The Great Recession took a heavy toll on the nation’s banking industry and dramatically reshaped its makeup. A total of 465 banks failed and their assets and deposits redistributed to the country’s remaining 7,176 institutions, fewer than many feared, but still a major and expensive disruption. It has been well documented that in almost all of the recent bank failures, commercial real estate lending was a major factor in weakening them to the point of collapse.

Rather than rehash that point, a new federal audit and evaluation took a different view and examined how banks with heavy CRE loan concentrations survived through the recession’s critical years and avoided demise.

The FDIC Office of Inspector General (OIG) completed a study of FDIC-supervised institutions with significant acquisition, development, and construction (ADC) loan concentrations that did not fail during the recent economic downturn.

ADC loans are considered the riskiest type of commercial real estate (CRE) lending. During the recent financial crisis, FDIC analysis shows that failed institutions had concentrations of ADC loans to total assets that were roughly three times the average of concentrations of non-failed institutions.

The objective of the new audit was to identify factors that may have helped banks mitigate the risks historically associated with ADC concentrations during periods of economic stress. The banks the OIG studied had characteristics and ADC loan concentrations similar to those that failed. In general what it found was that the banks that did not fail had a combination of the following six characteristics:

Geographic Location Played a Significant Role in Financial Performance

For starters, it helped that almost all of them were geographically immune. Most bank officials the OIG interviewed emphasized that the economic decline was not as steep in their marketplace as it was in other areas of the country. Although every region of the country was impacted by the financial crisis to some extent, the economic fallout was not uniform across the country. Bank failures were more concentrated in areas that experienced greater economic distress – including Georgia, Florida, Illinois, and California. Of the banks that survived, the OIG found only one bank that was located in one of the states with the greatest number of failures.

Implemented More Conservative Growth Strategies

In general, the banks that failed pursued aggressive growth strategies centered in ADC lending, which left those institutions more vulnerable to the economic downturn. While the 436 banks in the OIG study experienced some increasing ADC concentration levels from 2005 through 2007, most of the bankers it spoke with characterized their institution’s risk appetite as being conservative or moderate. Bank officials from one bank explained that the bank was aggressive early but also “got scared” early. In addition bankers stated that once the economy declined, they mitigated the risk associated with their ADC loan concentrations by intentionally reducing their ADC loan portfolio, thus further diversifying their loan portfolio,

Implemented Prudent Risk Management Practices and Limited Speculative Lending, Loan Participations, and Out-of-Area Lending.

Most banks included in the study had stronger loan underwriting practices than failed banks and, consequently, a lower risk profile in general. Generally, bank officials said that speculative loans were originated only on a limited basis before the economic crisis, if at all. Furthermore, in cases where banks did fund speculative ADC loans, bank officials indicated that loans were made to existing borrowers and were tied to strong customer relationships. Most of the banks that survived either did not originate out-of-area loans or did so only on a limited basis to existing customers.

Posted Lower Level of Non-Current Loans and Losses Associated with ADC Loans

The successful banks in the FDIC study generally experienced a lower level of non-performing loans and losses. For institutions that failed, non-performing ADC loans represented 8% of all nonperforming assets in the first quarter of 2000 and rose to a decade-high of 54% in the third quarter of 2008. For survivor institutions, non-performing ADC loans also rose but not as much – from almost 4% in the first quarter of 2000 to 23% in the third quarter of 2009.

Maintained Stable Capital Levels and Had Access to Additional Capital If Needed

Of course, capital serves as a buffer between operating losses and insolvency. The more capital a bank has the more losses it can withstand. Losses associated with ADC loans were not as significant for surviving banks compared to the banks that failed. In addition, most bankers commented that their bank’s access to capital was not restricted. If needed, their shareholders or outside investors were willing to invest additional capital.

Relied on Core Deposits and Limited Net Non-Core Funding Dependence

Examiners have historically categorized core deposits as stable, less-costly deposits obtained from local customers that maintain a relationship with the institution. Brokered deposits are considered potentially volatile, interest-rate-sensitive deposits from customers in search of yield. The FDIC’s research indicates that core deposits may reduce a bank’s probability of failure because they typically provide a bank with a stable and relatively cost-effective source of funds and are a direct indication of a bank’s valuable customer relationships and franchise value.

Por Luisa García Pelatti

Internacional Sotheby Realty anunció su entrada a la Isla con el lanzamiento de Puerto Rico Realty International Sotheby, una compañía inmobiliaria de lujo. Las oficinas estará localizadas en la avenida Ashford. El inauguración se celebrará el viernes, 19 de octubre.

La firma se centrará en la venta de viviendas de lujo a los clientes internacionales o locales.

Sotheby International Realty cuenta con más de 12,000 asociados de ventas localizados en aproximadamente 625 oficinas en 44 países y territorios alrededor del mundo.

Por Luisa García Pelatti

Banco Popular presentó una demanda por cobro de dinero contra La Ciudadela de Santurce, Inc. y el desarrollador, Carlos López de Azúa, en la que reclama el pago de $108.7 millones, según información que publica Boletín de Puerto Rico. Ciudadela podría ser uno de los préstamos morosos que Banco Popular podría estar considerando vender. Entre los posibles compradores podría estar Caribbean Property Group LLC (CPG) o alguna empresa de riesgo compartido participada por esa empresa, Goldman Sachs & Co. o East Rock Capital LLC.

En el mes de marzo del año pasado, Miramar Realty Management, una de las empresas de Carlos López de Azúa, desarrollador del proyecto Ciudadela, en Santurce, se acogió al Capítulo 11 de la Ley de Quiebras. La deuda era de $1.2 millones. El principal deudor era Guardsmark, un agencia de seguridad, con una deuda de $650,000.

La quiebra no afectaba a las otras empresas de López de Azúa. Entre los desarrolladores es habitual crear varias empresas y sociedades especiales con el objetivo de proteger sus bienes personales y los de otras empresas ante posibles dificultades.

Ciudadela, un proyecto residencial-comercial localizado en Santurce, ha estado envuelto en la polémica desde el principio. El proyecto se abrió a  licitación entre el 2003 y el 2004, cuando el Gobierno ofreció vender 22 cuerdas al desarrollador con la mejor propuesta. Las empresas estadounidenses Goldenberg y Parkway se asociaron inicialmente con la compañía puertorriqueña Miramar Real Estate Management para participar. Esas compañías figuraron en las peticiones de información del Gran Jurado que investigó los donativos de campaña del ex-gobernador Aníbal Acevedo Vilá. Finalmente, Miramar Real Estate Management licitó sola al retirarse las otras dos empresas.

As young Americans move to cities, retailers that grew up in the suburbs are following them. And unlike previous efforts, they are doing it the cities’ way.

With little room to expand in the suburbs, retailers, including Office Depot, Wal-Mart and Target, are betting that opening small city stores will help their growth.

It is a significant shift from their approach in the past, when they tried to cram their big-box formats into cities, often prompting big fights. This time, the retailers studied city dwellers with anthropological intensity and overhauled things as varied as store sizes (the city stores are a small fraction of the size of the suburban ones), packages (they must be compact enough for pedestrians) and signs (they are simple, so shoppers can get in and out within minutes).

“The suburbs are basically saturated with retailers,” said Patrick L. Phillips, chief executive of the Urban Land Institute, an urban-planning research nonprofit, “but it’s easy to develop stores in the suburbs, and hard to develop stores in cities.”

Office Depot has revamped its stores to create an “economically defensible” way of expanding into cities, said Kevin Peters, Office Depot’s president of North America.

The main objective for shoppers in cities is speed. So a store in Hoboken that is a model for the company’s urban branches is 5,000 square feet, about a fifth of a normal Office Depot. The shelves are about six feet high, much shorter than in a suburban store, so visitors can navigate quickly. The signs above the aisles are simplified so customers do not waste time interpreting them. The service desk, where shoppers can send packages or copy fliers, takes up a big chunk of the store, so no wandering is required.

A typical Office Depot has 9,000 items for sale. This one has 4,500. It sells immediate-replacement items (a pen) versus stock-up items (a 25-pack of pens). At sites where Office Depot has replaced one of its big-box stores with a small store, Mr. Peters said, the smaller iteration has retained 90 percent of the sales of its bigger predecessor.

Still, he acknowledged that the model was not perfect. A shopper in search of a desk, for instance, would have to study tiny dioramas of office sets; sales of desks in the small-format stores are, unsurprisingly, not great.

But retailers are now willing to come into cities on the cities’ terms — with all the zoning headaches, high rents and odd architecture — because that is where the growth is. Most large American cities are growing faster than their suburbs for the first time in almost a century, according to a Brookings Institution analysis of census results released last month, largely because young adults are choosing urban apartment life. That population shift, along with Internet competition, have made the car-focused, big-box model less relevant.

Target opened its first City Targets, in Chicago, Los Angeles and Seattle, on Wednesday. At 80,000 to 100,000 square feet, City Target, at its smallest just over half the size of a remodeled Target, is aimed at urban shoppers. For instance, City Targets would not carry a six-piece patio set, but a three-piece balcony set instead.

“We see this as an opportunity for the people who live, work and play downtown, who probably have a suburban Target they call their home base,” said Molly Snyder, a company spokeswoman. “You’ll see less 12-packs of paper towels and more four-packs, knowing most people will arrive by foot or public transportation and will have to carry it home.”

Wal-Mart, though it continues to build in the suburbs, is also courting cities. Where it once stampeded into urban areas — and often met huge resistance from residents that led to its retreat — it now uses more diplomacy. In Chicago, for instance, it has agreed to build stores with union labor, and it has donated to politicians and community groups in cities where it hopes to build. Wal-Mart is testing several types of city stores, like the large supercenters being built in Washington, the small Express stores in Chicago and the medium-size Neighborhood Market format store it will open in Los Angeles.

“It’s become easier to site a Walmart, and we have become more accepted by the community,” Leslie Dach, executive vice president for corporate affairs at Wal-Mart, said last month.

Getting approval is only part of the challenge, though. Existing small retailers in cities can be nimble in changing their shelves, as owners can see who is coming in and whether they buy starch, say, in the form of Popchips, rice noodles or yams. Executives at big retailers have little personal contact with most customers.

“It’s much more difficult for a big chain who’s got gigantic warehouses across the country to be sensitive to the local market,” said Mr. Phillips of the Urban Land Institute. On the other hand, large retailers have servers full of data that helps them customize to city shoppers.

Take Wal-Mart’s city-store prototype near Toronto, a 90,000-square-foot store that opened this year. It found that many nearby residents were recent immigrants living in apartments, and one of the first improvements they wanted to make was to their bathrooms, said Alan Blundell, vice president for Wal-Mart merchandise operations in Canada. So the store stocks a higher-than-usual quantity of toilet seats and shower heads.

Walgreen, after it acquired New York City-based Duane Reade in 2010, studied how Duane Reade, a city retailer for 50 years at that point, customized merchandise by neighborhood using loyalty card data.

For instance, a store in Union Square attracted commuters and tourists using the subway there, while the store a few blocks north drew mostly local residents. So the Union Square site carried lots of foot products for the unprepared tourists, along with cosmetics and snacks, while the branch just north of it was more heavily stocked with household-cleaning items, toothpaste and the like. In richer areas, Duane Reade will carry gluten-free products and loaves from Eli’s Bread, said Joseph Magnacca, president of daily living products and solutions at Walgreen.

While Walgreen had city stores before it bought Duane Reade, it used the Duane Reade example to build and refine urban stores elsewhere. For instance, city shoppers dislike items in jars because of the weight. And weird architecture is often part of an urban store, so turn those pillars and columns into displays for candy, gum and magazines.

Over all, Mr. Magnacca said, the only standard element of running city retail is that nothing is standard.“No footprint is exactly the same and no product mix is exactly the same,” he said. “There is no one best solution.”

The U.S. demand for medical services is expected to skyrocket over the next decade due to demographic trends and new healthcare legislation. As baby boomers retire, the over–65 age bracket will grow by 36 percent and that age cohort traditionally consumes three times the medical services of younger people. Additionally, under the Patient Protection and Affordable Care Act, signed into law in 2010, 32 million additional Americans will have health insurance. This represents an 11 percent increase by 2019, according to an Urban Land Institute report. Job creation among healthcare practitioners will likewise mirror this expanded patient base.

These and other factors will increase the demand for medical office buildings by 19 percent by 2019, according to ULI. The need for an estimated 64 million square feet of additional MOB space in the coming decade dwarfs the 6.3 million sf that will deliver this year. Therein lies the conundrum of the MOB market: As vacancy rates dip below 11 percent and occupancy tightens, development is moribund. Why does a cautious attitude afflict the office market’s strongest subsector?

Physicians vs. Hospitals
In addition to broader economic factors affecting all commercial property types, healthcare real estate is impacted by increasing levels of regulatory compliance; in particular, PPACA was upheld by the U.S. Supreme Court in late June. This legislation has fostered significant marketplace uncertainty, profoundly influencing how tenants (physicians) and MOB owners (hospitals and equity investors) are approaching their real estate decisions.

Physician practices are hedging their options by “waiting it out” and taking more–measured, conservative approaches to their MOB space requirements. Specifically, healthcare tenants are frequently remaining in place, minimizing relocations and facility expansions, and opting for shorter–term lease renewals of 12 months to 24 months. Their approach is predicated upon the numerous unknowns of healthcare reform: anticipated decreases in insurance reimbursements, increased compliance costs, and the reality they may soon become salaried employees of larger healthcare systems.

Conversely, hospitals and affiliated health systems are operating as if healthcare reform will proceed either partially or wholly intact. These entities frequently have large geographic footprints, own significant real estate portfolios, and cannot afford a wait–and–see approach, given the need for longer lead times and bureaucratic realities of large organizations. Generally, hospitals are taking a more aggressive posture, pushing forward with distributed networks of healthcare facilities. Well–located MOBs, strategically positioned throughout patient communities, are highly desirable as they can achieve operational efficiencies and lower operating costs.

Yet, physicians’ and health systems’ real estate requirements for hospital–affiliated MOBs are converging due to increasing numbers of hospital–employed physicians. With the uncertainties surrounding healthcare reform, this trend provides mutual safety and economies of scale. Physicians gain the security of a consistent salary and lose the cost of tracking down third–party payments and covering insurance risks singlehandedly. Conversely, hospitals gain increased market share and improved cost containment.

MOB Asset Value
As more physician practices move to hospital ownership, an MOB’s hospital affiliation, or lack thereof, is an increasingly important indicator of asset value. From the perspective of MOB investors, hospital affiliation may provide greater overall tenant stability and credit ratings as the hospitals themselves become the lessees. This trend is enhanced by healthcare systems’ push for strategically located MOBs to form the backbone of their increasingly dispersed facility networks. In addition, real estate investment trusts and institutional investors, which accounted for 45 percent of 2011 MOB sales volume, specifically target health system–affiliated properties. Therefore, the investment community, physician tenants, and capital market participants increasingly favor hospital–affiliated MOBs.

Hospitals, in recent years, have gravitated toward the prospect of MOB ownership; however, their perspective in many cases may be shortsighted. In essence, they own the practices/occupants, so why not own the real estate? Some argue that hospitals have purchased and sold physician practices in the past and the pendulum will again swing away from owned physician practices, making long–term real estate decisions based upon short–term trends a costly mistake.

The recurring uncertainties of healthcare reform have curtailed physician–owned development projects over the past few years. Physicians continue to look for more flexible and fluid occupancy alternatives, with shorter–term lease options providing the desired flexibility. The same uncertainties have also affected the investment market for physician–owned, non–affiliated properties. Due to institutional investors’ requirements for creditworthy tenancy, private investors with greater risk tolerance encounter infrequent competition from institutional investors for non–affiliated MOBs.

Additional Opportunities
In addition to MOBs, other non–medical real estate properties are becoming important components of hospitals’ comprehensive approach to building networks of healthcare facilities. In particular, spaces and pad sites within well–located retail centers are forming health systems’ increasingly brand–specific, front–line facilities.

This shadow space effect seems to have some appeal to both physicians and hospital–affiliated practices. These users are particularly taking advantage of smaller spaces, ranging from 10,000 sf to 20,000 sf, that were formerly occupied by banks, video stores, and furniture stores. Cost–effectiveness together with the abundant parking ratios of many retail facilities can provide an economical space option for healthcare users. Additionally, the access, visibility, and branding opportunities of these retail sites offer healthcare providers a much–needed competitive advantage.

CCIMs can benefit by embracing the role of ongoing, trusted adviser to hospitals and physician practices alike. Specifically, CCIMs can help protect and enhance the MOBs’ underlying asset valuations by validating fair market value lease terms as well as navigating the potential impact of lease accounting changes. These proposed changes will place real estate leases onto hospitals’ balance sheets, thereby increasing reported occupancy expenses. Healthcare organizations will be required to recognize both liabilities for future rent obligations, and assets reflecting their right to utilize the underlying real estate. Additionally, hospitals that own land but not the real estate residing on it may have to account for these properties as both assets and liabilities. The net impact to hospitals’ perceived financial performance could be significant and influence their credit ratings.

There are significant advantages to specializing in healthcare real estate in a mature secondary market. Midsize markets are large enough to support specialization and encompass significant MOB inventories that attract local and regional investors as well as institutional capital, including large REITs. This broad investor cross–section provides opportunities to work with and represent a variety of owners with varying investment objectives. These relationships, in turn, enhance healthcare tenant advisory services.

Some of the greatest opportunities and challenges for a healthcare real estate firm include expanding geographically to other metropolitan areas. In particular, tertiary markets are a compelling opportunity. Service providers in smaller markets frequently cannot afford to specialize, which allows a larger more–specialized company to bring significant expertise in healthcare–related property management, property marketing and leasing, tenant representation, buyer and seller representation, and acquisition and development consulting to otherwise underserved markets.

Commercial real estate pricing continued to recover through May 2012 at a fairly surprising pace across the board given the disappointing level of U.S. job growth and other economic factors, with gains expanding from the best  institutional-grade buildings to smaller and more general quality properties.

The two broadest measures of aggregate pricing for commercial properties within the CCRSI that comprise the equal-weighted U.S. Composite Index, which tracks investment grade and general commercial sale prices, each posted gains in May over year-ago levels, based on 853 repeat sales recorded during the month and more than 100,000 repeat sales since 1996, according to July’s CoStar Commercial Repeat Sale Indices (CCRSI) report.

In another promising sign for the investment market and prospects for firmer pricing, the percentage of commercial properties selling at distressed prices in May was the lowest since mid-2009. Rising occupancy levels in most markets and increasing rents in the multifamily sector have dampened the overall level of distressed trading, helping lift commercial property pricing.

Both the U.S. Value-Weighted Composite Index and the U.S. Equal-Weighted Composite Index posted year-over-year growth in May, a sign that the pricing recovery is reaching across all size and quality categories within U.S. commercial property.

The U.S. Value-Weighted Composite Index weights each repeat sale by transaction size or value and is heavily influenced by larger transactions. The index reached its highest level in more than three years, since early 2009, reflecting the sharpening appetite of investors for high-end assets, especially within primary gateway metro areas and for institutional-grade multifamily assets.

Meanwhile, the 6.6% increase of the Equal-Weighted Composite Index in May over the same month last year was the largest gain since before the start of the Great Recession in 2007. Improvement in the equal-weighted index, which measures each sale pair equally and better reflects the market influence of the smaller transactions that make up the bulk of CRE transaction volume, has picked up speed over the last several months.

In fact, the uptick in pricing shows that demand growth for smaller and lower-quality commercial property assets has caught up with demand for institutional-quality properties in recent quarters. Over the past year, growth in demand has been consistently strong for investment grade, while generally trending up for the general commercial sector.

However, the equal-weighted index has only recovered 8.8% since it reached its trough in March 2011, compared with a 36.1% improvement for the value-weighted index, which bottomed earlier, in January 2010.

Strong leasing activity in technology driven office markets such as San Francisco and Austin, TX and in lower-cost national distribution warehouse hubs such as Chicago and Dallas, TX has driven relatively strong absorption over the past year of institutional quality properties.

A slackening of demand in the retail market eroded the top-line numbers for general-grade properties, despite moderate absorption in the office and warehouse markets in second-quarter 2012.

Can appraisers avoid the pitfalls of today’s market?
Appraisals in today’s market are not for the faint of heart. Comparable sales are scarce, markets are changing quickly, and rules and regulations are stricter than ever. One false step could imperil even the most solid transactions.

“Today, there can be significant gaps in valuation metrics across property classes and among the various markets and submarkets,” says Von Moody III, CCIM, CRE, MAI, senior manager of Thomson Reuters in Denver, N.C. “These gaps can create hazards.”And these hazards can create angry brokers.

Mind the Gaps
“Lack of comparables has appraisers using properties that would never have been accepted four years ago,” says Eric R. Rehn, CCIM, vice president of Cassidy Turley in Walnut Creek, Calif. Rehn sees appraisers using comps from other markets, not giving credit if a comp is a “fire sale” or real estate-owned, and underestimating values by as much as 25 percent. But such practices aren’t just common in Walnut Creek.

Russell Byron Webb, CCIM, managing partner with Silver Oak Commercial Realty in Southlake, Texas, notes that an appraisal almost affected one of his recent sales because the appraiser used a 30-year-old class B office building as a comp for a newly built class A building. The bank ordered another appraisal.

In other cases, acceptable comps might not be able to offset rapidly changing markets. For example, James B. Marian, CCIM, of Chapman Lindsey Commercial Real Estate Services in Tucson, Ariz., recently listed an REO land property that had to be continually reappraised because the market was declining so quickly. By the time he got a new list price, the market would already have dropped well below the appraised value, and the bank refused to sell below that value. To avoid these precipitous price declines, Marian says, appraisers should be required to “disclose market trends and communicate possible near-term value adjustments, especially in rapidly declining markets.”

For some commercial real estate professionals, these market conditions have spotlighted a fundamental shortcoming: “Appraisals are retrospective documents, which means they are based on outdated data, especially in declining or appreciating markets,” says Stephen R. Collins, CCIM, executive vice president of Environmental Liability Transfer in St. Louis, Mo. “Investors are prospective, which means they consider factors other than past sales.” Collins suggests that, in most cases, investors can underwrite deals more accurately than appraisers.

A Safer Path
For their part, appraisers know they can’t please everyone. But they also recognize that they have to use all of the tools in their toolbox to make a credible valuation.

When appraising investment properties today, the key factor is net operating income, says Randy Scheidt, CCIM, MAI, FRICS, president of Don R. Scheidt Co. in Indianapolis. “Tenants are asking landlords for concessions or moving out, and these properties might lease up for less,” he explains. “We all need to do a better job giving credible projected income streams to future buyers or current owners.” If current comps aren’t available, an old property with a similar projected NOI might still be useful, Scheidt adds. But appraisers need to clearly document their reasoning in such cases.

Appraisers can also use local listings to bolster a more forward-looking analysis. “We generally use four sale comps and two or three listings that are adjusted for a discount,” says Jeffrey T. Miller, CCIM, MAI, president of Miller Real Estate Advisors LLC in Alpharetta, Ga. “Listings are sometimes the best comps because it’s hard to say a similar property will sell for more than the other’s listing price.”

The current climate also requires a more thorough market analysis. “More attention is being placed upon micro-market-area information reflecting vacancy, absorption, and locational attributes,” says Brian D. Frank, CCIM, GAA, an appraiser for Accurate Services Commercial Property Valuation in Chandler, Ariz. “It has become a mix of current reported data and speculative common sense, with the consideration of future upside potential.”

In Frank’s market, for example, the location of an office condominium property near a major medical facility might offset the current oversupply weighing down office condo sales prices and market lease rates. “As economic conditions improve and absorption increases, this product type would be expected to recover much earlier in the process,” Frank explains. He runs a direct capitalization rate analysis on current market lease rates to illustrate the difference in pricing from sales to potential income.

“I’m finding that properties in outlying areas and older class C properties are again selling for prices relatively in line with direct cap rates of current market lease rates,” Frank says. “This has not been the case for the last two years and indicates that buyers are not willing to take on risk or pay for future upside potential for this property type. In other words, what you see is what you get.”

For REO sales, Frank adds, lender motivation must be considered as well. If appraisers understand lender motivation, they can more accurately assess the current market value vs. the disposition or liquidation value.

Ultimately, however, the client sets the definition of value. “A typical problem is a bank client that requests market value but incorrectly expects a disposition or liquidation value,” Miller says. If the appraiser provides a market value, which assumes a 12-month marketing and exposure time, the broker and bank expecting a sale within a few months will be frustrated.

In addition, listings services are sometimes unreliable, so appraisers need a little help from their broker friends. “Typically, appraisers will interview market participants to confirm data,” says Miller, who uses all available resources to track down the “biggest and best players” in a given market. Recently, he searched the CCIM Find a Professional database to locate experts who could confirm market data for a Colorado land deal. “The CCIMs have a big picture view of the world, are happy to assist, and often share new insights on market activity,” he explains.

Other market participants might need a little more coaxing. “Some brokers say, ‘That’s not my job — you find the data,’” Scheidt explains. “But if brokers want to do the best job for their clients, they need to provide the most credible and up-to-date data available. Greater cooperation among brokers, appraisers, and property managers, along with better data, will result in a more acceptable valuation for all parties.”

Mega retailers target island; existing shopping centers plan expansions
Puerto Rico is a retailer’s paradise, so say retail industry experts. Despite a six-year recession, retail sales on the island remain high, and that fact hasn’t been overlooked by stateside retailers and shopping-center developers.

“While sales in the [mainland] U.S. have been slower because of the nation’s weak economy during the past few years, local sales have remained stable,” said James J. Farrell, executive vice president of development & redevelopment at DDR, owner & managing company of 546 shopping centers in 41 states, Puerto Rico and Brazil, to CARIBBEAN BUSINESS during an exclusive interview. “Occupancy rates in our facilities average 96% and average per-square-foot sales are higher than on the U.S. mainland.”

Motivated by these facts, DDR (formerly Developed Diversified Realty Corp.) announced plans to redevelop four of its shopping centers in Puerto Rico—Plaza del Sol and Rexville Plaza in Bayamón, Plaza del Norte in Hatillo, and Plaza Escorial in Carolina.

“These redevelopments are being driven by strong tenant demand for high-quality space, and with limited new construction on the island, our centers continue to offer a compelling choice for expanding retailers,” said Paul Freddo, senior executive vice president of leasing & development for DDR.

DDR is making a gross investment of more than $50 million in these centers, and projects to generate a return that exceeds the company’s 10% return-on-investment threshold for redevelopment. The projects will be funded with retained cash fl ow and capital recycled from the continued disposition of nonprime assets.

The redevelopment at Plaza del Sol, a 676,000-square-foot mall that features a Wal-Mart, Home Depot, Bed Bath & Beyond and Caribbean Cinemas, is expected to begin this year and be completed by year’s end. The project includes relocating the existing food court and converting the former one into about 25,000 square feet of space in the mall’s highly desired and trafficked central corridor. The redevelopment and remerchandising effort is expected to further increase current sales per square feet to more than $500.

Plaza del Norte, a 671,000-squarefoot mall that also generates more than $500 in sales per square foot and includes such brands as Wal- Mart, Sears, Toys “R” Us and T.J. Maxx, will be redeveloped to include a 30,000-square-foot expansion and renovation of the existing J.C. Penney Co. store. The project also includes the addition of a Rooms To Go, the combination of three small retail-space units to accommodate a PetSmart, carts and kiosks, and significant interior and exterior renovation. The project is expected to be completed in early 2013.

Improvements at Rexville Plaza include the addition of a CVS pharmacy and a Marshalls in the space currently occupied by an under-performing Pueblo supermarket. In addition, the redevelopment and remerchandising strategy will greatly enhance the property’s cash fl ow and significantly upgrade the physical components of the asset. The project is expected to be completed soon.

The project at Plaza Escorial, which currently features a Wal- Mart and Sam’s Club that together generate annual sales of more than $250 million, will include the addition of a PetSmart, which will open before year’s end in the space formerly occupied by Borders. This location will represent PetSmart’s fourth location in a DDR center in Puerto Rico.

“Investments in the industry during the past few years on the U.S. mainland have been slow and retailers want to expand,” Farrell said. “Retailers talk to each other, and those without presence on the island have learned about the excellent sales performance of those already established here. Puerto Rico has become the choice for expansion.”

DDR owns or manages value-oriented shopping centers with a total of about 126 million square feet of retail space. The company’s assets are concentrated in markets with stable populations and high-growth potential. DDR is a self-administered and managed REIT (real-estate investment trust), operating as a fully integrated real-estate company traded publicly on the New York Stock Exchange.

Retail is one property sector that never has time to rest on its laurels. As they battle the lingering effects of the recession and increased online shopping competition, retailers are once again shifting store strategies.

The steep economic downturn forced many retailers to clean house by eliminating underperforming stores, upgrading locations, and taking a hard look at their broad approach to future growth. The chief task going forward is how to squeeze more efficiency — namely lower costs and higher sales — out of brick-and-mortar stores in a world where online shopping is rapidly increasing.

“I think that the number of stores are going to be reduced, the size of the stores is going to be reduced, and the operating functionality of the stores is going to increase,” says Henry Englehardt, CCIM, a senior vice president at Colliers International in Walnut Creek, Calif.

Big-box retailers are already shrinking store footprints to reduce expenses. “Office supply stores were the first, but now you see retailers across the board looking to reduce their store footprints,” says Chad Gleason, CCIM, a principal at Real Estate Investment Services in Kent, Wash. Big boxes that currently occupy 20,000 square feet to 25,000 sf are looking to slim down to 12,000 sf to 15,000 sf. “It is a big chunk of real estate, and you have to pay that bill every month,” he adds.

Big-box retailers are also using smaller footprints to access urban markets. Target, for example, plans to expand its new urban prototype in 2012. The urban stores range between 60,000 sf and 90,000 sf — half the size of a typical suburban store. Walmart is also looking for new locations for its neighborhood grocery, which, at 40,000 sf, is about one-fourth the size of its superstore format.

Bricks and Clicks
Retailers are challenged with the task of transforming strategies and operating models into a “store of tomorrow” to attract greater customer loyalty and a larger share of customer spending. Certainly, brick-and-mortar retailers are doing everything they can to embrace the high-technology shopper, working to combine the in-store experience with the convenience of online shopping with either direct delivery or in-store pick-up.

But online retail continues to exceed sales growth from traditional brick-and-mortar channels at an alarmingly high rate. In fact, the average growth rate of online sales has been about 20 percent annually, while the growth rate for traditional retail sales is averaging about 3 percent per year, according to a 2011 retail study by Deloitte Consulting.

The good news for brokers and investors is that brick-and-mortar retail stores are not going the way of the dinosaur. But retailers do recognize the importance of adapting store strategies to meet the demands of a changing retail environment. “The forward-thinking retailers and merchandisers are partnering and figuring out how to get more efficiency out of the existing bricks and mortar,” Englehardt says. Many retail executives believe that the role of the physical space is shifting from a transactional model to an experiential one, in which customers have a personalized experience with the brand. In fact, 85 percent of retail executives polled in the Deloitte retail study indicated that providing customers with a compelling brand experience will become a store’s primary role in five years.

As such, retailers are looking at innovative changes to draw more people into stores, such as expanding on the store-within-a-store concept, notes Englehardt. Although this concept has been around for years, retailers hope that partnering with the right brand will create more buzz and help draw added customer traffic. Sears is leasing 43,000 sf inside its high-performing Costa Mesa, Calif., store to teen clothing brand Forever 21, a prototype arrangement that, if successful, could be repeated in other markets. Target is partnering with Radio Shack to house 1,500 mobile phone stores, and is reportedly working on a deal with Apple for in-store kiosks.

Signs of Life
Other retailers have remained active throughout the recession, notably discounters such as Family Dollar, Dollar General, and Ross Dress for Less. The wireless stores fueled by AT&T, Verizon, and Sprint have also continued to aggressively roll out new stores. “There are a number of small shop retailers that are actively looking and transacting deals. The challenge is that they are all chasing the best sites,” says Jonathan E. Lindsey, CCIM, a broker with The Shopping Center Group in Birmingham, Ala.

Fast-casual restaurants are another active segment of the market. For example, Lindsey represents Smashburger, which recently executed the brand’s first lease in Alabama with a location in Madison. The restaurant group is looking for multiple locations in that market, and may open as many as 10 new locations in central and northern Alabama over the next five years.

Entrepreneurial growth is driving retail activity in areas such as the Rio Grande Valley in Texas. Operators that have a franchise or license agreement with brands such as Domino’s, Cash America Pawn, and T Mobile are looking for space. “We’re still having a hard time getting out leases that need a finish-out allowance, because everybody is still cash poor,” says Cindy Hopkins, an independent broker and owner of HCRE in Harlingen, Texas. “But I think franchisees have a more active outlook and want to make things happen in 2012.”

Activity is coming from the mom and pops who have either retired or been laid off and now want to open up a store, agrees Gleason, who serves clients in the secondary and tertiary markets outside of Seattle. “A lot of these new entrepreneurs are going into older, second- or third-generation space in smaller downtowns on short-term leases and having success with it,” Gleason adds.

Backfilling Empty Space
Across the country, many markets are still working to backfill vacancies left when large category killers such as Borders, Circuit City, and Linens N Things closed hundreds of stores. In addition, many cities have been hit by the loss of local and regional players. For example, Bruno’s Supermarkets closed more than 60 Bruno’s and Food World stores across Alabama and Florida.

Empty big-box space has created attractive opportunities for retailers that are jockeying for position in top markets. The greater San Francisco Bay Area has virtually no big-box vacancy, as new retailers entering the market have snapped up space. Sprouts Farmers Markets, Fresh & Easy, and Hobby Lobby — “those retailers have stepped up very aggressively and picked up some of the vacant space,” Englehardt says.

Fitness centers also have been expanding in northern California. Engelhardt represents Safeway, which has closed a number of its stores as the chain consolidated. Brands such as LA Fitness and 24 Hour Fitness have been very interested in leasing those spaces, which typically span about 28,000 sf.

Other markets have seen creative re-use of vacant big-box spaces. For example, one opportunistic local investor in Alabama converted a more than 40,000-sf Bruno’s Supermarket into a climate-controlled self-storage facility. That investor is looking at similar conversion opportunities throughout the Southeast, notes Lindsey. Other empty big-box stores are being carved up to create multitenant space. For example in Jasper, Ala., a former 48,000-sf Food World store has been re-configured to house tenants that include a new Goody’s, Hibbett Sports, and a thrift store.

Big boxes aren’t the only empty spaces seeing creative re-use. “Many office users are still using retail space for their general office requirements — mainly due to the lack of available office space, or the cost associated with finishing out new offices,” adds Hopkins. Finish-out costs for office buildings outweigh the cost for retail space in the Rio Grande Valley.

Recession Rebound
The retail real estate sector was hard hit by the economic downturn, leaving hundreds of store closings and major bankruptcies in its wake. But current industry data is pointing to a market that has stabilized and is on a tentative cours e for recovery.

The net absorption of retail space for 2010 and 2011 was a combined 119.9 million sf — nearly triple the amount of new construction that came online during the same period. That absorption has helped to reduce vacancy rates 50 basis points to 9.7 percent at year-end 2011 and vacancies are forecast to improve further to 9.2 percent by the end of 2012, according to Marcus & Millichap.

The retail picture is improving, but those gains are not even across the board. Markets vary widely depending on the specific economies and dynamics within local markets. There continues to be a big divide between the A locations and older B and C properties. Top malls, luxury retail stores, and well-located grocery-anchored shopping centers, as well as wholesale clubs and off-price outlets have outperformed the general retail market.

All 44 markets tracked in Marcus & Millichap’s National Retail Index are expected to post job growth, vacancy declines, and effective rent growth in 2012. However, certain geographic markets are bouncing back faster than others. San Francisco, San Jose, Calif., and Seattle ranked as the top three cities in the index. Those top cities are bolstered by technology, a strong outlook for job and population gains, as well as tourism growth. At the bottom of the index are markets that are still struggling such as Jacksonville, Fla., Cleveland, and Detroit.

“Retailer activity is not nearly at the pace that existed in 2006 and 2007, and in many ways, that is good,” Lindsey says. The aggressive expansion that was occurring during the peak of the market led to overbuilding and poor decision-making for many retailers and developers. The retail activity that has emerged today is driven by a more-conservative, strategic approach.

Retailers that are in expansion mode are highly focused on strategic growth that makes sense, which is why there is heightened competition for top locations, he adds. “The constant rule of location, location, location is valued even more.”

Beth Mattson-Teig is a business writer based in Minneapolis.

Appetite for “A” properties
Buyers may not be venturing too far out on the risk spectrum. Yet the rise in sales volume over the past year is an added vote of confidence in the retail market recovery.

Investors continue to favor “best in class” retail properties. Grocery-anchored centers and “A” credit single-tenant properties such as Walgreens are widely sought after. “Those single-tenant deals are very much in demand. There is much more demand than there is supply right now,” says Jason Donald, director of retail brokerage services at Cushman & Wakefield of Florida, in Tampa, Fla.

Despite a third-quarter pullback in buying activity, retail property sales totaled $42.4 billion in 2011 — a 91 percent increase in volume over the prior year, according to New York–based Real Capital Analytics, the largest gain of all the property sectors. Major metros continue to generate the most transactions; the top five most active markets by volume for retail sales include Manhattan, Los Angeles, Boston, Chicago, and Atlanta.

Investment continues to trickle down to secondary markets such as Charlotte, N.C., Nashville, Tenn., St. Louis, Atlanta, Birmingham, Ala., and Tampa. “Capital has started to find its way into these smaller markets, be­-cause what you would pay for one property in New York, you can potentially capture two or maybe three properties in the Southeast,” Donald says.

For example, Cushman & Wakefield is working with a private buyer based in Manhattan that is selling off some existing properties and reinvesting that money in Florida, because he feels that the market has hit bottom and there is some upside. “Like most, he is looking for a deal,” Donald   says. The buyer is looking at single-tenant and multitenant properties, as long as the amount of small shop space is not greater than the anchor tenant.

“The retail market does offer plenty of opportunities for today’s investors, particularly if the buyer has a tenant in tow or excellent tenant relationships and has the horsepower to hold, market and re-fit, and lease,” agrees Tom Hill III, CCIM, owner of Tom Hill Realty & Investment in Waterbury, Conn. Grocery-anchored or national pharmacies such as CVS and Walgreens are generating low capitalization rates of 6.0 percent to 7.5 percent, while non-anchored centers are seeing cap rates upward of 10 percent and are not moving quickly. “There are lots of bargains, but you need all cash to get one, and many buyers with cash want huge discounts due to the re-leasing risk,” Hill adds.

It has become increasingly evident to those in the commercial real estate industry that improving building energy performance and making other sustainable and green improvements can impact property values and balance sheets. To some degree, building owners find themselves caught in a ‘Catch 22′ situation. On one hand, buildings that are slow to adopt these changes and implement green retrofits and more efficient operations are seen as being at a competitive disadvantage in the market. On the other hand, lenders willing to finance such green improvements are few and far between.

How do stakeholders in this profit-driven industry go about financing these building improvements in an uncertain economy?

Energy Efficiency Retrofit Financing Options

A recent report issued by Anthony J. Buonicore, PE, BCEE, QEP, managing director at Buonicore Partners LLC, entitled, Energy Efficiency Retrofit Financing Options for the Commercial Real Estate Market, cites the lack of commercially-attractive funding as a major impediment to energy efficiency investment in the CRE market. A recent McGraw-Hill survey confirmed that building owners seeking to pay for energy retrofits for their properties often are forced to rely on resources from the internal balance sheet rather than outside funding.

Buonicore reiterates what owners have been saying to lenders for years, “To really move this market, there is a clear need to make energy efficiency financing a mainstream financial asset class with a high degree of standardization, predictability and scale.”

“Ideally,” said Buonicore, “such funding should come without any capital expense, without adding debt to the property, will cover the entire cost of the project, contain favorable tax deductions for the expense, and present favorable terms with low rates and extended repayment periods.” Does everyone have their magic wands ready?

Despite the dearth of mainstream financing, Buonicore surveys the financing options that have sprung up for retrofits and finds a surprising number are able to meet many of the ideal criteria outlined above, no magic needed.

In addition to internal and debt financing, these mechanisms include lease/lease purchase agreements, ESCO (energy service company) financing, energy service agreements, government loan programs, PACE (property assed clean energy) programs, and on-bill utility financing.

In identifying the advantages and drawbacks associated with each and with several energy efficiency underwriting options, it’s clear that Buonicore’s main contention that making energy efficiency financing a ‘mainstream financial asset class’ remains an elusive goal.

Editor’s Note: Financing Green is a three-part series taking a look at energy efficient retrofit financing options, the role of data in overcoming the uncertainty of financing green improvements, and real-world examples of funding green improvements for the tenant or end-user.

Financing Building Energy Efficiency, Overcoming Uncertainty

At the Second Annual Conference on Sustainable Real Estate hosted by NYU Schack Institute of Real Estate, a panel confirmed the scarcity of financing available for green building improvements.

The discussion was led by moderator Susan Leeds, CEO of New York City Energy Efficiency Corp. The panelists included: Caroline Blakely, vice president multifamily risk with Fannie Mae; Greg Hale, senior financial policy specialist with the Natural Resources Defense Council; Sean Neil, managing director of Transcend Equity; and Arah Schuur, director of the energy efficiency building retrofit program with the Clinton Climate Initiative.

CRE lenders and banks understand commercial real estate and the risks involved – after all they’ve been making loans collateralized by commercial property for years. But for many lenders, green is a new thing, one that doesn’t fit neatly into underwriting programs that often require years of data for evaluating risk and assessing the long-term financial impact from investments.

In addition to looking for the costs versus the savings of implementing green improvements, lenders also are looking for more historical data documenting the increased rent income or increased property values that can be expected from such investments. Numerous studies have shown that Energy Star and LEED-certified buildings can attract higher rents and generate increased demand from tenants, which can lead to higher income and sale prices. However, lenders want to see more actual data instead of projected results, panelists noted. Policy data and market performance are also important assessments for lenders to consider in evaluating a specific project.

As a means for side-stepping the issue until more definitive data to satisfy lenders is available, panelists cited one option that may work in the current lending environment, and that is for building owners to roll the cost of green improvements into an ongoing building retrofit or repositioning. That way, panelists said, owners may overcome lenders’ reluctance to consider green improvements as a stand-alone investment.

The panelists noted that financing for green improvements should become more available as more historical performance information is standardized and analyzed. They acknowledged that vast amounts of data are currently being collected on countless green improvements for commercial real estate buildings, such as the energy savings of light sensors or LED lighting, or the cost savings of using low-flow fixtures in restrooms, and even the environmental and employee health impact of clean air technology.

However, they also cited several challenges associated with the data being collected. One problem they identified is that different entities are collecting the information using different criteria and methodologies, which make it difficult to make valid comparisons between data sources.

Another issue is that the collected data can quickly become obsolete as newer and more advanced technologies are released into the marketplace. Often these newer technologies do not have the testing or data available that banks and lenders would like to see in order to make proper assessments on the risk versus the reward of implementing such improvements. For example, 10 years of performance data doesn’t exist for a brand new solar panel or light sensor.

The panelists cited the importance of collecting data, and aggregating and presenting it coherently as critical to getting money flowing for green improvements. Only then will lenders, building owners and related parties be able to review the available options, analyze the execution process, and then look for optimal financing options.

In his keynote address, Richard L. Kauffman, senior advisor to the secretary, Department of Energy, introduced several themes that would be repeated in the panels to follow that day, including that big banks are unlikely to, and perhaps should not, provide financing for green improvements, which are too small and risky. Instead, owners should be looking to capital market investors, state bonds, local banks and government incentives to pull together the necessary capital for individual green improvements to their existing commercial buildings. He also cited points often brought up between lenders and stakeholders in the green improvement industry, namely the need for more metrics, empirical data on risks, and actual cost vs. performance data, not just promises of what a new technology can be expected to deliver.