COVER STORY, JULY 2005

BULLISH BOSTON RETAIL
New England is in the midst of a retail renaissance, with sales and leasing activity reaching new heights in 2005.
Kevin Jeselnik

Ask anyone in the know and they will tell you. Ask brokers, ask developers, ask landlords, ask retailers. Right now, the retail market in New England is sizzling.

Not that it was ever a weak market in years past. Rather, it’s that activity has never before reached this pitch. Retail occupancy rates in Boston and its surrounding suburbs have hovered around 94 or 95 percent for the past 15 years, according to Jim Koury, senior vice president at Boston-based Spaulding & Slye Colliers. “[Spaulding & Slye Colliers] is seeing a 50 percent increase in the number of sales compared to last year,” Koury says.

In the investment sales market, properties are trading at historic prices and money is being infused into the market by a variety of investors. Leasing activity is strong, with a backlog of retailers trying to break into the increasingly tight New England market. And interest rates, the cause of so many fears at the start of the year, have remained at 2004 levels while cap rates have dropped slightly from 7 to 6.5. Yes, so far, 2005 has been a very good year for retail.

One of the major factors in the continued success is the recent drop in 10-year treasury from 4.6 to 3.9 percent. Many expected, and it was forecasted, that the rates would incrementally increase throughout the year, eventually curbing the present abundance of investment activity. “We anticipated the rates going up from 4.6 to 5 percent by the end of the year, but it looks like that is not happening,” Koury says. “One of the big reasons [that the rates will not go back up] is that inflation has remained largely in check and the European Union’s recent step backwards has caused some capital to flow back into American currency. I would say that for the next 12 months that interest rates will be bouncing around from 3.8 to 4.5 percent.”

“That is my personal opinion,” he adds. “And it would have been totally different a month ago.”

A number of professionals in New England share Koury’s opinion on the matter. “I think we are going to see rates moving up and down over the next 12 months and that the capital markets are extremely reactive to these shifts,” says Jonathan Aron, vice president with Boston-based NAI Hunneman Commercial.

Robert Tito, executive vice president and principal with NAI Hunneman, adds, “If the 10-year treasury note stays within 3.5 and 4.5 percent, we are in really good shape in terms of investment sales due to the fact that most of the properties are selling at a +/- 7 cap rate.”

So, the prevailing opinion is that, while the market is slightly volatile due to the unpredictability of the interest rates, investment sales will continue to prosper well into 2006.

The low cap rates on investment property throughout the region are only fueling the fire. While lower cap rates may indicate lower return on investment, they are not discouraging buyers from seeking out high-quality product, says Ted Chryssicas, a senior vice president and head of the retail services division at Meredith & Grew in Boston. “I have not seen the cap rates slow down the buyers at all,” he notes. “Because buyers cost of money is cheaper (with the low interest rates), the yield is about the same.”

“It discourages buyers, but it has not stopped them from buying,” adds Tito. “It is relational to the interest rates. Now that the 10-year treasury is below 4 percent, some of the inventory that has been sitting on the shelf because of the cap rates is moving.”

“There is a touch of irrational exuberance in the market right now in terms of buyers,” Koury explains. “Part of it is this herd mentality; part of it is that these investors have to get their money invested and start generating returns. Investors are reticent to invest in the stock market, because returns have been somewhat anemic. And that is why we are seeing this historic pricing. I have been doing this for 20 years and it has never been better.”

A new trend affecting investment sales is the emergence of institutional investors into the retail market. Before the cap rates dropped, institutional money represented only 20 to 30 percent of the capital flowing into New England retail. And virtually no REITs were involved. In 2003, 17 percent of the capital came from REITs; that number grew to 70 percent in 2004. “The combination of low interest rates leading to low cap rates and the switch from the private sector as the dominant purchasers to the institutional sector are the biggest changes in the retail commercial real estate investment market,” Koury says.

Another popular investment vehicle is the 1031 Exchange. According to David Nugent, a principal with Boston-based American Retail Properties, the tenant-in-common investors have had a significant impact on the market. “It has enabled investors who would never normally be able to have a stake in these high-yield retail properties to invest and reap the returns,” he says.

Prices for retail properties vary greatly across product type and rely heavily on location, but the consensus is that your average retail properties such as strip centers are trading for approximately $150 to $160 per square foot. But sales prices can reach much higher in prime locations for centers anchored by high credit-rated tenants, reaching $300 or more. National drugstore chains and high-end lifestyle retailers often need to be present to generate these lofty prices.

Aside from the drugstores and high-end apparel retailers, other hot types of retailers include the medium box users such as Staples and Linens ‘n Things, restaurant chains, and supermarkets.

Interest in grocery-anchored centers is very high, driven by increased investment activity among REITs in that sector. These and other neighborhood centers are the most fashionable types of product right now. There are more supermarket-anchored centers being built in New England than the other types combined.

Leasing activity is experiencing continued success along with investment sales. Even if future demand slackened, the current backlog of retailers seeking to enter the market would be sufficient to last through 2006, Chryssicas says. “At Wayside Commons in Burlington, marketing efforts are just underway and it is almost fully leased. Meredith & Grew is leasing up Eaglewood Shops, which is under construction right now, in the smaller market of North Andover and it is already 90 percent leased. If you have a project near some affluence, you can easily lease it up.”

The most popular submarkets for retail activity are the suburbs of Boston, namely Burlington, North Reading, Worcester and Nashua — that is where the majority of projects are being proposed and developed. To say that any submarkets are struggling now means only that rents are staying flat, says Koury.

As it stands, landlords have the upper hand. Anyone holding a quality property in a relatively strong market will have the space leased before project completion, with four or five potential tenants lined up to fill it. Vacancies rarely last, as new retailers are quick to backfill almost any urban location. Anchor spaces that became vacant in the past 2 years were quickly sucked up by Target and Wal-Mart and other boxes. The high barriers-to-entry and lack of developable land create quite a fierce competition between retailers looking to locate in the market.

“Projects are few and far between in New England,” Chryssicas explains. “So when they pop up in the Boston marketplace, retailers have to pay attention. Because if you don’t jump on the opportunity, you could be locked out for another 10 years.”

Suburban rental rates per square foot range from the mid-$20s into the low $50s in particularly strong areas, notes Nugent.

In Boston, the hottest retail districts continue to be Newbury Street, Wellesley Center, Boylston Street and Brookline. Rental rates on Newbury Street can reach as much as $100 per square foot, but most often run in the high double digits. But most retail districts inside the city command rents between $40 and $60 per square foot.

The biggest problem is the lack of available space, says Annette Born, who owns Urban/Born Associates, a boutique firm specializing in street-level retail brokerage throughout Boston. “The issue is that Boston is under retailed. Well-positioned space is at a premium and everyone wants it.”

Even rising rents do not deter many retailers, Born says. “I have a backup list for many of these retail communities. It’s just a matter of the right space coming available.”

The worry is that, as Boston’s reputation as a world-class retail destination grows, so will its rents. “I think that landlords are really starting to push the rents. That makes me a little nervous,” Born says. “I would like to see that the retailers are doing enough volume to justify the rents. Rents that were in the $30s are rising in $10 increments and reaching the high $40s and into the $50s.”

Whatever concerns retail real estate professionals in New England may have, they are tempered by the terrific performance over the past so far in 2005. Retail real estate, historically strong throughout New England, has never been better. The forecast is great for the near future, as it seems interest rates will stay where they are and demand will not diminish in the next 12 to 18 months. Watch for more record prices generated for high-demand centers and expect leasing to remain tight and competitive. Expect the market to end the year as it began; optimistic forecasts will intermingle with cautious glances at the interest rates, hopeful for another year of significant activity.

Big Spenders With the New England retail market surging, retail properties are trading hands at historically high prices. Here are two examples: Cottage Plaza Pawtucket, Rhode Island Spaulding & Slye Colliers recently brokered the sale of the 75,000-square-foot Cottage Plaza in Pawtucket, Rhode Island, for approximately $306 per square foot. Jim Koury of Boston-based Spaulding & Slye Colliers recently negotiated the sale of Cottage Plaza for $23 million. The 75,000-square-foot property, which is located at the intersection of Cottage Street and Pawtucket Industrial Highway, sold for just more than $306 per square foot, the highest price per square foot ever paid for a supermarket-anchored shopping center in New England. CB/KRC Cottage Plaza LLC sold the property to an undisclosed institutional investor. REITs and other institutions have been paying increasingly high sums for grocery-anchored retail throughout New England over the past 2 years. CB/KRC had no intention of disposing of the property before Koury came to the company with an offer from the buyer. Cottage Plaza was completed in 2004 and is located in an underserved market, according to Koury. The center is anchored by Super Stop & Shop. Other tenants include Sally Beauty, T-Mobile and Hollywood Video. Malden Square Malden, Massachusetts In Malden, just north of Boston, NAI Hunneman Commercial has brokered the $7.65 million sale of a 24,000-square-foot retail building at 318-320 Main Street. Anchored by a Walgreens and co-tenanted by Blockbuster Video and D’Angelo Sandwich Shop, Malden Square sold for approximately $318.75 per square foot. Robert Tito of NAI Hunneman represented the seller, 318 Main Street Corporation, and procured the buyer, Malden Plaza Realty Trust, in the transaction. The impressive price is due in large part to having a A+ credit-rated tenant such as Walgreens anchoring the property, says Aron. Investors are much more likely to acquire properties occupied by high credit-rated tenants that reduce both the interest rates and risk involved in the investment. — Kevin Jeselnik

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