How Will Increasing Interest Rates Affect Retail Investments?

06.14.2017

(Spring Creek Village, Edmond, Oklahoma)

On June 14th, the Federal Reserve increased the federal funds rate by another .25%, which will take the prime rate to 4.25%. It is expected by many that a third increase will be approved later this year further impacting investors’ expected investment returns.

Since 2000 in the OKC market, power centers have been considered the most prestigious investment for institutional investors. Offering national or regional credit, long-term leases and well-positioned properties these types of assets were very attractive to large retail investors with a national footprint. These properties were trading in the 5% to 6.5% CAP range only a few years ago. Today, the uncertainty of many big box tenants is affecting the value of these once prestigious investments. Although we have seen new development projects with 10-year leases produce a sales price equating to a going in 7% CAP, the majority of older power centers are now selling for an 8% to 9% CAP. In the past year, with fewer institutional buyers driving prices up, local investors can now potentially acquire properties with more reasonable returns. Another issue for non-institutional buyers to consider is lender requirements for local investors can be more extensive, including requiring reserves for lease transaction costs, costs for downsizing or relocating tenants and other property related capital costs.

One asset type which may not be dramatically affected by increased interest rates is the Single-Tenant NNN corporate leased properties. McDonald’s, Chick-fil-a, Taco Bell, Starbucks, etc. will always be one of the hottest and secured investments for a retail investor. Typically, buyers don’t acquire these properties with high levels of debt, and many times no debt at all. This type of investment attracts higher net worth investors looking to invest their money on long-term leased properties. Given the fact that these assets are typically secure and stable, there will almost certainly be a pool of investors for this asset class.

Small shop retail may be the most affected by rising interest rates. These are properties in the range of 50,000 square feet or below. They bring lower risk since turnover doesn’t cripple the investor with high retrofit costs. Although most buyers looking at these assets are risk averse, spiking interest rates may still be a factor. With the expectation of increased interest rates, we are seeing many long-term investors locking in interest rates for 10 years to pay down the principle as quickly as possible.

Overall, the retail investment market has been active in Oklahoma. Good locations and quality retail centers are in high demand and the expected incremental increase in interest rates will likely not affect investors’ appetite for these assets. Retail owners are stabilizing their power center investments by repositioning some big box tenants into smaller space which is more suitable for their new business model. Buyers that remain active in today’s market by capturing quality retail assets at higher capitalization rates due to less competition from out of state institutional money should see more favorable investment returns compared to the last five to seven years.

Retail Investment Team, Price Edwards & Company

Paul Ravencraft, George Williams, Phillip Mazaheri, CCIM
Retail Investment Team