have a few overbuilding issues in certain sub-markets. Charleston, Asheville and Wilmington also were listed as top choices. These markets fall under the radar screen on a national perspective, but on a regional scale of investors, they are solid areas.

Centers where value could be added were the preferred property type of our survey respondents. The number one criteria we hear for this type of property is that it must be located in a major market like Raleigh or Charlotte with the Number 1 or 2 grocer in the market. Stabilized assets were the least preferred property types of investors looking for centers in our survey. Redevelopment properties fell in between value added and stabilized assets. Redevelopment properties are one of the most difficult properties to acquire. You really have to walk out on a plank a little bit. The opportunity often starts as a value added center and then, over time, turns into a full blown redevelopment opportunity. A lot of these properties are regional malls. It is important to note that our survey respondents were primarily strip center owners, so they weren1t really interested in acquiring regional malls.

The impact of the hypermarkets - grocery stores combined with value department stores - has been important to a lot of markets in the Southeast. The value of a number of grocery-anchored shopping centers has been affected by hypermarkets like Wal-Mart Supercenter or SuperTarget. Wal-Mart also has a neighborhood center concept that it is launching in the Southwest. It recently purchased five sites in Houston to build the concept. Ten of Wal-Mart' 15 largest markets for the Supercenter concept are in the Southeast so they have the distribution in place. The retailer also recently announced a new distribution center in Henderson, North Carolina, which will be for refrigerated goods. Kmart recently announced a new senior employee is an ex-Wal-Mart employee who is one of the architects of the Supercenter concept. This could signal a more aggressive move by Kmart into that field. One-third of all new Target stores built in 2001 will be be SuperTargets, including the first SuperTarget in North Carolina.

Another phenomena to watch in the Southeast is the so-called string city that has been developed along Interstate 85 from Charlotte to Atlanta. Rapid growth has forced communities in this area to make decisions about retail as far as zoning issues and other legislation. Some of these markets are even setting limits on store size. This issue will be increasingly important, especially as retailers continue to expand in this growing Charlanta mega market.

Product Type

According to our recent survey of investors, the Number 1 property type that people wanted to buy was grocery-anchored neighborhood centers. Number 2 was community centers. Power centers were low on the list. Lifestyle centers also had some interest. Some of the best examples of lifestyle centers are Konover Property Trust' Mount Pleasant Towne Centre (Mount Pleasant, South Carolina). In Alabama, Bayer Propertie' The Summit also defines this concept while in Georgia, Cousins has developed two lifestyle centers, The Avenue East Cobb and The Avenue Peachtree City, and has plans to develop more Avenues in the Atlanta market. In Charlotte, Phillips Place is the best example of this concept.

Exit strategy has been an interesting thing to observe with lifestyle centers. Not many lifestyle centers have been sold by their original developers so a pricing model hasn1t really been determined for them. There are investors who are looking at lifestyle centers, but they are unsure of whether to price them as a power center or a neighborhood center. Our feeling is that the ulimate cap. rate will be a weighted average of the cap. rates for the various components of the center (i.e., entertainment component, neighborhood center component, speciality center component, etc). Therefore, cap. rate comparisons might be difficult as each center will have a different component mix. In addition, the high dollar amount of tenant finish built into the rent structure will impact underwriting.

Gary Saykaly, Charles Moore, Mike Burkhart and Tim Perry are CB Richard Ellis' Southeast/Mid-Atlantic Retail Investment Advisors.

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