The Bratton Team

To date, 2 shopping centers have sold this year. With initial returns in the 7% – 8.5% range, you can see the motivation for investors to acquire this type of “bricks and mortar” asset. These yields are similar to what investors are receiving in the BEST commercial real estate markets across the country. The following article by Maura Webber Sadovi of the Wall Street Journal explains the attraction investors have to well-located shopping centers on the mainland.

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By MAURA WEBBER SADOVI Wall Street JournalKarlin Real Estate

Karlin Real Estate paid $50 million for the grocery-anchored Shea Scottsdale shopping center.

The sale of the Shea Scottsdale shopping center just outside Phoenix helps explain a curious phenomenon taking place in retail real estate.

On one hand, one would expect investors to be shunning grocery-anchored shopping centers, which have been suffering from high vacancy and anemic rent growth. New competitors have surfaced, including online shopping and monster retailers like Wal-Mart Stores Inc. and Target Corp., that offer aisles of discounted food.

On the other hand, so far this year investors have snapped up $7.9 billion of retail centers with supermarkets, sending volume up 68% from the $4.7 billion sold in all of 2010, though the level is still well below the peak in 2007, according to Real Capital Analytics Inc., a real-estate research firm. The U.S. sales volume of all other retail properties rose 32% to $20.8 billion this year to date, from $15.7 billion in all 2010.

Retail real-estate investors include giants like Blackstone Group LP. Earlier this year New York-based Blackstone agreed to buy 588 U.S. shopping centers from Centro Properties Group, many of which were grocery-anchored, in a transaction that valued the properties at over $9 billion. Last month Blackstone agreed to buy 36 mostly grocery-anchored U.S. shopping centers from Equity One Inc. in a deal valued at $473.1 million.

The deals are largely being driven by yield. Karlin Real Estate, a Los Angeles investment firm, paid $50 million for two adjacent shopping centers known as Shea Scottsdale and expects the property to have an initial return of under 7%. By comparison, yields on office buildings and rental apartment buildings in downtowns of a half-dozen major cities are in the 5% to 6% range, according to Real Capital.

Blackstone’s initial yields were 8.1% and 7.7% in its Centro and Equity One deals, respectively, according to people familiar with the matter. Those are good initial returns considering that Blackstone’s borrowing costs were in the 4% to 5% range.

Karlin expects its yield to go higher on Shea if it succeeds in bringing new tenants to vacant space in the 277,000-square-foot center, which is 85% leased. “We expect to get to a double digit return in about two to three years based upon operating efficiencies, rent increases and by filling vacant space,” says Matthew Schwab, a managing director with Karlin.
Yields, of course, can also fall if tenants move out or go bust. Grocery-anchored retail shopping center vacancy rates in the Phoenix area ticked down to 8.5% in the third quarter, from 8.8% in the second quarter, though they are still above the year-earlier level of 7.4%, according to Reis Inc.

It used to be conventional wisdom that grocery-anchored centers were downturn-resistant. But, with the new competitors, that no longer is the case. “Supermarkets are no longer safe anchors,” says Burt P. Flickinger III, managing director of Strategic Resource Group, a New York retail consultant.

But that is where good market intelligence comes in. The Shea Scottsdale Safeway Inc. store logs annual sales of $500 a square foot annually, above the $300 range for the Phoenix area, and the nearest grocery store is three miles away, according to Michael Hackett, a retail investment sales broker with Cassidy Turley BRE Commercial in Phoenix.

Also, Mr. Schwab says he is confident he could replace Safeway, whose lease expires in four years, because of Shea’s location. The seller of the property was the Herberger family, which bought the land in the early 1950s, when Scottsdale had a population of about 2,000. Since then it has swelled to over 200,000, and Scottsdale is home to exclusive spas and some of the Phoenix area’s most-upscale residential areas.

“It’s a question of betting on the right grocer in the right location,” says Ben Carlos Thypin, director of market analysis with Real Capital.

Even if vacancy rises at Shea, Karlin may be safe because it is acquiring the shopping center with no debt, as it does in most of its deals. The investment company was founded in 2008 to invest capital for Dr. Gary Michelson, a surgeon whose unusually large hands and concerns about invasive spinal surgery led him to make part of his fortune inventing and selling medical devices. Karlin owns more than two million square feet of office, retail and industrial properties, and some 1,500 apartment units.

Karlin is planning to spend about $1 million to upgrade and rebrand the Mediterranean-style Shea Scottsdale , which was developed as two separate, contiguous shopping centers. “We’ll be redesigning [it] to make it much more pedestrian-friendly,” Mr. Schwab says.

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