Matthews™ Fall/Winter 2017 Publication

TM

FUTURE DEVELOPMENT FORECAST: DALLAS AND LOS ANGELES A MODERN LEASE ON MILLENNIALS: INVEST IN THE RIGHT UPGRADES

NAVIGATING CHANGE: TRANSFORMATION OF RETAIL HOW IS E-COMMERCE AFFECTING YOUR PRODUCT TYPE?

FALL/WINTER 2017

DALLAS | LOS ANGELES B Y D AV I D HAR R I N GT O N

12 CONTENTS

FALL/WINTER | ISSUE NO. 3 | MATTHEWS PUBLICATION

12 Future Development Forecast | Los Angeles & Dallas

16

16 How is E-Commerce Affecting Your Product Types?

24 Another Prime Purchase | Amazon & Whole Foods 32 Mix It Up | Q&A with Michael Pakravan 36 Is the Value of Your Asset Depreciating?

41 2017 Multifamily Market Report - California & Texas 60 Overruled! | New Pro Tenant Multifamily Laws in LA 66 5 Signs You Need A Property Manager 70 Navigating Change: Transformation of Retail 78 A Modern Lease on Millennials 84 Top Trends in Industrial Real Estate 90 Top MSAs | These Cities are Booming... Here’s Why 102 San Fernando Valley Report 108

E-Commerce Transforming Demand in the Industrial CRE Sector

112

Neighborhoods Moving - New L.A. Markets Take the Field

116

Invest Now & Save Later - 5 Simple Steps to Save on Your Property Expenses

120 Is This Property Corporately Guarenteed?

124

State of Financing: Single Tenant Net Lease Investments Q&A with Brian Krebs

70

A MODERN LEASE ON MILLENNIALS: Invest in the Right Upgrades CRAIG IRVIN & NICK DELL

78

126 STNL Cheat Sheets

The large their prim millennia populati global w

MatthewsTM REIS Disclaimer 2017 This publication has been produced by Matthews Retail Group, Inc. solely for information purposes and the information contained has been obtained from public sources believed to be reliable. While we do not doubt their accuracy, we have not verified such information. No guarantee, warranty or representation, expressed or implied, is made as to the accuracy or completeness of any of the information contained and Matthews REISTM shall not be liable to any reader or third party in any way. This publication is not intended to be a complete description of the markets or developments to which it refers. All rights to the material are reserved and cannot be reproduced without prior written consent of Matthews REISTM.

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A NEW GEN ERATI ON OF LEADERS FOCUSED ON

ON E O B J ECTI V E : R E DEF IN IN G THE TRADITIONAL

BROKERAGE EXPERIENCE

R E TA I L | M U LT I FA M I LY | I N D U S T R I A L | L E A S I N G | M A N AG E M E N T

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M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

5

LETTER FROM THE CEO KYLE MATTHEWS

G E T YOU R P OP C OR N R E A DY A stand off has emerged in the real estate market. The “bid vs. ask� spread has continued to widen, suggesting sellers and buyers expectations are getting further and further apart. Buyers are no longer willing to pay for the price sellers are asking for. The current market shows a tangible decrease in investment sales velocity, yet on average, cap rates have not begun to move up. Something has got to give, and as buyers generally dictate the market, sellers must make the move.

Buyers are recognizing we were in an appreciating market from 2010 to 2016, and a six year run-up of prices cannot continue to rise. So, taking the timing of cycles into consideration, political uncertainty and looming tax reform, buyers have become increasingly skittish and unwilling to stretch to purchase potential assets they would have acquired in the past. Due to the substantial pull back in the market, cap rates will undoubtedly start to creep north, and deal velocity will continue to decline if sellers do not adjust their expectations. We are already starting to witness this in Class C assets or properties located in tertiary markets. We’ll see cap rate movement in Class B properties next, and eventually the Class A markets and core product.

While in no way do we expect a market decline like we saw from 2008 to 2010, get your popcorn ready. Buyers will begin to see better purchasing opportunities, so sellers need to quickly adjust pricing if they are committed to selling a property now. If not, be prepared to wait another five to seven years to experience the pricing opportunites available today.

KYLE M AT T H EWS CHAIRMAN AND CEO

CONTRIBUTORS K Y L E M AT T H E W S

CHAIRMAN & CEO

R A D O S L AV Z L AT K O V

C H I E F F I N A N C I A L & O P E R AT I N G O F F I C E R

D AV I D H A R R I N G T O N

E V P & N AT I O N A L D I R E C T O R , M U LT I FA M I LY

E L WA R N E R

E V P & N AT I O N A L D I R E C T O R , S H O P P I N G C E N T E R S

CHAD KURZ

S V P & N AT I O N A L D I R E C T O R , S T N L

ARON CLINE

SVP & SENIOR DIRECTOR, STNL

S C O T T H E NA R D

SVP & REGIONAL DIRECTOR, SHOPPING CENTERS

M I C H A E L P A K R AVA N

S V P & N AT I O N A L D I R E C T O R , R E TA I L L E A S I N G

DA N I E L W I T H E R S

S V P, M U LT I FA M I LY

C A LV I N S H O R T

FVP & SENIOR DIRECTOR, STNL

Interested in advertising?

G A RY C H O U

FVP & SENIOR DIRECTOR, STNL

J O R D A N U T TA L

VP & DIRECTOR, STNL

Contact brand@matthews. com for more information.

JOSH BISHOP

VP & DIRECTOR, STNL

BRADEN CROCKETT

AV P & D I R E C T O R , S T N L

L I N D SAY T S U M P E S

AV P & D I R E C T O R , S H O P P I N G C E N T E R S

T I M WO O D S

N AT I O N A L D I R E C T O R , A S S E T S E R V I C E S

MINNIE ALLISON

DIRECTOR, ASSET SERVICES

E DITORI AL & DE SIGN CAT RAY HANA COOKSON ALFONSO LOMELI ERICA RAGLAND LEANNE JENKINS MARINA RUBIO

CON T R IBU TOR S AARON GUIDO

CONRAD SARREAL

KYLE MIRRAFATI

ANDREW PEASH

CRAIG IRVIN

KYLER BEAN

ALEX HARROLD

DALTON BARNES

MATT COATES

ANDREW GROSS

DANIEL SHIEH

MAXX BAUMAN

ANDREW IVANKOVICH

DANIEL MCQUAID

MICHAEL CHISLOCK

AUSTIN FISHER

DEVON DYKSTRA

MICHAEL MORENO

BILL PEDERSON

GORDON MILLER

MICHAEL ASTORIAN

BRIANNA BURGESS

GREGORY AMATO

MITCHELL GLASSON

BRUCE EVERSOLE

JAKE SEIJAS

NICK DELL

BRYANT HOOVER

JEFF MILLER

RAHUL CHHAJED

CHARLES WRIGHT

JIM BRANDON

SAM SILVERMAN

CHRISTOPHER LASKERO

JOSEPH NELSON

TYLER GROTH

CHUCK EVANS

JON PRATER

WESLEY CONNOLY

CONNOR OLANDT

JORDAN POWELL

YURIY CHAVARHA

KEVIN CHANG

SP E CIA L T HA N KS TO

BARRINGTON CAPITAL CORPORATION

CONNECT MEDIA

CREXi

BISNOW

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

7

MARKET T R E N D S Quarterly Transaction Volume (In Billions) | Source: CoStar

$180 $160 $140 $120 $100 $80 $60 $40 $20 $0

Q1 Q2 Q3 Q4

Q1 Q2 Q3 Q4

Q1 Q2 Q3 Q4

Q1 Q2 Q3 Q4

Q1 Q2 Q3 Q4

Q1

2012

2013

2014

2015

2016

2017

U.S. Unemployment Rate Source: TradingEconomics.com

2016 Q1

8 |

2016 Q2

2016 Q3

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

2016 Q4

2017 Q1

2017 Q2

Retail Source: CoStar

The Big Players That Have Slowed Down Staging a Comeback Office Supply Stores Fading Fast

U.S. GDP Growth Rate Source: TradingEconomics.com

5% 4% 3% 2% 1% 0% -1% -2%

2014 Q1

2014 Q2

2014 Q3

2014 Q4

2015 Q1

2015 Q2

2015 Q3

2015 Q4

2016 Q1

2016 Q2

2016 Q3

2016 Q4

2017 Q1

2017 Q2

2017 Volume Source: RCA

January February March April May June July Total

$34B (22%) $25B (16%) $44B (19%) $29B (12%) $34B (15%) $45B (19%) $26B (11%) $237B

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

9

2017 Retail

Source: RCA

Month

Volume

YOY Chg

# Props

Jan

$5,322,966,330

-29%

532

30,884,467

$185

6.5%

Feb

$3,662,000,677

-26%

411

22,458,701

$167

6.5%

Mar

$9,870,441,908

41%

689

45,103,690

$178

6.5%

Apr

$3,955,141,477

-33%

401

20,061,376

$186

6.5%

May

$4,929,571,796

-21%

483

26,458,799

$193

6.5%

Jun

$5,736,775,234

-17%

582

33,773,479

$192

6.5%

Jul

$3,986,389,879

-54%

421

21,905,331

$188

6.5%

2017 Industrial

Total Units Avg. PSF Avg. Cap Rate

Source: RCA

Month

Volume

YOY Chg

# Props

Jan

$5,168,911,966

-18%

593

75,641,860

$77

6.8%

Feb

$2,920,460,539

-11%

348

44,582,675

$74

6.8%

Mar

$6,772,907,801

78%

533

71,218,081

$80

6.9%

Apr

$3,835,451,379

-19%

430

52,355,926

$84

6.9%

May

$6,566,156,453

54%

547

78,430,217

$86

6.9%

Jun

$5,288,037,061

10%

557

62,204,419

$81

6.8%

Jul

$4,615,842,333

10%

471

56,877,544

$85

6.8%

2017 Apartment

Total Units Avg. PSF Avg. Cap Rate

Source: RCA

Month

Volume

YOY Chg

# Props

Total Units

Avg. PPU

Avg. Cap Rate

Jan

$9,245,147,485

-48%

541

73,906

$148,410

5.7%

Feb

$8,829,279,791

-8%

512

68,750

$143,209

5.7%

Mar

$9,548,835,639

-24%

595

82,790

$136,649

5.7%

Apr

$11,263,457,442

28%

591

88,186

$138,559

5.7%

May

$9,541,451,442

-10%

563

74,443

$138,304

5.7%

Jun

$14,864,600,552

-8%

803

110,432

$141,585

5.7%

Jul

$9,990,204,379

-3%

472

67,314

$146,365

5.6%

10 |

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

Rent Growth in Multifamily

Top 20 Rent Growth Markets Source: TradingEconomics.com Year-Over-Year Same Store Rent Change, 2016Q1 - 2017Q1

Sacramento

8.0%

Inland Empire

5.5%

Seattle

5.5%

Las Vegas

5.0%

Orlando

4.8%

San Diego

4.4%

Salt Lake City

4.3%

Orange County

4.0%

Los Angeles

3.9%

Phoenix

3.9%

Minneapolis

3.8%

Tampa

3.8%

Dallas - Fort Worth

3.7%

Atlanta

3.7%

Detroit

3.5%

Columbus, OH

3.4%

Raleigh

3.2%

Cincinnati

3.2%

Kansas City

3.1%

Portland, OR

3.0%

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

11

FD EUTUR E VELOPMENT FORECAST LOS AN GEL ES & D A L L A S

BY D AV ID H ARRI NGT ON

12 |

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

Multifamily developers are encouraged by strong operating fundamentals in the industry across the nation. The outlook for current multifamily development being delivered to the market remains favorable for developers, while absorption of rental units continues to hold steady. National statistics reflect a positive forecast going forward and developers are invigorated for the remainder of 2017. However, there are signs of some slow down, and certain factors should be closely monitored before future investment is considered.

While enthusiasm continues through 2017, some influences still weigh the decision when considering new multifamily development. A tighter lending environment, barriers to new development, higher labor expenses, and material costs, remain as hurdles for developers. For the Los Angeles and Dallas-Fort Worth metro areas, we continue to see many opportunities present themselves which minimize these negative factors and forecast profits, but caution still exists.

the number of multifamily permits being issued today are in decline in many metros across the country - forecasting the multifamily supply coming to market in the next several years.

Although market fundamentals remain strong, there may be other factors turning investors away from continued development. Not only are developers taking a higher risk making the decision to bring new supply to the market at this time in the cycle, but they’re also paying a premium price for their resources.

The developer demand for construction entities, lending rates, and building materials has been tremendous, causing development costs to be at a near alltime high. Once this inventory comes online, developers must realize premium square foot rates in order to recoup the high construction costs. Thus, in order to realize profits, the rental market must remain strong.

As of May 2017, national multifamily development realized 335,000 units completed, an increase of more than 18 percent year to date. Given the continued The national real estate market has market success experienced over the last been positive for an extended period of few years, this increase was expected. A time. As we go deeper into the current strengthening labor market, and continual investment cycle, the consideration of rent growth has fueled new inventory. downside risk has risen, and no investor wants to be caught in a development cycle However, the May 2017 numbers also reflect multifamily housing deals declined if the market swings negative. Permits 25 percent, while building permits are issued in 2014 and 2015 are currently down 13 percent nationally. coming to market in high numbers of new supply, but research signals that

United States Multifamily Permitting 500 400 300 200 100 0

M AY

JUN

JUL

AUG

SEP

OCT

NOV

DEC

JAN

FEB

MAR

APR

M AY

SOURCE: U.S. CENSUS, AXIOMETRICS M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

13

A June 2017 report titled Vision 2030, released by the National Multifamily Housing Council (NMHC) and the National Apartment Association (NAA), shows that developers must continue building at a pace similar to 2017, in order to meet national housing demands. The report analyzes the dynamics of the nation’s apartment inventory and the demographic trends of tenant base. According to the report, the market will need to deliver 325,000 units to the market annually in order to keep up with expected demand for rental housing.

Although 2017 has been a banner year for new apartment deliveries, projections are not supporting the same velocity for inventory deliverables going forward. Vision 2030 gave a bullish outlook for the future as the demand for multifamily grows and inventory lags. As the report notes, demographic shifts from the Baby Boomer generation to Millennials and Gen Z, as well as new immigrants surging into the country, will have an increased impact on this demand. More diverse market segments are entering the renter pool and staying there for longer periods of time. This increased pressure on rental markets is the foundation for the report’s positive forecast.

7000

6000

5000

As of July 2017, Los Angeles realized a total of 36 employed cranes, second only to Seattle with 58. This indicates confidence in the Los Angeles market for rent growth in a tight labor market. That confidence is supported by second quarter 2017 numbers that show new units being absorbed nearly as quickly as they are coming online.

Investors in the Los Angeles market continue to see solid fundamentals in apartment development. The lack of available multifamily rental inventory will continue to drive investing throughout Los Angeles. Our outlook for the region remains bullish, and opportunities should be sought aggressively.

4000

3000

2000

1000

JUN

JUL

AUG

SEP

OCT NOV DEC JAN LOS ANGELES

F E B M A R A P R M AY J U N DALLAS

SOURCE: U.S. CENSUS BUREAU

14 |

While much of the country has decreased multifamily permitting, the Western U.S. has increased construction starts by just over eight percent in May 2017. This is also true for the Los Angeles market, which produced more inventory in the second quarter of 2017 that it had in more than five years. In fact, the Los Angeles metro area alone has approximately 1.25 million rental units in inventory, and this must be sustained to meet projected demand.

However, concern remains with recent employment statistics in Los Angeles. Coming in at approximately one-third of the employment figures for 2015 and 2016, job growth in Los Angeles rose just over one percent annually. The major hurdle that has plagued the employment market is wage stagnation, but if this can trend upward, it will be a boost for the Los Angeles rental market.

Number of Permits Permitted: 2016-2017

0

Los Angeles Rental Market Remains Bullish

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

Dallas-Fort Worth Experiencing a Boom

The Dallas-Fort Worth (DFW) metro area continues to experience rapid economic expansion and a boom of multifamily rental apartment development. DFW has delivered near record-breaking numbers of rental units to the market over the last year and has over 50,000 units in the pipeline.

Job growth has remained steady, as DFW created nearly as many jobs as New York - with a population of half the size.

Over the last decade, the DFW MSA, fourth largest in the U.S., has created a higher number of jobs than any other metro area, with the exception of the New York MSA. However, national statistics hint at the challenge to keep providing new rental inventory to meet the pace of job growth. In fact, 2017 numbers show that developers have pulled back a bit in Dallas, with the annual permitting numbers down 16 percent as of May. That is not to say that things are at a standstill in Dallas.

Even though permitting numbers fell by 16 percent building permits recently hit 20,000, which is still the second highest in the country. In the midst of this building bonanza, the DFW area has continued to see new highs in average rents per square foot across the board - up over five percent from a year ago. This is especially true in Fort Worth, with annual permits experiencing double-digit gains and rent growth exceeding six percent.

The North Texas multifamily market is performing well, and new units are being absorbed quickly. The economic growth of the region is fueling the ongoing development. Production remains impressive even with the slight dip in current permitting numbers. Saturation is always a concern in this environment, but the statistics prove that renter demand has kept up with all of the new supply coming to market. Thus, we remain positive on the Dallas-Fort Worth area while keeping a close watch on absorption figures.

For more information regarding your next multifamily investment, please contact:

David Harrington E David.Harrington@matthews.com P 310.295.1170

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

15

16 |

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

How isis r u o y g n i t c affe

- ty pe In 2017, we have seen continued growth in e-commerce and technology, thanks in large to the online behemoth - Amazon. What is the potential for e-commerce to affect your single- tenant net-leased product type?

Take an inside peek at how resilient your product type is against the ever-growing threat of e-commerce.

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

17

AUTO SERVICES

RESILIENCE

BRADEN CROCKETT LOW

HIGH

As with any service based retail business, the auto repair and service industry is extremely resilient to e-commerce and should continue to prevail through this siege on retailers.

The main reason for this is that even if Amazon or other e-commerce companies can ship parts, they will have a tough time replicating the expertise required to perform necessary repairs. However, one thing that may change is the location of auto service retailers. Historically, the best performing auto service retailers have been out-parceled to malls or dense retail corridors. If the anchors that are susceptible to e-commerce continue to vacate, then this may lead to a significant decline in traffic, substantially isolating auto service retailers. Auto service retailers should focus more on retail corridors that will continue to have high traffic or to focus on locations that better capitalize on the fleet services that generate a higher volume of business to business sales. While customer preferences may be changing rapidly within the

C O N TAC T braden.crockett@matthews.com (214) 692-2040

QSR

retail, wholesale/ fleet service customers are less likely to be affected by these trends.

RESILIENCE

Efficiency is key to stay relevant in today’s market, something that quick service restaurants (QSRs) are skillfully able to provide to their

GARY CHOU LOW

HIGH

customers. QSRs prove to be resilient in the era of e-commerce because they meet the needs of their customers in the most time sensitive way possible. Today, people ages 18 to 32 are spending about 45 percent of food dollars on eating out which has led many to choose to stop at Chipotle or McDonald’s for their quick food fix.

This on-the-go concept meets many consumer demands, ultimately leading to QSRs resilience against e-commerce. These types of restaurants will stay relevant until consumers decide that there is something else that is trendier or more efficient. To remain in the now, it is necessary that QSRs keep up with their ever-changing consumer base. Therefore, many have partnered with online platforms to connect with their customers digitally. Many QSRs are featured on food delivery applications or have introduced online ordering to make it easier for their consumers to get what they want quickly and efficiently. Experience is also important to the typical fast food consumer, if QSR brands can keep up with

C O N TAC T gary.chou@matthews.com (310) 919-5827

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M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

food trends and maintain updated facilities, there should be no major reasons why the product type would have problems in the age of e-commerce.

RESILIENCE

Although not guaranteed, convenience stores should continue to be relevant during the rise of e-commerce. Typically, convenience stores are recession and e-commerce proof despite the fact most convenience store

CONVENIENCE M AT T C OAT E S

LOW

HIGH

chains are diversifying product channels and are seeing a declining rate in shopping trips. The key strategies that will help convenience stores combat e-commerce are increasing the speed of service, improving the overall consumer experience, and implementing further personalization of product offerings. For example, many convenience store chains located on the East Coast are thriving because they are keeping up with the wants and needs of their customer base, namely millennials who make up nearly half of convenience store consumers. Furthermore, Wawa is taking advantage of personalization by showcasing ingredients and preparing food directly in front of their customers as they order. Other convenience store chains such as 7-Eleven are adding fresh food to their product offerings specifically to cater to millennials. Additionally, 7-Eleven has announced its acquisition of over 1,000 stores in 18 states from Sunoco and has partnered with food delivery apps such as DoorDash which, in turn, should elevate the company’s “convenience” factor. It is unlikely that convenience stores will become obsolete in the near future if they continue to adapt to modern consumer preferences. Convenience stores and gas stations should continue to be a staple in our economy, particularly because people will always value their time, which further aids in this sector’s resiliency against e-commerce.

C O N TAC T matt.coates@matthews.com (949) 432-4505

RESILIENCE

MEDICAL MICHAEL MORENO

LOW

HIGH

When looking at the net lease environment, countless tenants business models are continuing to be affected by the rise of e-commerce. The prominence of services like Amazon, Alibaba, and Zappos are threatening brick and mortar sales around the country. However, one of the most resilient tenant verticals to the rise of e-commerce is medical. As traditional retail tenants are losing ground, medical tenants are gaining. One of the main reasons for this is the fact that medical real estate is primarily service based. They are not selling a product or good, but rather a service, and an extremely specialized one. They do not operate in the same space as any of the e-commerce companies currently in the market, and because of that, they are securing spaces in many single tenant and shopping center locations nationwide. The increase in medical tenants and real estate can be attributed to the aging of the U.S. population and the continual need to care for this growing demographic. For these reasons alone, medical can be looked at as one of the most resilient tenants when it comes to its

C O N TAC T michael.moreno@matthews.com (949) 432-4511

strength against e-commerce.

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C A S UA L D I N I N G C A LV I N S H O RT RESILIENCE C O N TAC T calvin.short@matthews.com (949) 432-4506

LOW

HIGH

The restaurant space, particularly casual dining, is one of

and affordable, all of which contribute to a better customer

the most e-commerce proof sectors in the market because

experience. Millennials are reshaping the economy by

it is a service and experience based industry that cannot be

choosing ease and convenience over everything else. One

recreated online. For these reasons, e-commerce is not an

could argue that companies such as UberEATS, GrubHub,

immediate threat because investors will continue to shelter

and DoorDash have the potential to affect the bottom line for

capital in and consumers will continue to dine at these

casual dining restaurants negatively, however it is unlikely

restaurants, just as they’ve done for the entirety of their life.

that it will cause a major stir within the asset class as a whole.

However, despite casual dining’s success in the marketplace,

Customers who use online delivery services are likely to

the expectations of customers are increasingly harder to fulfill.

order the same items and quantity level as they would if they

There is a massive amount of completion in the restaurant

were sitting down at the restaurant. What they won’t get is

space, and it’s a constant struggle for concepts to remain “in

the pleasurable experience that the hospitality industry has

the now.” The big adjustment that the casual dining sector

to offer. Given this momentum of change, it is important that

must make to stay relevant in the market is to meet the

casual dining restaurants keep up with the times to best serve

greater demand for higher quality food at affordable pricing.

their customers.

Today’s generation wants food that is fresh, convenient,

B I G B OX R E TA I L

RESILIENCE

E L WA R N E R LOW

HIGH

Big box retailers have been more susceptible to e-commerce than many other retailers because they sell products that are found online. With the rise of e-commerce, many big box retailers have gone bankrupt but not for the reasons you think. Many big box retailers are going out of business because they are selling outdated merchandise, leading to fewer customers coming in through the doors. Sales have been dipping across the board because customers are finding better, trendier, and updated products online rather than in these stores. Retailers are not providing the right mix of product, and the competition is stronger than ever. Bankruptcy is the reality of capitalism and retailers who distinguish themselves as being low price retailers are being driven out by stores like Amazon who have a cheaper product offering. To stay competitive in the market, big box retailers need to re-focus their attention on the merchandise they offer. As long as these retailers can provide a stimulating shopping experience, the correct product mix, and a strategy that incorporates e-commerce, big box retailers will prevail in the era of online shopping.

Big boxes were developed at a site coverage of 20 to 30 percent, meaning that they have relatively low density, and over the long-term the land that many of these big boxes have been constructed on will have tremendous value against the rise of e-commerce.

Therefore, selecting a big box investment comes back to the fundamentals of real estate where investors must understand the underlying land value and the future highest and best use of a site. These changes have and will continue to provide savvy investors with tremendous long-term growth while still getting near term yield.

20 |

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

C O N TAC T el.warner@matthews.com (949) 873-0507

DRUG STORES J O R D A N U T TA L

RESILIENCE

LOW

HIGH

C O N TAC T jordan.uttal@matthews.com (310) 919-5707 Traditional drugstores have very little competition amongst

the online space the to go-to for prescriptions. Where

the established players in the market, making the threat of a

pharmaceuticals are concerned, the sale and delivery of them

new competitor or concept slim. The sale of pharmaceuticals

are very predictable, making the industry a logistical dream

has a lot more legality surrounding it than your typical retailer

for e-commerce. The convenience offered by an e-commerce

which assists in keeping up a barrier to entry in the drugstore

company could lure customers to switch, but the legality of

market. However, if an online retailer has the resources and

moving drugstores online plays a vital role in keeping the

influence to penetrate the market, the barrier to entry may

sales in store. E-commerce companies, such as Amazon,

be threatened. Amazon, the e-commerce power house, has

must ensure that they are meeting all regulatory requirements

recently been making strategic hires to get into the pharmacy

such as transfer laws and e-prescribing within the

space which could ultimately change the way consumers

pharmaceutical space. Therefore, it is unlikely that we will

receive health services, medicine, and prescriptions. Currently,

see significant competition enter the lucrative market anytime

Amazon is testing out their “pharmacy” concept in Japan,

soon. It would be tough to take down pharmacy giants, such

and has entered the U.S. through selling medical supplies/

as CVS and Walgreens, who have a loyal customer base

equipment and started hiring for its “professional health

that has always gone to their local pharmacy to get their

care program.” Online retailers could expose the true cost

prescriptions instantly.

of drugs thus, lowering everyone’s bottom line and making

GROCERY STORES E L WA R N E R & L I N D S AY TS U M PE S

RESILIENCE

LOW

HIGH

With the retail landscape being at its most pivotal point, service-based retailers are at the forefront of sustainability, and this includes grocery stores. Although e-commerce companies can ship produce and food to consumers, the overall threat they pose to grocery stores is still minimal, and the industry is still resilient for a variety of reasons. Online retailers will need to ensure that produce delivers on time, remains fresh and undamaged in transit, and will need to compel communities of different income levels to subscribe to e-commerce services.

Until e-commerce retailers figure out a way to service customers as consistently as brick and mortar locations can, e-commerce companies won’t be an imminent threat to grocery retailers. In the unique case of the e-commerce giant, Amazon, acquiring Whole Foods, Whole Foods’ real estate footprint can be bolstered. The acquisition can be great for the retailer because many of its locations will serve as distribution centers and delivery hubs, that will C O N TAC T el.warner@matthews.com (949) 873-0507 lindsay.tsumpes@matthews.com (949) 873-0270

further promote foot traffic to the store and nearby retailers. Although this is ideal for Whole Foods and Amazon, competitors will be forced to adapt to this recent acquisition and change to the grocery space by offering efficient at-your-door services. At the moment, the threat of e-commerce is at bay for grocery stores but can become alarming if grocery stores fail to adapt and provide adequate and consistent services to the consumer.

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AU T O PA RT S

RESILIENCE

CHAD KURZ LOW

HIGH

With the entrance of online retailers into the auto parts space, specifically, Amazon, poses a significant threat to brick and mortar auto part retailers. For auto part retailers, the largest portion of sales and growth are now coming from professional customers who don’t urgently need products on hand but could get them delivered on a regular basis. For example, Advance Auto Parts has grown their professional sales from under 40 percent to nearly 60 percent of their total store sales in the past five years. Even more troubling, despite overall growth in sales, Advance Auto Parts Do-It-Yourself customers aren’t buying as many auto parts as they were five years ago despite a significant increase in the total number of store locations. With online retailers entering the marketplace, it is troubling that professional sales represent so much of auto part stores revenue due to the inherent risk of online retailers and lower profit margins. If professional sales were to move just ten percent of their business to Amazon due to convenience or pricing, it could devastate the auto parts retailers. In the e-commerce world, it’s hard to imagine the auto parts industry outlasting a head to head competition against a behemoth like Amazon, a company that has a market value ten times larger than the three leading auto part retailers combined. While Advance Auto Parts, O’Reilly Auto Parts, and AutoZone have combined to lose $15 Billion of their market cap this year, over one-third of their market value, Amazon, has gained around $125 Billion to theirs. Amazon can withstand a competitive market more than a traditional brick and mortar due C O N TAC T chad.kurz@matthews.com (214) 692-2927

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to their sheer mass and other revenue producing segments to eventually weed out their brick and mortar competition.

I N C A S UA L D I N I N G , Q U I C K S E R V I C E R E S TAU R A N T S , AU T O S E R V I C E S , A U T O PA R T S A N D C O N V E N I E N C E S T O R E S

â„¢

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Another

Prime

Purchase How Amazon’s Aggressive Entry into the Grocer Market Will Impact Shopping Centers BY: LINDSAY TSUMPES

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Chances are you’ve seen conflicting retail facts and theories every time you read commercial real estate news. Despite historically strong leasing fundamentals, the wave of retail bankruptcies and changing consumer preferences in conjunction with other political and monetary risk has left heavy uncertainty in its wake.

“Experiential” has become the new buzz word for

the future paradigm of thriving retail, and we’ve seen several pure play e-tailers moving into the brick-andmortar space, most notably internet behemoth, Amazon.

It isn’t hard to argue that e-commerce has significantly impacted retail; however, to say that internet sales are killing retail is an over simplification that does not accurately portray the whole story.

Here are a few stats that shed light onto the current retail landscape:

E-commerce sales in the first quarter of 2017 accounted for 8.4% of total retail sales

Online shopping accounted for 2% of the grocery sector’s sales in 2016

53% of retail internet sales are captured by Amazon

60% of Gen Z’ers prefer in store shopping to online shopping

(U.S. Census Bureau)

(Kantar Retail)

(Slice Intelligence)

(Accenture)

Grocery stores have traditionally been one of the most insulated categories of retailers to the pressures of e-commerce as perishable goods and razor thin margins make food delivery models misaligned with consumer behavior and cost prohibitive. However,

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Amazon’s purchase of upscale grocery chain, Whole Foods, is thrusting the historically stagnant grocery space into a period of transformative change. Here we dissect the facts surrounding the transaction’s potential impact on the grocery anchored space.

the facts: On June 16, 2017, Amazon.com announced its bid to acquire premium supermarket chain Whole Foods for $13.7 billion in an all-cash deal offered at $42 per share, a 27 percent premium to Whole Foods’ previous closing price.

On August 23rd, 2017, the U.S. Federal Trade Commission said it would allow the AmazonWhole Foods deal to proceed and Whole Foods’ shareholders voted to continue with the acquisition two of the biggest hurdles Amazon had to overcome.

By Monday, August 28, 2017, Amazon and Whole Foods had officially closed the deal.

According to Cowen & Company, combining Amazon’s grocery sales with Whole Foods’, will represent 3.5 percent of total U.S. grocery spending, making it the nation’s fifth-largest grocery retailer.

Amazon’s current online food delivery service has recently opened two drive-through grocery stores and a tech-driven experimental store under the name Amazon Go. Whole Foods is the 30th largest retailer by annual sales in the U.S. Founded in Austin, Texas in 1980; Whole Foods has 460 supermarkets in the U.S., Canada and the United Kingdom with 91,000 employees. In 2016 Whole Foods generated $15.72 billion in sales and $507 million in net income. Whole Foods 2016 sales translate to approximately $940 per square foot.

Due to increased competition from traditional supermarkets that are mimicking Whole Foods’ organic merchandising, Whole Foods has seen transactions-

which is used to measure traffic - fall by 3.9 percent. Following this, the grocery store reported comparable store sales falling by another 1.9 percent in late July, their eighth consecutive quarter of same-store sales declines.

THE IMMEDIATE IMPACT OF THE PLANNED ACQUISITION In its announcement of the acquisition, Amazon said it had no current plans to lay off Whole Foods employees and Whole Foods founder, John Macke, will remain as CEO. Both Whole Foods and Amazon stock have gained value following the bid announcement, and the closing. If current trends continue, the rise in Amazon’s stock value could surpass the $13.7 billion price tag of the acquisition.

The stock value of traditional grocers plunged with the announcement. Kroger, Food Lion, Giant, Sprouts, and Supervalu were amongst the losers, as were major multiline chains that feature groceries like Walmart, Target, and Costco. Since the deal was announced in June, shares of grocery-store companies have taken a beating. Cumulative stock value losses in the immediate aftermath of the announcement were $22 billion, and now, there has been an additional loss of $12 billion in value to six of the largest food retailers.

Many analysts in the business expect grocery stocks to fall even further.

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the vision: On August 24th, Amazon issued a press release stating its plans for Whole Foods. By the time the deal closed on the following Monday, banners reading “We’re growing something good - Whole Foods + Amazon” already hung over the grocer’s entry ways, and many of the recently announced plans had already taken effect.

AMAZON’S PLANS FOR WHOLE FOODS INCLUDE: •

• •

• •

Lower Prices: Amazon has begun slashing prices to make healthy and organic food affordable for everyone, focusing particularly on reducing the prices of products that tend to be pricier and are targeted at core shoppers.

Online Grocery Shopping: Whole Foods’ privatelabel products are now available through Amazon. com, AmazonFresh, Prime Pantry, and Prime Now. Amazon will continuously be adding the full array of products to their online platform.

Using Whole Foods Locations to Showcase Amazon Products: Since August 28th, Amazon has set up displays featuring their products within Whole Foods stores. They now offer Echo and Echo Dot devices at a steep discount. It remains to be seen what other merchandise will be added.

• •

• •

Amazon Prime: Integrating Amazon Prime (estimated at 60 million members) as the point-ofsale system and Whole Foods customer rewards program for “special savings and in-store benefits” which will provide Amazon with a data-centric personalized marketing tool.

Amazon Lockers: Doubling as distribution centers, in select locations, Amazon Lockers will be introduced providing customers the option to have items shipped from Amazon.com to their local Whole Foods or return items to Amazon during a grocery shopping trip.

This is just the beginning for Amazon. Amazon and Whole Foods Market plan to offer more in-store benefits as they work together to integrate logistics, and point-of-sale and merchandising systems. Other theories being discussed in commercial real estate news regarding the impact on Whole Foods, the grocery category, and grocery anchored centers include increased home delivery, introduction of new product categories, increased targeted digital marketing and improved bargaining leverage with vendors and suppliers.

The impact: POTENTIAL IMPACT ON OTHER GROCERS Stock market investors are preparing for the worst and bidding down the value of traditional supermarket chains. Drops in valuation make it more difficult for grocers to finance property upgrades and other competitive initiatives.

“

The longer-term challenge for the grocery industry is to effectively respond to Amazon’s soon-to-beimproved marketing and its hold on Millennials, who are coming into their own as a dominant consumer segment.

”

Anticipated price wars will put even further downward pressure on competing grocers. In the past, Amazon is known for selling items at break-even or even at a loss to gain market share. Many analysts predict that competing grocers may not be able to keep up since Amazon has begun lowering Whole Foods’ prices while still maintaining their commitment to high quality.

As a first line of defense, traditional grocery chains like Safeway, Kroger and multi-line

merchants such as Walmart and Target are increasing their digital marketing efforts. Some grocers are even cutting down on their plans for expansion to invest more in digital initiatives. For example, Kroger has reduced its store openings in 2017 from 100 to 55 to further cater to its digital platform. Major chains have also been moving into organic meats and produce, and increasing prepared fare as smart ways to boost margins. This trend will likely be accelerated in the near term, especially in market areas that include a Whole Foods store. However, these merchants primarily use “memberships” and other marketing platforms simply as a gateway to discounts, and are at a disadvantage when it comes to having corresponding data-centric personalization of offers and services.

The longer-term challenge for the grocery industry is to effectively respond to Amazon’s soon-to-beimproved marketing and its hold on millennials, who are coming into their own as the dominant consumer segment. Unless grocery merchants can adopt data-centric targeted messaging based on purchase histories and digital footprints, they are at a distinct disadvantage to Amazon-like personalized marketing and are likely to see market share erosion over time.

We have already seen this trend with large chains like Kroger, whose shares have plunged nearly 35 percent in 2017. With increased competition and

adecrease in sales, Kroger has been forced to reduce its profit forecast for the year by10 percent.

POTENTIAL IMPACT ON WHOLE FOODS ANCHORED SHOPPING CENTERS: In the near term, Whole Foods is likely to remain strong and possibly receive a bump in traffic due to publicity about the Amazon acquisition. And if Amazon’s well-known expertise in process management and logistics can improve Whole Foods’ operations, property owners and managers have a winner on their hands. However, cautious optimism is prudent as there are likely to be bumps along the way, as even Amazon has had several failed attempts.

WHOLE FOODS & AMAZON LOCATION OVERLAP MAP

WHOLE FOODS LOCATIONS AMAZON LOCATIONS SOURCE: CREDiFi M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

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at innovative concepts in the past. Even if Amazon is successful, challenges are expected. Lower prices and the introduction of Amazon Lockers will drive additional traffic. This trend may be further exacerbated in the future if Amazon introduces new product categories and non-grocery Amazon items. Higher foot traffic may challenge parking requirements for both Whole Foods and their co-tenants, in turn rendering current locations insufficient to serve the new Whole Foods model. In some cases, new product categories may also step on the toes of other shopping center merchants.

Owners are advised to check their exclusivity clauses and be prepared for issues, especially with Amazon’s bargaining power as a credit grocery anchor. On the other hand, if Whole Foods eventually evolves into a combination of grocery store and warehouse that skews heavier towards food delivery than in-store purchases, traffic to centers may suffer down the road.

FOR MORE INFORMATION REGARDING GROCERS AND GROCERY ANCHORED SHOPPING CENTERS PLEASE CONTACT:

LINDSAY TSUMPES LINDSAY.TSUMPES@MATTHEWS.COM

(310) 880-8418

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With these new factors in play, the ideal size of the future physical Whole Foods footprint is uncertain.

Whole Foods may need more space to account for increased storage, distribution, and product, or on the flip side, may downsize by creating smaller 365 Whole Foods stores more similar to Amazon Go.

POTENTIAL IMPACT ON CENTERS ANCHORED BY NON-WHOLE FOODS GROCERY STORES Amongst other grocers, there will continue to be winners and losers, and over time grocer margin erosion is likely. Nonetheless, investors’ appetite for a grocery anchored product is expected to remain strong as Whole Foods rivals innovate and evolve to more directly compete with Amazon. Increased scrutiny is prudent as owners should gain a better understanding of the grocer’s plans for the future – not just facelifts, but also monitoring if the grocer is making adjustments to the product mix, marketing, and operations, as well as making sure the space fits the grocer’s requirements moving forward.

OUR TAKE - RETAIL IS NOT DYING. IT’S CHANGING. Despite the uncertainty and speculation, Amazon is reinforcing retailers’ needs to have a physical footprint.

As Amazon works to pioneer a true omnichannel strategy that provides consumers with a seamless and interactive transaction experience, the perception of what constitutes an anchor is changing. An anchor is no longer necessarily thought of as the biggest tenant.

Tenants are right sizing while food, beverage, and entertainment tenants are the new anchors. Focus has shifted from leasing to merchandising as landlords need to dedicate more energy to curating their shopping centers’ uses. Common area experience has become just as important as the in-store experience leading to decreased coverage and increased common area.

However, not all retail is well located nor can all retail be experiential. Poorly located shopping centers will continue to die as will retailers that cannot evolve to provide an engaging shopping experience that beats the online click of a button.

One of the most far-reaching advantages e-commerce has had over brick-and-mortar is data collection. As of yet, landlords and tenants have not figured out how to effectively collect, evaluate, and monetize the

information they have. If retailers and owner/developers can solve for this piece in brick-mortar-stores, it will have a leveling effect through true omnichannel embodiment. Amazon is working to accomplish this and is currently in the lead through the infrastructure provided by Prime.

With Amazon’s purchase of Whole Foods, we are witnessing the merger of e-commerce with retail, and are entering a new world of change in retail centers. Expect this trend to continue at an accelerated pace. Future consolidation of grocers is a likely possibility while we will also continue to see the trend of smaller format grocers; however, if using Whole Foods locations as distribution centers is successful, the ideal future footprint for Whole Foods may buck the overall industry trend.

Moving forward, which competing grocers will step up to the challenge Amazon has presented? Historical performance of a shopping center is becoming a weaker indicator of future success. Every center is highly unique and should be evaluated individually for its potential to fit with evolving retail trends.

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mix it

up

For years, landlords have attempted to find the perfect harmonious synergistic tenant mix in their commercial properties and whether it involves a daily needs shopping center in Los Angeles or a new food hall in a 20,000 SF basement in Manhattan, the goals have always been aligned. But it’s not just about maximizing net income and reducing vacancy, it’s about finding the right balance.

Q&A How can landlords create the ‘right balance’ in their shopping centers?

The answer is simple and comes down to two critical elements. The first, having the right team in place that is effectively communicating and whose goals are aligned. Your asset manager is thinking four steps ahead. Your property manager is keeping the property bright and clean. Your leasing broker has prospective tenants lined up months before a tenant vacates. The second element is keeping up with the times.

The retail sector is undergoing some major changes. Are there any specific changes that have stood out to you?

One thing that you can always count on when it comes to commercial real estate is change. Change in ownership, change in management, change in operating expenses and of course change in tenant

Michael Pakravan, SVP and National Director of Leasing for Matthews™, discusses what landlords and owners should do to create their centers signature cocktail of tenants.

mix. It may feel like e-commerce has completely destroyed the retail sector and that we will never recover from the drastic change in consumer behavior.

The truth is that the retail sector has always undergone change and will always continue to do so. There will always be a new technology every few years to shake things up.

Both Retail and CRE experts have advised creating an experience for consumers in order to avoid the possibilities of vacancies in centers. Thoughts?

Studies have shown that people who spend their money on experiences rather than things, are inherently happier people. Multiply that theory by the fact that people can buy clothes sitting on their couch in subscription form at two am on a Tuesday, with no delivery fee, and you have a formula for huge vacancies in the retail sector right? Wrong. Vacancy doesn’t have to mean failure, but instead opportunity.

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What are the types of tenants absorbing vacant spaces in the current retail cycle?

Make way for fitness, service, medical, entertainment and of course more food!

From large format gyms like Equinox to large format discount gyms like Planet Fitness or Crunch, the sector is growing with no end. Let’s not forget all the crossfit gyms or specialty fitness gyms like Soul Cycle, Club Pilates, ILoveKickboxing, Core Power Yoga, Bar Method, the list goes on and on. What’s unique about this growing tenant type is that they are expanding into all different types of demographic areas and different sized spaces. So whether it’s a vacant 40,000 SF Sports Chalet that LA Fitness is moving into, there seems to always be fitness tenants interested in just about every vacancy no matter size or location.

52%

of consumers are likely to switch brands if a company doesn’t make an effort to personalize communications to them

SOURCE: SALESFORCE

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Continuing on the health and beauty trend, there has been a huge increase in demand in the service sector. It’s not just about hair and nails anymore.

European Wax Center and Massage Envy seem to be popping up in every neighborhood, as well as men’s grooming businesses such as Floyd’s Barbershop or John Allen, which also happens to be a subscription or membership club -see a trend here? And if you’re not waxing, cutting or shaving your hair off, you can visit the local Laser Away to zap it off. I hear if you buy a package of 6 treatments, you get a free Botox session! Right in line with the burst in health and beauty services, landlords have also been leasing prime retail locations to medical tenants. 20 years ago, we never would have thought that a pad building out in front of a grocery anchored center would be prime real estate for a dentist. Companies like Pacific Dental and Western Dental have proven this to be a winning combination for both the tenant and landlords. Urgent Care facilities have also been chasing prime retail locations in a wide range of demographic markets.

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87% of customers think that brands need to put more effort into providing A

CONSISTENT EXPERIENCE SOURCE: Accenture

Entertainment uses have also been on the rise, more evidence shows a behavioral shift in consumers choosing to pay for experience instead of tangibles.

Lucky Strike, Dave and Busters, Top Golf are just a few of the major players in the marketplace today.

Concepts like escape rooms, “barcades” and trampoline parks such as Skyzone or Urban Air have also developed cultish followings by consumers. of consumers are likely to We’re also seeing a big switch brands if a company doesn’t surge make of an new effortrestaurants to personalize communications to them adding to shopping centers.

How does this tenant type vary from the fitness, service, medical, and entertainment sectors?

While the tenant types above have filled the physical void or vacancy in commercial buildings, restaurants have filled a different void or vacancy- the psychological

more than 50% of organizations will redirect their investments to customer

experience innovations SOURCE: GARTNER

void. Restaurants are the new anchors for commercial property. They drive people out of their homes and into shopping centers and malls. In the past, people would leave their homes to go shopping and would just happen to eat. Today, people leave their homes to eat and happen to shop. Food and beverage have always brought people together socially either at restaurants, bars or coffee shops. It’s also another opportunity to announce to your friends and followers on social media that you were special enough to of consumers are likely to switch brands if a company doesn’t visit the new B- List celebrity infested Indonesian make an effort to personalize restaurant. Restaurant growth in the country is at an communications to them all-time high. The choice used to be between cooking at home or going out. Today, it seems like the choice is between going out and Postmates, adding a different dynamic for restaurants and an additional source of revenue, translating to the ability to payer higher rents.

No complaints from landlords there.

MICHAEL PAKRAVAN MICHAEL.PAKRAVAN@MATTHEWS.COM (310) 919-5737

consumers expect a consistent experience wherever they engage (e.g., website, social media, mobile, in person)

75%

SOURCE: SALESFORCE

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II SS TT HH EE V VA A LL U U EE O O FF

YO U R A S S E T D E P R E C I AT I N G ?

BBYY CC HH AA DD KK UU RR ZZ

IfIf you you were were offered offered aa Walgreens Walgreens property property inin aa secondary secondary market market at at aa 3.80 3.80 percent percent return, return,you youwould wouldbe bedumbfounded. dumbfounded.Most Mostinvestors investorsare aresmart smartenough enoughto toknow knowthat thatmost most Walgreens Walgreens properties properties for for sale sale on on the the market market are are inin the the five five to to seven seven percent percent cap cap rate rate range. range.However, However,when whenlooking lookingat atthe theactual actualreturn returnon onthese thesetypes typesof ofassets, assets,investors investorsare are receiving receivingcloser closerto tothree threeto tofour fourpercent percentreturn returninstead. instead.Let’s Let’sdetermine determinewhy! why!

At Atthe theend endof of2016, 2016,aaWalgreens Walgreensproperty propertywas wassold soldat ataa5.55 5.55percent percentcap caprate, rate,and andtwo two months months later later another another Walgreens Walgreens was was sold sold at at aa 7.35 7.35 percent percent cap cap rate. rate. When When looking looking at at both bothassets, assets,almost almosteverything everythingwas wasidentical: identical:same sametenant, tenant,absolute absoluteNNN NNNlease, lease,aasimilar similar market market inin the the same same MSA, MSA, and and identical identical market market conditions. conditions. So, So, what what was was the the significant significant difference difference that that affected affected the the cap cap rate rate change? change? The The answer, answer, the the first first asset asset had had 19 19 years years remaining remainingon onthe thelease leaseand andthe thesecond secondhad hadonly onlyfive fiveyears yearsremaining. remaining.

W H AT C O N D I T I O N S A F F E C T

Cap Rates?

LO C AT I O N

LEASE TERM

STRENGTH OF GUARANTEE

PERFORMANCE

The better the location, the lower the cap rate

The longer the lease term, the lower cap rate

The stronger the tenant’s guarantee, the lower the cap rate

The better the tenant’s performance (store sales), the lower the cap rate

RENT INCREASES

MARKET RENT

The greater the rent increases, the lower the cap rate

The lower the rent comparaed to market, the lower the cap rate

MICROECONOMICS MACROECONOMICS The more robust the tenant’s outlook, the lower the cap rate

When comparing the two assets, all the factors are nearly identical. One could argue that the Walgreens with only five years remaining is a superior asset; the store sales are above the national average, and the rent is below the national average for a Walgreens. Conversely, for the Walgreens with 19 years remaining, the store sales were below the national average and rent was above the national average. Thus, why did the Walgreens with five years remaining sell for 180-basis points higher than the Walgreens with 19 years remaining? Again, the answer is the difference in lease terms which causes the arbitrage in cap rates.

The stronger the tenant’s conditions, the lower the cap rate

The property with 19 years remaining is a depreciating asset because the cap rate rises as the lease term wears off. To expand, as the denominator increases and the numerator remains the same, it creates a lower value. Therefore, it is safe to assume that if all conditions remain the same throughout the 14 years, the asset will be worth 32 percent less than the original purchase price. It’s important to remember, we are judging a below average performing longterm lease compared to an above average short-term lease. If sales remain below average for the entirety of ownership, the asset would be worth even less and the average return would be even lower.

C U R R E N T VA L U E O F P R O P E R T Y Assuming the rent is $400,000 for the asset and the buyer purchases it at a 5.55 percent cap rate, the value equals $7,207,207. $400,000 (Net Operating Income) 0.555 (Cap Rate)

=

$7,207,207 (Value of Property)

F U T U R E VA L U E O F P R O P E R T Y Walgreens’ leases are flat, meaning that there is no rent growth and the NOI does not increase over time.

However, because there is a difference in cap rates between where a 19-year lease would trade compared to where a five-year lease would trade (Âą180 basis points), there is a new value $400,000 (Net Operating Income) 0.735 (Cap Rate)

=

$5,442,176 (Value)

As you can see, the value of the property is worth $1,750,031 less compared to what it was worth when the owner first purchased it. This change in price prompts the question, what is the total return?

Assuming the buyer did not use debt to acquire the property, the total return is much lower than the original 5.55% cap rate that the buyer purchased the property for. The buyer received $400,000 per year for 14 years resulting in a total of $5,600,000. $400,000 per year (Net Operating Income) x 14 years = $5,600,000 (Total Rent Recieved)

In the 14 years, the property will be worth $1,765,031

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less than what the owner originally paid for the investment- providing a total return of $3,834,969 over the 14-year period. $5,600,000 (Total Rent Recieved)+(1,765,031) (Difference in Equity) = $3,834,969 (total return)

Because the owner originally purchased the property at $7,207,207 the landlord’s total return is much lower than the actual cap rate which they acquired the asset.

While the owner is receiving $400,000 of income they are losing $126,074 of equity per year. $3,834,969 (Total Return) 14 (Number of Years)

$273,926 (Total Annual Return) $7,207,207 (Initial Investment)

=

$273,926 (Total Annual Return)

3.80% = (Total Annual Return as a Percentage)

In analyzing the data, the biggest arbitrage between the lease term and cap rate occurs once the lease term drops below ten years. In our findings, we conclude that there is roughly a 35-basis point spread in cap rates between 20 years and 15 years.

However, between 15 years and ten years, there is a 52-basis point spread, and between ten years and five years, there is a 110-basis point spread in cap rates.

Once the asset drops below five years, it becomes challenging to get an accurate read on the cap rate arbitrage. Therefore, many single-tenant net-lease assets are depreciating investments due to the cap rate arbitrage as the lease term expires.

S O , H O W C A N YO U AV O I D Y O U R A S S E T F R O M D E P R E C I AT I N G I N VA L U E ?

INCREASE RENT

INVEST IN CORE REAL E S TAT E M A R K E T S

Having rent increases throughout the lease term is

In our study, we found that the cap rate arbitrage in

incredibly important because as the cap rate increases

core markets experience about half the rise in cap

(denominator), the NOI also increases (numerator)

rates compared to non-core markets. Therefore,

which helps to preserve the value of the asset. In the

a Walgreens in an affluent area such as Miami, FL,

example above, a Walgreens with a 10 percent rent

might only experience an increase of 90-basis points

increases every five years would provide approximately

compared to the 180-basis points. Thus, providing 20

46 percent greater return over the 14 years.

percent greater annual return over the 14 years.

STRONG STORE PERFORMANCE

SELL BEFORE THE ASSET DROPS BELOW TEN YEARS

Additionally, we found that strong store performance

In analyzing the data, a single-tenant net-leased asset

experienced roughly half of the depreciation that a

rises roughly 85-basis points between year 20 to year

store with below average performance experiences.

10. However, in the next five years, the asset sees a

In our example above, a strong performing site would

rise of 110-basis points. In the Walgreens example,

provide roughly a 10 percent greater annual return

the investor would have received a 10 percent higher

than an average performing store and a 20 percent

annual return by selling after nine years compared to

greater annual return than a below average performing

selling after 14 years.

store. In our example, the five-year deal was a strong performance site.

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If the owner would have purchased astrong performing store, with rent increases, in a core market, and sold it after ten years, they would have received a 171 percent greater return on an annual basis.

The most frequently asked question is: if all of this is true, why did my asset appreciate over the last decade?

The simple answer is a significant market shift. For example, over the past decade cap rates were consistently 100 – 200 basis points higher than they are in today’s market. In 2010, a Walgreens with 20 years on the lease was trading in the mid 6 percent range. In 2016, that same Walgreens deal was trading around a low 5 percent cap rate. If you’re willing to bet the market will continue to improve, you likely don’t have much risk in terms of depreciation. If the market remains the same as it is today, expect a significantly lower overall return than the actual cap rate you’re purchasing the property at. However, if the recent pattern of cap rates rising continues, investors will likely see an even lower overall return. More importantly, investors could be in a very difficult position a decade from now especially, if they have a loan.

The question then becomes - what should you buy?

It is recommended that an investor purchases an asset class that will not be affected by e-commerce, and the lease reports store level financials. Additionally, it is necessary to take the location of a property into consideration. A promising property is located in a stable metropolitan area with strong expected population growth, and rising rental market. Lastly, an investor must ensure that they find an asset that provides rent increases throughout the term of the lease and ensures that current rent is below or in-line with market rent.

There are still a great number of deals in the net lease world, but it’s important to focus on the total return of the investment over the estimated hold period. Furthermore, investors should avoid analyzing an investment based solely on the current cap rate or current cash flow.

In today’s market, be careful you are not purchasing a six percent cap rate that provides a three percent overall return.

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For more information, contact: Chad Kurz chad.kurz@matthews.com (214) 692-2927

2017

Multifamily Market report CALIFORNIA | TEXAS

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Orange County By: David Harrington

DAVID.HARRINGTON@MATTHEWS.COM DIR: (310) 295-1170

Average cap rates Cap rates compressed in the second quarter to 4.25% as compared to first quarter sales that came in at a 4.53% cap rate average. This 6.2% difference is likely due to supply constraints and the overall lack of deal volume. Also, the smaller deal size attracts a larger buyer pool, and this added competition will create higher pricing by applying pressure on buyers to stretch.

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Q2

Average price per unit The average price per unit in Orange County boasts a very healthy average. The second quarter was $265,676 which is just over a 10% increase from the first quarter average.

Q1 Q2

$240,230

Q1 Q2

$295.08

Q1 Q2

$533.467 M

$265,676

Average price per sf While the cost per unit rose by more than 10%, the cost per square foot was down in the second quarter. This figure was down by nearly 14% from the first quarter average. This is an indicator that the units sold in the second quarter should have been slightly larger in size on average than units sold in the first quarter.

$253.86

total dollar volume While the number of transactions didn’t suffer that severely, the actual dollar volume of deals traded was down by 25% from the first to second quarter of 2017. Pricing moved up on average, so the difference in dollar volume reflects the size of buildings being sold. The first quarter’s average building sold contained 43 units, while the second quarter’s average building sold contained 32 units.

$397.795 M

Transaction volumes For all multifamily transactions of five units or more in Orange County, the number of transactions from the first to second quarter of 2017 were in the same range.

However, second quarter figures were down slightly from the first quarter by 7.6% showing a further decline from the end of 2016 numbers. When looking back at the first and second quarter of 2016, transaction volume in 2017 thus far is generally in the same range.

Q1 TRANSACTIONS

Q2 TRANSACTIONS

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Koreatown -

Average Average price price per per sf sf

AlthoughAlthough the average the average price perprice square perfoot square has foot dropped has dropped NON-RENT CONTROLLED slightly, itslightly, is not enough it is not of enough a dip to of be a dip concerned. to be concerned.

The priceThe price NON-RENT CONTROLLED per square perfoot square in these foot areas in these hasareas always hasbeen always extremely been extremely importantimportant to investors to investors as it gives asan it gives idea of anthe idea type of the andtype size and size of units inside of units ofinside the apartment. of the apartment. $300 per$300 square perfoot square is still foot is still the consistent the consistent average average for rent controlled for rent controlled properties properties and is and is RENT CONTROLLED generallygenerally the sweet the spot sweet for investors spot for investors as they decide as theyon decide what on whatRENT CONTROLLED deals willdeals be purchased. will be purchased.

An explanation An explanation as to whyasprices to why went prices went up, but the up,price but the perprice square perfoot square wentfoot down went could down becould because be because apartments apartments with larger with units larger andunits better and unit better mixes unit were mixes being were being sold in Q2 sold versus in Q2Q1. versus As a Q1. general As a rule, general the rule, largerthe thelarger units,the units, the higher thethe higher pricethe perprice unit, per but unit, will cede but will to acede lower toprice a lower perprice per square foot. square foot.

Q1 Q2

Q1 Q2

$550.47 $550.47

Q1 Q2

Q1 Q2

$307.19 $307.19

$506.15 $506.15

$294.29 $294.29

Total Total dollar dollar volume volume The rise The in overall rise intransactions overall transactions has naturally has naturally led to anled increase to an increase NON-RENT CONTROLLED NON-RENT CONTROLLED in total dollar in total volume. dollar volume.

However,However, there hasthere beenhas a larger been a larger increaseincrease in dollar in volume dollaras volume compared as compared to the increase to the increase in overallin overall transactions transactions (142% vs.(142% 166%).vs.The 166%). increase The increase can be viewed can beas viewed as prices resorting prices resorting back to their backhigher to theirvalues higherseen values in mid-2016 seen in mid-2016 to the end to of the2016, end and of 2016, still aand strong still amarket strongfor market rent controlled for rent controlled RENT CONTROLLED RENT CONTROLLED properties. properties.

The dollar The volume dollarfor volume non-rent for non-rent controlled controlled properties properties saw a drastic saw adecrease, drastic decrease, despite having despitethe having samethe amount same of amount of transactions transactions as rent controlled. as rent controlled.

We are still Weseeing are stillthe seeing spillover the spillover from the from $132the million $132monster million monster sale at 1724 saleNatHighland 1724 N Highland Ave in Ave in Hollywood.

Hollywood.

The volume Theseen volume in Q2 seen more in Q2 closely moreresembles closely resembles what thewhat volume theshould volumebe should throughout be throughout the rest of thethe rest year. of the year.

Q1 Q2

Q1 Q2

$137.140 $137.140 M M

Q1 Q2

Q1 Q2

$96.059 $96.059 M M

$34.687 $34.687 M M

$159.262 $159.262 M M

Transaction Transaction volumes volumes The reports Theof reports a slowing of a real slowing estate real market estateinmarket Los Angeles in Los Angeles have been have greatly beenexaggerated. greatly exaggerated.

As evidence As evidence of the hotofmarket, the hot market, Hollywood Hollywood and Koreatown and Koreatown apartment apartment transactions transactions increased increased by 142% by from 142% Q1 to from Q2Q1 in to 2017.

Q2As in 2017. predicted As predicted from our from last our last publication, publication, the election the election and rising and rates rising caused ratesacaused slight pause a slight pause in the market, in the but market, all signs but all aresigns pointing are pointing up regarding up regarding overall overall transaction transaction volume. We volume. may We not may get tonot theget levels to the welevels saw at wethe saw at the height ofheight 2016, but of 2016, look but for continued look for continued activity throughout activity throughout Q3 Q3 with a natural with aslowdown natural slowdown coming in coming the final in the months finalof months the year. of the year.

Q1

Q1 Q2

Q2

NON-RENT CONTROLLED NON-RENT CONTROLLED

Q1

Q1 Q2

Q2

RENT CONTROLLED RENT CONTROLLED

- Hollywood

By: Greg Amato

GREGORY.AMATO@MATTHEWS.COM DIR: (310) 955-5833

Average price per unit NON-RENT CONTROLLED

The fact that the overall dollar volume increased at a higher rate than transaction volume highlights the market prices rebounding from the small dip seen at the beginning of the year. While there was not an explosion back to 2016 levels, the price per unit in Hollywood and Koreatown for rent controlled properties saw the expected rise as the market found its footing again. The fact we are seeing similar unit values now as seen at the end of 2016 gives the notion that overall, the market is stabilizing and while it may not reach higher levels, it is still very strong and should continue to be.

Q1 Q2

$493,309 $398,704

RENT CONTROLLED

Q1

$198,469

Q2

$221,330

Average cap rates Throughout all of Los Angeles, cap rates and GRM have generally been consistent. The strength and stability of apartments in Los Angeles will always be consistent as compared to other locations and product types across the country. The sweet spot for buyers and sellers on cap rate continues to be around 4%, although we do see sub 4% rates in the nicer parts of the two areas. Buyers are still focusing on sub 16 GRM’s as an indicator of where they feel comfortable purchasing. Rent control laws will always shy away investors from investing in properties that are selling for a multiplier higher than 16 because the restrictions on how much an investor can raise rents to increase their gross rental income limits the returns if the multiplier reaches levels any higher than they are. For this reason, it is why I believe Cap Rates and GRM’s have been the most consistent metric throughout the entire life cycle of our current strong market dating back to 2015.

NON-RENT CONTROLLED

NON-RENT CONTROLLED

NON-RENT CONTROLLED

NON-RENT CONTROLLED

RENT CONTROLLED

RENT CONTROLLED

RENT CONTROLLED

RENT CONTROLLED

4.05% 4.09%

3.70% 4.06% Q1

Q1

Q2

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Transaction volumes South Los Angeles County has had a consistent amount of activity over the last five quarters. Overall, this area averaged 25.8 transactions a quarter with no drastic change from quarter to quarter. The first three months of 2017 has roughly 40% fewer transactions than we saw in Q4 of 2016.

This drop off is likely due to hesitation in the market derived from political uncertainty. After Trump’s election, many potential sellers decided to wait and see how the market would react instead of going through with a sale.

Q1 TRANSACTIONS

Q2 TRANSACTIONS

Average price per unit The average price per unit has also remained relatively consistent when excluding outliers. The spike in Q1 of 2017 may partially be explained by the smaller sample size of transactions. However, the hesitation in the market during that quarter also explains the higher price per unit. Typically, smaller buildings sell for higher prices per door while larger buildings experience economies of scale. Sellers of large buildings would be more sensitive to hesitations in the market which explains why there are fewer large buildings sold that quarter. Thus, resulting in a higher average price per door.

Q1 Q2

$169,067 $192,639

Average Averagecap caprates rates Cap Cap rates rates have have notnot significantly significantly changed changed over over thisthis period. period.

Q2Q2 of of 2016 2016 was was a little a little higher higher due due to to twotwo outliers outliers in in that that sample. sample.

The The increase increase in average in average price price perper square square foot foot tells tells us us that that buyers buyers areare paying paying more more forfor buildings buildings than than they they used used to.to.

However, However, they they areare stillstill achieving achieving thethe same same return return onon their their investment. investment.

This This stagnant stagnant return return insinuates insinuates that that while while building building prices prices have have gone gone up,up, rents rents have have also also gone gone up.up.

Owners Owners areare now now receiving receiving more more revenue revenue forfor their their more more expensive expensive buildings. buildings.

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Q2Q2

Average price per sf The average price per square foot is a useful statistic to compare prices in the market across different buildings of ranging sizes, more so than the price per unit. Over these five quarters, we have seen a steady increase in the average price per foot sold. This increase tells us that while many owners were hesitant to sell in our most recent quarter, sellers who did sell were able to achieve higher prices for their buildings.

Q1 Q2

$228.58

Q1 Q2

$49.884 M

$175.56

Total dollar volume Overall, the total dollar volume declined over the last five quarters. However, the data is somewhat misleading as sale price per deal has remained consistent except for a couple of outliers. Most of the sales in this region are capped at around 3 million dollars. Q1 of 2016 had one $30 million deal and two other deals that sold for roughly $15 million. Apart from those transactions, Q4 of 2016 did not have many large deals close. All in all, the changes in total dollar volume mirror the shifts in the number of transactions.

$165.740 M

SouthLA By: Austin Fisher

AUSTIN.FISHER@MATTHEWS.COM DIR: (424) 220-7261

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Transaction volumes For all multifamily transactions of 5 units or more in the Inland Empire, the number of first quarter transactions far outweighed the amount in the second quarter. The figures reflect a 39% decrease in transactions from quarter to quarter. While difficult to peg an exact reason, a post-election rise in interest rates is the likely cause of many Q4 2016 deals getting pushed into 2017.

Q1 TRANSACTIONS

Q2 TRANSACTIONS

Average price per unit From Fromthe thefirst firstquarter quarterto tothe thesecond, second,the theaverage averageprice price per perunit unitwas wasrelatively relativelyflat. flat. The Theaverage averagebuilding buildingtraded traded ininthis thissubmarket submarketwas was68 68units unitsininsize sizeand andthe thesecond second quarter quarteraveraged averaged$131,930 $131,930per perunit. unit.This Thisisisdown downless less than than1% 1%from fromthe thefirst firstquarter quarteraverage. average.

Q1 Q1 Q2 Q2

$132,420 $132,420

Q1 Q1 Q2 Q2

$519.082 $519.082M M

Q1 Q1 Q2 Q2

$151.99 $151.99

$131,930 $131,930

Total dollar volume Dollar Dollarvolume volumefrom fromquarter quarterto toquarter quarterwas wasdown down36%.

36%.

When Whentransaction transactionvolume volumedrops dropsby bynearly nearly40%, 40%,then then dollar dollarvolume volumeisisbound boundto tobe bedown downsignificantly, significantly,which whichisis what whatwe weare areseeing seeingininthis thiscase. case.

$332.860 $332.860M M

Average price per sf While Whilethe thecost costper perunit unitremained remainedflat, flat,the thecost costper persquare square foot footwas wasdown downininthe thesecond secondquarter. quarter.This Thisfigure figurewas was down downby bynearly nearly13% 13%from fromthe thefirst firstquarter quarteraverage. average. This This drop dropisisan anindicator indicatorthat thatthe theunits unitssold soldininthe thesecond second quarter quarterwere wereslightly slightlylarger largerininsize sizecompared comparedto tothan than units unitssold soldininthe thefirst firstquarter. quarter.

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$132.90 $132.90

Inland Empire By: David Harrington

DAVID.HARRINGTON@MATTHEWS.COM DIR: (310) 295-1170

Average cap rates Cap rates compressed in the second quarter to 5.44% as compared to first quarter sales that came in at a 5.71% cap rate average. This 5% difference is likely due to supply constraints and the overall lack of deal volume.

However, the same upward pressure on pricing is not seen in cost per unit or cost per foot in this market.

Q1

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Tri Cities By: By: michael michael astorian astorian

MICHAEL.ASTORIAN@MATTHEWS.COM MICHAEL.ASTORIAN@MATTHEWS.COM DIR: (818) DIR: (818) 923-6123 923-6123

Transaction volumes Transactions stayed relatively steady quarter over quarter with Q3 2016 having the highest amount at 41.

Overall the average was about 32 sales per quarter. Q2 2016 had the lowest number of transactions at 25, as well as the lowest total dollar volume at $66,227,000.

Q1 TRANSACTIONS

Q2 TRANSACTIONS

Average Averagecap caprates rates Cap Cap Rates Rates got got more more aggressive aggressive towards towards the the end end ofof Q3 Q3 2016 2016 but but increased increased toto anan average average ofof 3.90% 3.90% byby the the end end ofof Q4, Q4, which which went went against against the the high high average average price price per per unit unit and and high high average average price price per per square square foot. foot.

When When prices prices dropped dropped inin Q1Q1 2017, 2017, cap cap rates rates started started toto decline decline asas well. well.

Q1Q1

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Q2Q2

Average price per unit The average price per unit increased steadily from Q1 2016 to Q4 2016 by 74% but then dropped by 27% in Q1 2017. Q4 2016’s average price per unit was $380,703, which was way above the average of $275,755 throughout 2016 and into 2017.

Q1 Q2

$276,573

Q1 Q2

$102.609 M

Q1 Q2

$338.49

$189,391

Total dollar volume Q2 2016 came in with the lowest total dollar volume, but the average price per unit and price per square foot increased. Total dollar volume was rising steadily into Q3 and Q4 of 2016 but dropped by 65% in Q1 2017.

$85.984 M

Average price per sf The average price per square foot increased steadily from Q1 2016 to Q4 2016, with a dip in Q3 2016. Overall the average price per square foot started at $282.77 at the end of Q1 2016 and reached $398.67 by the end of the year. This metric dropped at the end of Q1 2017 by 15%, just like the average price per unit fell into the new year.

The decline could be a factor of the 10-year Treasury, which increased in November of 2016, impacting interest rates. This change in rates caused the cost of capital to increase and prevented investors from paying prices like $398 per square foot and $380,000 per unit. By the end of Q4 2016 and going into Q1 2017, investors could no longer afford the prices they were paying before.

$364.62

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Average price per sf Average Averagenon-rent non-rentand andrent rentcontrolled controlledprice priceper persquare square foot footboth bothhad hadoutliers outliersininQ2 Q2affecting affectingthe theaverage. average.

We Wesaw saw$264.40 $264.40ininQ1 Q1and and$169.13 $169.13ininQ2 Q2ininnon-rent non-rent controlled controlledproperties, properties,and and$246.35 $246.35ininQ1 Q1and and$156.41 $156.41inin Q2 Q2ininrent rentcontrolled controlledproperties. properties.ItItisisimportant importantto tonote note that thatan anaccurate accuraterepresentation representationof ofboth bothrent rentcontrolled controlled and andnon-rent non-rentcontrolled controlledassets assetsininQ2 Q2would wouldbe beabove above $200 $200aasquare squarefoot. foot.

NON-RENT NON-RENT CONTROLLED CONTROLLED

Q1Q1 Q2Q2

$264.40 $264.40 $169.13 $169.13

RENT RENT CONTROLLED CONTROLLED

Q1Q1 Q2Q2

$246.35 $246.35 $156.41 $156.41

Total dollar volume Q1 saw more than 92 million dollars in transaction volume with it’s 13 transactions, and Q2 saw a huge jump of 834 million dollars in transaction volume with nine transactions. The large discrepancy came in part by a portfolio sale from IMT a large developer of multifamily assets, in which they sold off newly developed properties in Sherman Oaks and Encino. Rent controlled multifamily assets had much less of a difference between the two quarters and saw roughly 79 million in transaction volume in Q1 and 83 million in Q2.

NON-RENT NON-RENT CONTROLLED CONTROLLED

Q1 Q2

$92.296 M $834.870 M

RENT RENT CONTROLLED CONTROLLED

Q1 Q2

$78.349 M $83.154 M

Transaction volumes Year over year transaction volume has seen a significant decrease, and Q1 and Q2 of 2017 has kicked off to a slower start than previous years. As expected there has been a slowdown in trading volume with non-rent controlled assets caused by less inventory of these properties in the San Fernando Valley, and investors have been incentivized to hold these properties as Los Angeles continues to see rent growth. Q1 saw 13 nonrent controlled transactions while Q2 experienced nine.

There was more activity with rent controlled properties which saw 27 transactions in Q1 and 32 transactions in Q2.

The slowing of transaction volume can be attributed to uncertainty in areas such as interest rates, tax policy, new Los Angeles laws and regulations, and the growing gap between buyer and seller pricing expectations, among others. Q3 and Q4 will begin to tell us whether the market is just revving its engine or beginning to stall out.

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Q1

Q1

Q2

Q2

NON-RENT NON-RENT CONTROLLED CONTROLLED

Q1

Q1

Q2

Q2

RENT RENT CONTROLLED CONTROLLED

San Fernando

Valley By: aaron guido

AARON.GUIDO@MATTHEWS.COM DIR: (310) 295-4335

Average price per unit The average price per unit in Q1 for non-rent controlled properties was $315,000 while Q2 saw a much lower $179,697. This disparity was caused by outlier transactions in both Q1 and Q2, shown by the median price per unit of $277,778 in Q1 and $237,500 in Q2. Rent Controlled properties achieved an average of $199,474 in Q1 and then saw a dip of $147,697 in Q2.

NON-RENT CONTROLLED

Q1 Q2

$315,002 $179,697

RENT CONTROLLED

Q1

$199,474

Q2

$147,697

Average cap rates Cap rates continued to stay compressed in non-rent controlled properties thanks to the aggressive pricing and competition surrounding the assets. Q1 saw an average of 4.13% and Q2 had a slight uptick of 4.33%. Rent controlled properties saw an average of 4.39% in Q1 and 4.58% in Q2. Even with the continued difficulty of extracting upside through turning over units in rent controlled properties, cap rates remain low.

NON-RENT CONTROLLED

NON-RENT CONTROLLED

RENT CONTROLLED

RENT CONTROLLED

Q1

Q2

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Long Long Beach Beach By: jim brandon By: jim brandon

JIM.BRANDON@MATTHEWS.COM JIM.BRANDON@MATTHEWS.COM DIR: (310) 955-5836 DIR: (310) 955-5836

Transaction volumes For all multifamily transactions in the Long Beach area of five units or more, the number of first quarter transactions was equal to the amount in the second quarter. The figures reflect a steady demand for Long Beach multifamily. While difficult to peg an exact reason, many of the transactions are actually off-market – as less than half were at one point listed.

Q1 TRANSACTIONS

Q2 TRANSACTIONS

Average Averagecap caprates rates TheThe capcap rates rates compressed compressed by a bylow a low 5%,5%, as expected as expected in ainmarket a market thatthat hadhad equal equal transactions, transactions, butbut slightly slightly higher higher overall overall dollar dollar volume. volume.

ThisThis suggests suggests thatthat buyers buyers areare continuing continuing to aggressively to aggressively approach approach Long Long Beach Beach multifamily. multifamily.

Q1Q1

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Q2Q2

Average price per unit The price per unit saw a smaller change in Q2, increasing about 5% from the first quarter average. The likely cause is larger units, on average – in addition to higher prices – being sold in the second quarter, although the average number of units remained consistent.

Q1 Q2

$177,365 $187,062

Total dollar volume Dollar volume from quarter to quarter was nearly equal, only increasing slightly in a steady market, but should see an increase in the second half of the year.

Average price per sf In a nearly identical market, the cost per square foot saw the greatest change in Q2, increasing about 11% from the first quarter average. The likely cause is smaller units, on average, being sold in the second quarter.

Q1 Q2

Q1 Q2

$153.421 M $161.808 M

$261.49 $289.91

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Transaction volumes In the review of 2016, there was a total of 139 transactions in San Antonio. The number of transactions for Q1 and Q2 averaged roughly 29 sales, while Q3 and Q4 jumped up to 41 sales. During the first quarter of 2017, transactions settled down with a total of 23 sales.

Though, as San Antonio is set to be one of the fastest growing economies, and the Metroplex continues to grow, there is minimal concern for an economic setback.

Q1 TRANSACTIONS

Q2 TRANSACTIONS

Antonio

SSaann

By:By: Craig Craig Irvin Irvin

CRAIG.IRVIN@MATTHEWS.COM CRAIG.IRVIN@MATTHEWS.COM DIR:DIR: (214) (214) 692-2055 692-2055

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DallasFort Worth By: Danny Mcquaid

DANNY.MCQUAID@MATTHEWS.COM DIR: (214) 932-1284

Transaction volumes

The momentum from 2016 carried into the first quarter of 2017 in the Dallas-Fort Worth multifamily market, as there was a total of 107 transactions in quarter one. Volume slowed down in quarter two, as quarter two saw only 73 total transactions. With over 35,000 units expected to be delivered in 2017, the slow down we see in quarter two is likely due to the amount of supply coming on to the DFW Market. This has caused buyers to become more cautious within the Dallas-Fort Worth market.

Q1 TRANSACTIONS

Q2 TRANSACTIONS

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Transaction volumes Transaction volume in 2017 has cooled off from 2016 where the last two quarters of the year hit 56 transactions each. In 2017, the City of Houston saw a total of 57 transactions combined for the first half of the year.

The first and second quarters of this year saw a very consistent number of transactions with 31 transactions in the first quarter and 26 transactions in the second.

n o t s Hou Q1 TRANSACTIONS

Q2 TRANSACTIONS

By: Nick By: Nick DellDell

NICK.DELL@MATTHEWS.COM NICK.DELL@MATTHEWS.COM DIR: (214) DIR: 932-9155 (214) 932-9155

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Austin

By: Craig Irvin

CRAIG.IRVIN@MATTHEWS.COM DIR: (214) 692-2055

Transaction volumes

Looking at the numbers, the first two-quarters of 2017 slowed down from 70 transactions at the end of 2016 to a total of 72 transactions in 2017. When comparing the first quarter to the second quarters transaction volume, the two came in at a close tie. Quarter one had a total of 34 transactions with quarter two only bringing in an extra four transactions to take the lead with 38 total.

This similarity in transaction volumes indicates investors comfortability in the marketplace. As the market has been relatively consistent, we can expect more deals to become available allowing for more transactions to occur in the coming quarters. As Austin is reported to grow by more than 30 percent over the next 15 years according to the Urban Institute, the number of transactions in the market are expected to rise.

Q1 TRANSACTIONS

Q2 TRANSACTIONS

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BY AARON GUIDO & DANIEL SHIEH While face-offs between tenant advocates, proper ty owners and developers are common, the super-hot Los Angeles metro area is experiencing a raft of new laws and ordinances that favor tenants.

The legislative onslaught buttresses the City’s Rent Stabilization Ordinance (RSO), which applies to apar tments, townhomes, and housing that fall under the umbrella of rent-controlled units.

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N E W A N D P R O P O S E D L AW S I N C LU D E :

A change to “Cash for Keys” tenant buyouts notifications Creation of a Public Rent Registr y Allowance for non-conforming “bootlegged” units in areas zoned for multifamily Just-cause Evictions for non-rent control units Potential repeal of the Costa-Hawkins Act Matthews ™ takes a look at LA’s new ordinances and laws to provide owners and developers with strategies to respond to a changing regulator y landscape.

C

A

S

H

F

O

R

K

E

Y S

The City of Los Angeles passed ordinances in September and December of 2016 that created more r igid guidelines for landlords who are pursuing “cash for keys” tenant buyouts. Tenant buyouts are a popular practice for proper ty owners in a hot housing market like Los Angeles, where landlords can remodel freedup units and demand higher rents.

Under the original ordinance, a landlord is required to pay the current tenant a specific amount of money when they relinquish the unit. The new RSO ordinance specifies exactly how the tenant is informed. A landlord is required to provide a disclosure notice that states all the tenant’s rights in a buyout process, including a stipulation of language that states “You (tenant name), may cancel this Buyout Agreement any time up to 30 days after all par ties have signed this Agreement without any obligation or penalty.”

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Besides the specific language, the owner is free to create the terms of the buyout. The Housing Depar tment of the City of Los Angeles has the terms for both landlords and tenants listed on their website at www.hcidla.lacity.org/buyout-agreements. Among the provisions of the ordinance:

LANDLORD

TENANT

1. Before making a buyout offer, the landlord must

1. The tenant is not required to accept or sign the

give to the tenant the RSO Disclosure Notice, which must be signed and dated if the tenant chooses to accept the offer.

2. The Buyout Agreement must be in the primar y

language of the tenant.

3. The Buyout Agreement must contain in 12 point

bold language above the signature line as follows: “You, (tenant name), may cancel this Buyout Agreement any time up to 30 days after all par ties have signed this Agreement without any obligation or penalty.”

4. The landlord must file a copy of the signed and

dated RSO Disclosure Notice and Buyout Agreement with HCIDLA within 60 days of both par ties signing the Buyout Agreement.

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Buyout Agreement.

2. The tenant may consult with an attorney or call

HCIDLA prior to accepting the landlord’s offer.

3. The tenant may cancel the Buyout Agreement

up to 30 days after signing it without obligation or penalty.

4. If the owner does not comply with the

requirements above, then the tenant has the right to cancel the Buyout Agreement for any reason at any time without obligation or penalty.

5. If the owner does not comply with the requirements

above, then the tenant may asser t an affirmative defense to an Unlawful Detainer action and may have a private civil remedy against the owner.

P U B L I C

R E N T

R E G I S T R Y

Passed in December of 2016 and effective Januar y 2017, the City of Los Angeles approved a mandatory rent registr y where landlords must provide the rent amount for ever y rent controlled (RSO) unit they own. This information will then be posted to a public registr y, where tenants will have access to the information, and can dispute any discrepancies.

The Public Rents Registr y was created in order to place a check on owners who may be illegally increasing rents on rent-controlled units. Completing the process will gr ant an owner a registr ation cer tificate, and without the cer tificate an owner will not be legally allowed to collect rent from an RSO unit. For the first year of the registration (2017), owners who have not completed registration will receive a provisional cer tificate, but 2017 will be the only year that provides for a provisional cer tificate.

Registration is due by the last day of Februar y of each year. To register, visit the City of Los Angeles Rent Registr y at www.hcidlabill.lacity.org.

ALLOWANCE FOR NON-CONFORMING “BOOTLEGGED” UNITS

Hoping to help ease the housing crisis, The City of Los Angeles passed a law in May of 2017 granting legal allowance for multifamily “bootlegged” units that do not conform to area zoning restrictions.

Each year the City identifies 600 to 700 bootlegged units, many of which are dubbed non-conforming and thus are vacated by order. Instead of ordering vacancies of these apar tments, the new law makes it easier for landlords to legalize them as long as they guarantee the multifamily complex will incorporate a minimum of one low-income unit for a period of at least 55 years.

The goal of the legislation is to clear red tape that stands in the way of recognizing available housing units in a city plagued with a severe undersupply.

According to Har vard Joint Center for Housing Studies, Los Angeles residents spend more than half their income on rent. With the new addition of lowincome units, the city hopes to help ease Angelinos who are struggling with housing costs.

The bootlegged apar tments must meet fire, life, and safety codes, and must have been occupied for a period between December 11, 2010, and December 10, 2015. The required dates are meant to prevent owners from creating more non-conforming units and attempting to legalize them under the ordinance.

The Non-Conforming Units ordinance generated considerable debate before it became law, especially the provision requiring a low-income unit for 55 years. LA legislators have provided for a review of the law after one year.

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J U S T- C A U S E

E V I C T I O N S

Currently, building owners of non-rent controlled proper ties in Los Angeles hold the ability to evict tenants on a month-to-month lease with a 30-day notice. A proposal under consideration by the Los Angeles City Council’s housing panel may change that.If the proposal goes into effect, it will allow for the implementation of “ just-cause” eviction rules, which would be the same or similar to rules that are on the books for rent-regulated proper ties under the city’s Rent Stabilization Ordinance (RSO).

Rent Control regulations limit landlords to 3% annual increases, but rents can be adjusted to market r ates upon vacancy of the unit. This provision gives landlords a theoretical incentive to get rid of long-term tenants. Under LA’s RSO just-cause rules, a landlord’s ability to recover possession of a rental unit is limited to specif ic circumstances, which include failure to pay rent, refused landlord reasonable access to the unit to make improvements, permitting or causing a nuisance, and others.

The proposed provision to extend just-cause rules to non-rent controlled units will make evictions more difficult. The eviction process can take six months or more as a landlord seeks to prove nonpayment of rent or other proscribed circumstances, during which time the tenant might continue nonpayment until the case is settled. Evictions for nuisance can take even longer, as such proceedings typically require witnesses who may not want to par ticipate in a cour t proceeding involving a neighbor.

Landlord advocates maintain that owners typically have a good reason to remove tenants, and requiring jus t- cause evic tions creates unnecessar y legal

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hurdles . The legislation would be par ticular ly challenging for smaller mom-and-pop operations: “Their business is rental housing, not evicting,” said Linda Hollenbeck , a member of the board of the California Apartment Association. “Evicting is something they do when they have no other choice.”

Cit y s t af fer s ar e cur r ently devising jus t- cause guidelines for Los Angeles. They will likely look to ordinances adopted by Bay Area cities such as San Jose, Alameda and Oakland for guidance.

POTENTIAL REPEAL COSTA-HAWKINS ACT

OF

THE

The Costa-Hawkins Act is a 1995 California state law that prohibits municipal rent increases on certain kinds of exempted dwelling units. While the law allows rent increases in rent-controlled units when a tenant depar ts, it prohibits “vacancy control,”the power of the City to regulate rental rates on units that have been voluntarily vacated.

Repeal of the Costa-Hawkins Act will potentially have a big effect on vacancy decontrol, which is the term for regulations which allow owners to set rent at market or near-market rates when a unit becomes vacant, voluntarily or through eviction.

Without Costa-Hawkins, Los Angeles and LA county cities have the power to make it illegal for owners of rent-controlled buildings to increase rents after a unit becomes available.

The repeal of Costa-Hawkins, originally proposed

by State Assembly member Richard Bloom as a simple one-line repeal measure, ignited strong opposition. The California State Legislature has decided to consider it in 2018 after public hearings.

H O W L E G I S L AT I O N A F F E C T S L A PROPERTY OWNERS AND INVESTORS

The takeaway from passed and proposed legislation is that the city of Los Angeles is taking major legal and bureaucratic steps to handle the housing crisis.

It is likely that Los Angeles will follow the path of other pro-tenant cities such as San Francisco and Oakland by enacting legislation designed to supply much-needed affordable stock and to provide for new low-income housing.

Investors will face a more difficult process when tr ying to maximize returns on their multifamily investments: • INCOME/VALUE: Landlords and investors will find it more difficult to replace low-rental rate tenants in rent controlled units with new high-paying tenants

• I N C E N T I V I Z E S N E W M U LT I FA M I LY HOUSING STOCK: Investors will likely focus on

non-rent controlled proper ties, as most of the Rent Stabilization Ordinance legislation applies to units built before October 1, 1978 • UNSTABLE REVENUE FORECASTING: Even non-rent-controlled proper ties face the prospect of legislation that extends rent control to more multifamily complexes • PRESSURE ON MARGINS: Legislation uniformly includes provisions for incorporation of low-income units, a disincentive for new developments as well as for proper ty owner s with low income and non-conforming units, since returns will be lower in a market where the cost of entr y is already remarkably high

For more information on strategies to maximize investor returns on multifamily investments, contact your Matthews™ representative:

AARON GUIDO E P

aaron.guido@matthews.com 818.923.6111

DANIEL SHIEH E P

daniel.shieh@matthews.com 310.295.4378 M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

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BY: TIM WOODS &

MINNIE ALLISON

5 SIGNS YOU NEED A PROPERTY MANAGER

Property managers of the future are focused on using technology that allows them to cater to the tech savvy tenants of the world today, while improving the property value and creating an effortless process for multifamily owners.

If you’re an owner or landlord and answer yes to any of the questions below, it’s time to hire a property manager of the future.

you find it challenging to properly 1. do screen tenants?

• When it comes to searching for new tenants, implementing a comprehensive screening process is crucial. Having the ability to screen tenants through a cloud based management software will:

• •

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Eliminate those who are not a good fit for your property, saving you time, money, and a host of various issues.

Find more renters who are highly likely to fulfill all the terms of your rental agreement.

Track the status of tenants and applications submitted

2.

Are your tenants required to write a note or call to get in touch with you?

Is your voicemail filled with messages about clogged drains, broken items, and other apartment fixes? Property managers should be able to receive tenant requests through an online portal where tenants can: •

Submit maintenance requests from anywhere and at any time

•

Upload pictures of maintenance issues

•

Check the status of the maintenance request

•

View past maintenance requests

•

Create reports to keep your costs consistent and track payments

YOUR PROPERTY 3. DOES MARKETING CONSIST

OF CRAIGSLIST POSTS AND FLYERS?

“The Craigslist experience just doesn’t cut it with today’s digital-savvy renter. More than 90 percent of people looking for their next living situation are searching online first and more than 60 percent are looking on mobile,” says Matt Reilly, Director of Growth at RadPad. There are currently hundreds of rental listing sites available to help showcase your properties, attract qualified leads, and convert more prospects into tenants by capturing and marketing a lifestyle experience instead of just a few pictures and a short description.

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4.

Do you still collect money orders and checks for rent?

According to Zillow, currently 56% of renters pay rent in person. The modern renter relies on technology from their personal life to their finances, so if your property isn’t already accepting online rent payment, you’re behind the times. An online tenant portal can:

Create Convenience

Not only are tenants able to pay rent at their convenience, but landlords/owners aren’t bothered with the endless issues collecting rent in the mail or in person can cause

Add Safety or Security

Online payments eliminate risks associated with checks and identity theft

Improve the Tenant & Landlord Relationship Tenants will be able to set up automatic payments, providing less headaches than dropping off a paper check

Keep You Organized

Collecting rent online creates a seamless digital record that requires little effort for you and your tenants

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5.

are your monthly property reports difficult to access?

Property managers should be able to provide a full view of your investment. Property managers of the future will make sure your monthly reports are available 24 hours a day on a secure client portal featuring: •

Rent and other income received

•

Maintenance and repairs

•

Changes in a particular property or neighborhood

•

Results of marketing campaigns

The value of a property manager is in removing manual processes that are cumbersome for the average owner and housing property information in one central ecosystem where managers, owners, and tenants exist together. With the right property management team in place, they can provide higher quality service, better tenants, and instant access to operational and financial metrics.

If you’re ready to hire a property manager of the future today, contact a Matthews™ representative today.

TIM WOODS (310) 919-5725 TIM.WOODS@MATTHEWS.COM

MINNIE ALLISON (214) 692-2047 MINNIE.ALLISON@MATTHEWS.COM

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Navigating Change: Transformation of Retail BY: EL WARNER SHOPPING CENTERS SEEK

STRATEGIES TO NAVIGATE CHANGE When Charles Dickens wrote, “It was the best of times, it was the worst of times,” he was referring to London and Paris, the economic powerhouses of his time.

But the quote is well-suited to the retail landscape in the U.S. today.

THE BEST OF TIMES.....

After the Great Recession of 2008, the U.S. economy is chugging along with eight straight years of growth. At just over two percent, the U.S. growth rate is hardly spectacular or as good as it was during the boom years of the 1990s, but the American economy is performing better than that of most advanced economies of the world.

The nation is adding hundreds of thousands of jobs each month, unemployment is under five percent, gas prices are low, and middle- and lowerincome Americans are benefiting from 18 consecutive months of wage growth. The stock market is at an all-time high. It’s no wonder that consumer confidence is in positive territory.

Retail centers entered 2017 coming off a record holiday season, posting

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sales of $196.1 billion and a 3.8 percent gain over the previous year and the strongest rate of growth since 2011. Online channels grew as well, up 17.1 percent over Q4 2016 holiday season figures.

THE WORST OF TIMES....

While retail has clear winners in today’s economy –Class A shopping centers are faring better than B, C, and D centers, and online sales are strong– the casualty list is growing at an alarming rate. Some of the best-known names in the business, stores that often serve as traffic-producing shopping center anchors, are struggling mightily. Macy’s, Sears, J.C. Penney’s, Payless, and Barnes & Noble’s are shutting stores by the hundreds, and a record number of shopping centers and retail chains are declaring bankruptcy.

NAVIGATING TODAY’S TURBULENT SEAS REQUIRES IDENTIFYING THE SHOALS For property owners, devising a strategy means first identifying the issues that are making today’s retail environment so challenging. Matthews™ has identified some of the primary changes.

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OVERBUILDING The industry has added 16 million square feet of mall space since 1990, according to the International Council of Shopping Centers (ICSC), leading to more than 1,200 malls in America. However, changes in the behavior of the primary consumer of today –the Millennial– mean more online shopping and less-frequent mall visits.

Experts forecast the number of malls will decline to 900 in the next 10 years. According to Greenstreet Advisors, nearly 25 enclosed shopping centers around the country have closed since 2010, and another 75 are in danger of failing.

MILLENIAL PREFERENCES As the new generation reaches majority in numbers (80 million strong) and buying power, they seek either low prices, or luxury and “authentic experiences.” As evidence, the Wall Street Journal reports that Class A malls, which account for 3.5 percent of all malls, represent 22 percent of all mall revenues.

Millennial preferences include spending less on clothing. Apparel sales have declined by 20 percent since 2000. Especially hard-hit are logo-driven brands like Abercrombie and Hollister.

Instead of clothes, millennials are spending money on experience-creation. Travel and restaurants are big winners. Since 2005, spending on food services and drinking places has grown twice as fast as all other retail spending; in 2016, Americans spent more on restaurants and bars than groceries, a first. Expect this trend to continue, as millennial consumers put a premium on experiences that can be shared on social media: consumers are much more likely to share a post of their time at a restaurant, rather than talking to a clerk in petites.

E-COMMERCE Between 2010 and 2016, Amazon’s sales in North America quintupled from $16 billion to $80 billion. Sears revenue last year was about $22 billion, which means Amazon has grown by three Sears’ in six years.

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categories. The Biggger challenge for brick-andmortar is to match the policies that online retailers are increasingly offering.

•

Half of all U.S. households are Amazon Prime subscribers and have free shipping as a feature of their membership

•

Online retailers who market on the Amazon platform now match Amazon’s risk-free return policies, and non-Amazon e-tailers are following suit

•

The no-risk return policy has had the greatest impact in apparel, which has grown to be the largest e-commerce category

•

E-commerce retailers like Casper (bedding), Bonobos (clothes), and Warby Parker (eyeglasses) offer steep discounts, low- or no-cost shipping and other services

•

Mobile shopping, once devilishly difficult, is now much easier with the rise of shopping apps and faster computing response times. Since 2010, mobile commerce has grown from two percent of digital spending to 20 percent

Even brands moving aggressively online have struggled to match the growth of market leader Amazon.com Inc. The Seattle-based company accounted for 53 percent of e-commerce sales growth last year, with the rest of the industry sharing the remaining 47 percent, according to EMarketer Inc.

heeled. These Class B and C shopping centers and shadow centers took a drubbing during the Great Recession.

Unfortunately, millions of these budget consumers never recovered from hard times. The number of Americans living below the poverty line has doubled since 2008. Unless the economy shifts in such a way that business or government provides more opportunities and financial support for these people, they will continue to be no-shows at the mall, and these categories of commercial property will need to re-invent themselves.

“According to the Census Bureau and NRF, there are

“Retail is no longer a brick and mortar business; it is a brick and mobile business,” said Michael Glenn, manager at the Stony Point mall in Richmond, VA.

THE FALL OF THE MIDDLE Class B malls in secondary markets with sales of $300-$500 per square foot are hard hit by the changing environment, with tenant occupancies dropping to 6070 percent and revenues down to $200 per square foot.

THE RISE OF DISCOUNTERS Consumers found themselves forced to shop at discount houses during the Great Recession. TJ Maxx, Target and other discount chains responded with more fashionable merchandise, and gained a permanent following among millennials during their first real experiences in buying based on their own paychecks. Now these discount outlets are preferred destinations for both the budget-conscious and millennials, replacing traditional anchor department stores like Macy’s and J.C. Penney as go-to locations.

And as anchors falter and traffic declines, the collateral damage can be a critical blow to a mall, especially if tenants have co-tenancy clauses.

more than 1 million retail establishments across the U.S., and retail sales have been growing at almost 4% annually since 2010.”

RETAIL ISN’T DYING, IT’S CHANGING AND PROPERTY OWNERS MUST RE-STRATEGIZE THEIR FUTURES Most property owners are well aware of the approaches that have proved successful in the past are no longer working. The challenge is to devise a strategy that will not only meet the needs of the times, but also pave the way to greater opportunities in the future.

The good news: despite the focus on e-commerce, most Americans continue to do shopping in person.

Customers prefer physical stores 75 percent of the time, according to Cowen research. The key is to create the right experience, whether it’s online or off. Retailers should “re-focus on customers,” said Oliver Chen, an analyst at research firm Cowen & Co. “Management needs to be fixated on speed of delivery, speed of supply chain, and be able to test read and react to new and emerging trends.”

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like adjustable seats, tray tables, and apps to order meals for in-theater consumption.

.

Matthews™ has examined a number of moves that shopping centers are making to re-imagine their shopping centers. Since centers can vary considerably by class of property, region, and resources, not every new approach will prove fruitful. Our goal is to provide our clients with an array of tactics to consider in devising a strategy for their client makeovers.

1. RESTAURANTS RE-IMAGINED Restaurants are core elements of many malls making the transition to millennial preferences.

Innovations include updated versions of the multicuisine food court, and establishments that feature locally-sourced foods and beer.

2. MOVIE THEATERS RE-IMAGINED Multiplexes outfitted with deluxe features

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3. MORE SERVICES More malls are incorporating tenants that once were primarily found in shadow centers - spas, dental offices, cleaners. By developing the services appropriate for a center’s target audience, management can attract traffic that can easily become recurrent visitors. For example, Saks Fifth Avenue has launched an assortment of wellness services at its Manhattan flagship store, including massage and salt baths.

4. PROPERTY UPGRADES Millennials are not the ‘mall rat’ generation like Xers; drawing them to a shopping center requires a physical makeover to include open spaces, garden rooftops, and community and performance spaces.

5. EXPERIENCES FOR ADULTS Community-engaging and immersive events targeting millennials - wine tastings, movie nights, art shows, farmers markets, yoga demonstrations, running clinics, and culinary arts centers.

Matthews™ has been closely monitoring shopping centers in every part of the country, as well as trends that emerge from international markets.

Using a mix of data and experience, we are able to assist our clients in developing successful strategies.

For assistance, contact your Matthews™ Shopping Center expert.

6. EXPERIENCES FOR KIDS Kiddy playgrounds, children’s lending libraries, art fairs engage the family side of a community and burnish the center’s brand.

7. RE-PURPOSING Abandon the traditional retail shopping center concept and repurpose the property into office space, residential apartments, sports facilities, medical facilities, and other uses.

8. IMPROVE YOUR SHOPPING CENTER ONLINE EXPERIENCE Shopping center marketing has always been a crucial factor for retail sales offers. However, property owners need to adapt the reality of online marketing. “People who have a bad digital experience immediately go to a competitor – often with no switching cost at all,” noted Peter Blair, vice president of marketing for digital marketing agency Applause. “There will be further integration of our online and physical worlds, especially as users expect brands to engage with them through the digital channel of their choice, not the other way around,” Blair said.

9. ENLIST AN EXPERT WITH OUT-OF-THE-BOX THINKING The Dickens quote from “A Tale of Two Cities” goes on to say: “It was the age of wisdom, it was the age of foolishness.” Property owners are well advised to ignore the doom-and-gloom hype and focus on realistic strategies.

El Warner EL.WARNER@MATTHEWS.COM (949) 873-0507

F O L LO W U S :

w w w. m a t t h e w s . c o m

i ntro d u ci n g

matthews leasing services TM

In a transformative retail landscape, t he combination of an experienced real estate consultant and calculated market information is key to maximizing t he value of your assets.

Our innovative solutions help you capitalize on emerging oppor tunities, navigate t hrough obstacles, and ef fectively position your proper ty in t he marketplace.

e x p e r i e nc e t he m at t h e w s d i ff e re n ce t o d ay TM

™

A MODERN LEASE ON MILLENNIALS: Invest in the Right Upgrades CRAIG IRVIN & NICK DELL

THE MILLENNIAL GENERATION IS UPON US. The largest living generation in the U.S. is moving into their primary spending years. According to recent reports, millennials made up an estimated 79.8 million of the population in 2016, and will make up 50 percent of the global workforce by 2020.

Millennials have come of age during times of significant changes in U.S. society. While they are far more educated than previous generations – 61 percent have attended college – almost two-thirds of them have student debt of $10,000 or more, which can result in lower FICO scores. As a result, a historically-low percentage of millennials own homes, and more than 30 percent live with their parents. According to the Census Bureau, the homeownership rate for those under the age of 35 most recently declined to 34.3 percent. That’s down significantly from its pre-recessionary 43 percent level.

Millennials are less likely to be married and have children: 59 percent of millennials are unmarried – although they may be in a longer-relationship – compared to 62 percent of GenXers and 65 percent of Baby Boomers. For women, the median age for a first marriage is 27 years old and for men, 29, in line with a trend of marrying at a later age that has been steadily increasing for decades. And 60 percent of millennials have no children under 18 in their household – of those that do, almost half are unmarried.

In choosing a place to live and work, millennials love cities: 73 percent of 25-35 year-olds with a college education live in mid-sized to large cities. Job prospects are part of the lure, but metropolitan area life also exhibits social characteristics preferred by this generation: technologyconnected, filled with trendy bars, restaurants and other social centers, and tolerant of diverse races, ethnicities, and lifestyles.

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MILLENNIALS HAVE DISTINCT PREFERENCES IN HOUSING. 60 percent of millennials rent. While the number of millennials make them a prime audience for property owners, investors, and landlords, their must-have preferences in living quarters represent a shift from preceding generations.

A LIKE-MINDED AREA – NEAR A GYM. Millennials as a whole rate life experiences as more important than material possessions, and rate location second only to price in choosing a unit. They seek communities based on shared interests – tech hubs, arts centers, universities and academia, “green” cities and neighborhoods, hubs of political and social issues advocacy– and will choose a like-minded area over a location that meets traditional priorities like proximity to work or extended family.

Some millennial location preferences are more practical.

While they want a parking spot and relatively easy access to major roadways, they want a unit within walking or biking distance to public transit. They will pay a premium for proximity to a gym, yoga studio, bars, cafes and shopping, particularly those that are gentrified. In line with their views on the importance of the environment, millennials prefer a location near the great outdoors.

A SECURE COMPLEX THAT LOVES DOGS. City-loving millennials have a share of risk-takers, but the majority want security in their building. Gated or guarded apartment complexes and rental houses with alarm systems have always earned a premium rate. Newer, relatively inexpensive innovations are internet-based, include keyless access, and in-unit surveillance alerts to the residents and authorities. 61 percent of millennials prefer electronic access and security systems, and they are willing to pay up to 20 percent more for the ease and peace of mind. One thing they’ll be surveilling is pets: 35 percent of millennials are pet owners.

In multifamily apartment and condo complexes, millennials prefer outdoor community areas, with a fire pit, grilling facilities, and maybe even a pool. Millennials with children look for units with an on-site game room and proximity to playgrounds, basketball courts, hiking trails and skateboard zones.

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PUT YOUR UPGRADES INTO MILLENNIAL PREFERENCES. Millennials will pay a premium for a rental unit with certain features: High-security, gated community

Green-tech features like smart thermostats, Energy Star appliances, and built-in USB charging ports

On-site workout room with classes and fitness machines

High-speed cable and Wi-Fi

Outdoor social areas

24/7-access package lockers for their online purchases (88% of millennials receive at least one online purchase package per month)

In-unit laundry

On-site parking

However, millennials are less likely to pay more for features that until recently commanded top dollar. Among the features that have fallen in value are: Hardwood floors

Walk-in closets

Gourmet kitchen features like granite countertops and gas appliances

In a recent Multifamily Executive survey, more than half of millennials chose carpet over hardwood floors and a standard sized closet over a walk-in, rather than pay an additional $75 a month. In the kitchen, millennials will live with an electric cooktop rather than pay an additional $15 a month for gas.

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TOP AMENITIES Source: National Multifamily Housing Council

Alabama

75% MODULAR CLOSET SYSTEMS BIRMINGHAM

Illinois

93% MICROWAVES ST. LOUIS 79% PACKAGE DELIVERY AREA CHICAGO-GARY-KENOSHA

Arizona

92% CEILING FANS PHOENIX-MESA

Maryland

34% ON-SITE CHILDCARE BALTIMORE

California

35% CAR CHARGING STATION SAN FRANCISCO-OAKLANDSAN JOSE 97% PARKING LOS ANGELES-RIVERSIDEORANGE COUNTY 44% VEGETABLE GARDEN SAN DIEGO

Colorado

58% FIREPLACE DENVER-BOULDER-GREELEY

Florida

70% PARTY ROOM MIAMI-FORT LAUDERDALE 72% VALET TRASH ORLANDO

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North Carolina

65% BARBEQUE GRILLS CHARLOTTE-GASTONIAROCK HILL

Oregon

53% WALKABLE PORTLAND-VANCOUVER

Tennessee

99% CELLPHONE RECEPTION NASHVILLE 76% GREEN INITIATIVES BOSTON-WORCESTER-LAWRENCE Texas 87% SMART THERMOSTAT Minnesota SAN ANTONIO 47% BIKE STORAGE MINNEAPOLIS 94% ONLINE RENT PAYMENT

Massachusetts

Missouri

DALLAS-FORT WORTH

Nevada

55% BOOKSHELF HOUSTON-GALVESTONBRAZORIA

90% GARBAGE DISPOSALS KANSAS CITY 54% TWO MASTER BATHROOMS LAS VEGAS

New Jersey

51% PLAYGROUND PHILADELPHIA-WILMINGTONATLANTIC CITY

Georgia

43% LAUNDRY LOCKERS ATLANTA

Here’s a look at some of the most popular amenities by local market.

New York/Pennsylvania

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57% PUBLIC TRANSIT NEW YORK-NORTHERN NEW JERSEY-LONG ISLAND

Virginia

56% CONCIERGE SERVICE WASHINGTON-ARLINGTONALEXANDRIA

Washington

78% NON-SMOKING SEATTLE-TACOMA-BREMERTON

CHOOSE RELIABLE TECH PROVIDERS. For pets, babies, social media, binge-watching TV and other online activities, millennials expect high-speed, reliable internet and cable services for their units. But it’s not enough to simply install these systems – operators need to make sure these amenities are functional the majority of the time. Landlords who choose a provider with a good track record of fast and reliable response will greatly reduce the number of calls to their own service hotline.

Property managers can also improve relations and cash flow by instituting more online connectivity with their Millennial tenants. Among the desired services: Online rent payments Online rent due notices, but millennials prefer text for notices Online service requests, with text updates

BE PREPARED FOR RELO’S. College-educated millennials in urban areas may or may not work for startups, but they are subject to company edicts that require relocation on a short-notice. A recent study by real estate company, Zillow, reported that 62 percent of millennials will move within three years.

LOOK GOOD ONLINE. Your millennial audience is thoroughly techconnected: a full 90 percent of millennials search for rentals online, often from their mobile devices.

They will expect you to have a smart-looking, easy-to-navigate website, a mobile version of your website that is specifically optimized for mobile search, and a social media website with authentic participation by your tenants.

THE MILLENNIALS ARE THE NEW REALITY. Understanding shifts in consumer preferences has always been the key to successful marketing and operations. With millennials now making up the lion’s share of renters, owners and developers who invest in the right mix of property amenities and upgrades will shorten their sales cycle, optimize their rental revenues, and improve operating efficiencies.

To find out which upgrades and amenities have the most appeal in your specific market area, contact your Matthews ™ representatives:

CRAIG IRVIN craig.irvin@matthews.com 214.692.2055

NICK DELL nicholas.dell@matthews.com 214.932.9155 M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

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TOP TRENDS

IN INDUSTRIAL

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E-COMMERCE, E-COMMERCE, E-COMMERCE

For retailers with existing warehousing facilities, the challenge is to adapt operations and facilities away from their focus on to-store distribution, so that they can serve as to-consumer fulfillment centers. However, the range of products available online creates a wide variation in the needs of a potential e-commerce tenant. While 30 e-commerce merchants account for half of all online sales, the remaining half is a profusion of smaller companies with needs that shift as they grow. And while some may be startups with more dreams than capital, 600 of these “smaller” companies in the U.S. have online sales of $50 million to $2.5 billion, equating to about $1 million a day.

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Regardless of the size of the e-commerce operation, their fulfillment services mean that the tenant needs more footprint than traditional pallet-based businesses, including footage for packing, labeling and other directto-consumer operations. While distribution centers for brick-and-mortar retailers support $2,500-$3,500 of annual sales per square foot, that figure drops to $1,000 of annual sales per square foot for e-commerce retailers, meaning three times as much space.

AGING MANUFACTURING SITES BECOME DATA CENTERS

The rise of internet use has translated into a world awash in data, and the amount of data is growing exponentially, with global IP traffic forecasted to increase threefold over the next five years.

eager to inject new blood into declining areas, making the planning and approval process easier with the cities often providing tax and economic incentives making these developments attractive.

Data centers require extensive investments in cooling systems, fiber optics cabling, and large complex server computer configurations. The cabling inside the data center must connect with the outside world – meaning cables are buried lines that intersect with major power system nodes, which often involves right-of-way from road and railway networks. Though an expensive proposition, data centers are a hot commodity in the commercial sector.

Adaptive reuse provides an opportunity for real estate developers and examples of their use for data centers abound:

A large building capable of handling concentrated weight loads, connected to major power lines, with some office space, and plenty of parking may sound like the classic analog-age manufacturing plant, but today it’s being turned into much more. Companies are transforming these aging and sometimes abandoned relics of yesteryear into digital age data centers.

“Adaptive reuse” is the term for this transformation of industrial building stock. While the surrounding areas of these aging manufacturing buildings are often run down, the buildings themselves have great potential value, and nearby power plants may have idle capacity. Municipalities are often

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Chicago Sun-Times printing facility Realty Trust data center

317,000 SF

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Western Union and the Port Authority Largest data center in New York owned by Google

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R.R. Donnelley & Sons printing facility One of the largest data centers in the world, Lakeside Technology Center

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Biscuit Factory in ireland

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Sears now has a data center real estate division devoted to transforming store and warehouse facilities

Amazon data center

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TECHNOLOGY’S IMPACT ON MANUFACTURING FACILITIES

Technology affects everyone, including sectors that may lack the glamour of high-tech, e-commerce, and finance. Examples include facilities for manufacturing, industrial machinery, energy and infrastructure, which are increasingly moving to automation and softwarebased processing and control solutions.

For commercial real estate, one factor in the move to digital solutions can be a reduction in the size of equipment and processing areas, and thus a reduction in the square footage necessary for the physical plant.

Another factor affects site selection, as companies increasingly move to direct-to-customer solutions, the location of the end-user becomes a priority.

Beyond the immediate plant requirements for a move to digital, transportation systems become a critical priority; intermodal supply chain processes that to date

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have focused on delivering goods to a manufacturing facility must now accommodate distribution to an increasing number of customers, including end-users.

Manufacturers must move to more sophisticated processing and communications software to coordinate the many nodes of a goods transportation process, according to Curtis D. Spencer, president of IMS Worldwide.

These industrial sectors are making the move to digital, but they have a lot of catching up to do. In a recent survey by leadership consulting firm, Spencer Stuart, 83 percent of industrial manufacturers reported that a digital transformation was a high priority, but 84 percent said they were in the early stages of transformation, and face significant work culture challenges in effecting change.

SHALLOW BAY BUILDINGS

Demand for shallow bay industrial is through the roof, resulting in plunging vacancy rates and increased prices across the U.S., but particularly clustered within and on the perimeter of large metropolitan areas. With demand driven by a combination of online merchants and a shift by traditional retailers to “last mile” same-day delivery, these 15,000 to 50,000 square foot warehouses are designed for multiple tenants with light to moderate industrial needs.

consumers for two-day delivery, require larger parking lots to accommodate a growing number of employees.

“We can accommodate smaller importers with shallowbay buildings, so that’s a trend we’ve seen, definitely in the Southeast,” said Lawrence R. Armstrong, CEO of architecture firm Ware Malcomb. Armstrong noted that these buildings, which are designed for proximity to

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According to the NAIOP, the ideal shallow bay development characteristics include: •

Sites configured for offices, with parking in the front, and truck docks in the rear

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Multiple entrances for easy division into tenant spaces

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Ceiling heights of 24 to 30 feet – although developers can go higher to accommodate future growth in tenant inventories

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MICRO-DISTRIBUTION CENTERS

It is common knowledge that traditional retail stores are in heavy competition with Amazon and online retailers, who can deliver goods quickly from massive distribution centers scattered across the U.S.

point-of-sale (POS) management system, upgraded store registers capable of handling both in-store and online transactions, and in-store packing stations compact enough to handle volume without gobbling up valuable retail floor space.

Perhaps the best response is imitation: expand the services of a retail store to provide online shopping, complete with quick delivery, easy return policies and other benefits. This way, the consumer has the choice of visiting the store to sample or try on merchandise, then take it home or have it delivered, or do the entire transaction online.

Macy’s, for one, is having initial success with the transformation, posting double-digit online sales growth in 2016 even as overall sales declined four percent.

With nearly 900 points of distribution, a chain like Macy’s can enjoy local shipping rates at costs much lower than Amazon.

Seen in this light, a company like Macy’s Inc. has 870 Macy’s, Bloomingdales and Bluemercury locations that can serve as micro-distribution centers, augmented by 23 mega-distribution centers.

Walmart, the largest U.S. retailer, is taking a different tactic to meet a similar e-commerce micro-distribution goal. Walmart has recently teamed up with Google to post merchandise on the Google Express online shopping mall. Walmart will use its more than 4,690 store locations as distribution points for quick delivery.

Any retailer wanting to make the transition has several infrastructure hurdles: a fully-digitized inventory and

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VERTICAL CONSTRUCTION

E-commerce promises fast delivery for a plethora of merchandise categories, and that promise leads to increased inventory, more sophisticated handling, and logistics at the warehouse distribution level. While e-commerce growth has led to increased demand for warehousing space, the amount of land available for development has not grown, particularly in preferred locations in and on the perimeters of large metropolitan areas.

Solution: go tall. Architects are increasingly designing taller vertical warehouse buildings to provide additional square footage without increasing the building’s physical footprint.

“Land is getting to be more expensive, so like any other product type in commercial real estate, you end up going vertical,” according to Lawrence R. Armstrong, CEO of architecture firm Ware Malcomb.

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MEGA E-FULFILLMENT CENTERS

E-commerce companies are having a big impact on industrial real estate – renting out large blocks of space, propelling more new construction, and attracting more institutional and global investor money.

The newest generation of e-commerce demand has led to ‘mega’ size facilities capable of both handling large and often highly varied merchandise, and space to process and pack goods for delivery to consumers.

Mega e-fulfillment centers may be industrial spaces, but site selection and plant characteristics are much more like those traditionally associated with retail. To be successful, e-commerce companies must address the ‘last mile’ to the consumer’s door as their greatest priority. Thus, access to and quality of transportation corridors become as important as low rent in a successful real estate transaction.

Examples of recent mega e-fulfillment centers include: •

Louisville, KY is home hub for UPS and facilities for dozens of retail and e-commerce companies, including Best Buy, Guess, L’Oreal and Camping World

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Milwaukee, WI is the site for a new 1.5 million squarefoot Amazon fulfillment center, plus a 50,000 squarefoot in-fill location, one of 70 the e-commerce giant plans to launch in the next few years

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Nashville, TN is the site for a one million squarefoot facility for Under Armour

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Vancouver has a new 570,000 square foot Amazon warehouse and 189,500 in office space, and is experiencing high demand for third-party logistics (3PL) space

FOR MORE INFORMATION REGARDING INDUSTRIAL REAL ESTATE, PLEASE CONTACT: KYLER BEAN | KYLER.BEAN@MATTHEWS.COM | (214) 692-2192

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connect with everyone who matters.

*Indicates a National Connect Conference

www.connectconferences.com

These Cities are

Booming H E R E ’ S

W H Y

Chuck Evans | Jeff Miller | Andrew Gross

T

here is no debate that large Metropolitan Statistical Areas (MSAs) act as their own economies, drawing in jobs, consumers, housing, new development, and redevelopment - all of which work in unison to increase the value of real estate assets across all sectors. The main driver of this change, or at least an influential catalyst, is employment opportunity. When combining employment opportunity with a lower cost of living and stable inflation, population growth is immensely impacted, and a perfect storm is created for real estate opportunities. Population growth hedges against real estate downturns, lowering the risk of an investment. The influx of population increases the demand for housing, retail shopping, schools, and infrastructure. An increased demand for housing leads to new development of vacant parcels as well as redevelopment of aging property and the value of real estate begins to rise. Real estate values increase annually under this scenario without much modification from the investor. As a result of real estate values increasing, opportunities arise for higher rents per square foot, vacancies are easier to absorb, and retail sales increase, providing more security to owners.

But what happens when you own real estate in an area that has declining demographics, or jobs moving away from the area because it’s too expensive to live and prosper? When businesses move, people can’t afford to live in the same location, disposable income lessens, retailers store sales fall - their businesses decrease, residents leave to pursue better job opportunities in other cities, retailers follow them, and real estate values decline in a downwards spiral.

Population variations affect the patterns of real estate growth throughout all sectors and influence trends that can continue for decades. Matthews™ researched and examined a variety of data and factors regarding trends, change, population, demographics, and job growth, ultimately ranking the top MSAs in the United States by the highest number of year over year population increases.

Let’s dive into the top MSAs in terms of population growth, and see where you need to make your next investment.

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Dallas Fort Worth Arlington Population Growth by Average Number of People Per Year = 130,108 2016 Population Estimate = 7,233,323

The largest Metropolitan area in the South and fourth largest in the United States, the Dallas-Fort WorthArlington MSA has one of the highest concentrations of corporate headquarters in the United States. With a central location relative to the rest of the U.S. and home to 21 of the Fortune 500 companies, the Dallas MSA is one of the best areas to own real estate in the United States. According to Ten-X, Fort Worth is the third hottest housing market in the U.S., and Dallas follows, ranking as the fourth hottest housing market in the United States.

From 2008 to 2014, California lost 1,510 companies that moved their operations from the state and Texas received 219 of those companies. Of the 219 companies, Dallas-Fort Worth received 68 of those

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companies. During 2014 to 2017, Texas gained 37,552 jobs and $6.47 billion in investments with the biggest move being Toyota Motor Corporations’ relocation to Plano Texas, just 20 miles north of Dallas. This move alone is generating 4,000 jobs and $350 dollars in investments.

Texas is perceived to be more business friendly due to tax policies, but what many overlook is the corporatefriendly regulatory environment. Texas officials consistently tout the state’s more business-friendly environment, citing fewer business regulations and lower labor costs, partly because Texas is a right to work state. As a real estate owner, the state’s businessfriendly environment, and affordability makes it an attractive investment

New York Newark Jersey City

2

Population Growth by Average Number of People Per Year = 92,139 2016 Total Population Estimate = 20,153,634

Owning an appreciating asset is a crucial component to net-leased investments, and a common goal among many STNL owners. Due to its high demand and continuously rising rents, the New York MSA finds itself appreciating at an increasing rate, much more than most markets in the nation. Its lower cap rates directly signify the reduced risk and higher residual value of owning real estate in the area.

The New York MSA is incredibly sought-after for its employment growth, adding 199,700 jobs over the 2015 to 2016 period. Education and health services saw the largest growth, increasing 3.1 percent and adding 53,000 jobs. As this market strengthens, the unemployment rates are steadily decreasing, falling from 5.1 percent to 4.6 percent between Jan 2016 and Jan 2017, further validating the increased demand for real estate investments.

Market rents in the NYC MSA are much higher than the national average, but the continued growth provides security. Incomes in this area are some of the highest per capita in the entire country, attracting premium tenants who can afford the high rents. Additionally, high vacancy creates competition among tenants as the limited supply of retail locations drive up rents.

The best opportunities in these markets can be found in proximity to new skyscrapers currently being developed. Manhattan aside, Newark and Brooklyn are currently undergoing the most development and change. These new developments provide investors the opportunity to capitalize on these areas, quickly increasing their population density. Retail in the area immediately surrounding the new developments have the highest potential for success as the areas transform through the investment, renovation, and influx of people.

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Atlanta Sandy Springs Roswell Population Growth by Average Number of People Per Year = 80,962 2016 Total Population Estimate= 5,789,700

Rarely does a city experience both a booming job market and development in the same facet as Atlanta currently is. At 3.3 percent, Atlanta is the leading MSA for new jobs added, much of which can be attributed to extensive new development. Construction is Atlanta’s largest area of job growth at six percent, followed by professional and business services from expansions and corporate relocations. Retail opportunities in Atlanta are growing quickly, and with residents spending 20 percent more cash than the national average, current tenants in retail properties are experiencing increasing store sales.

Atlanta has been able to take on the added job growth and new developments by investing in transportation services and infrastructure three times faster than the rest of the U.S. As of May 2017, employment has risen by twice the national average, and in combination with statistically better wages, the area continues to be the back bone of Georgia by adding a strong and sustainable workforce for its growing industries. Atlanta is the ninth largest MSA in the country at just under six million people and is expected to continue growing by 50 percent in the next 20 years.

Multiple sports-related developments and investments are also expected to increase the value of properties east of downtown and in northern Atlanta.

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The Mercedes-Benz Stadium and SunTrust Park will house the Atlanta Falcons and Braves, respectively, when they open this Fall. The economic opportunity these stadiums produce is substantial. Being within minutes from downtown and in a densely populated area of the city, there are many opportunities to increase the rents and invest in appreciating assets in retail and quick service restaurants near the new Mercedes-Benz Stadium. Higher quality tenants will look to take advantage of the influx of both sports fans and other customers from non-sporting events at the stadium. Similarly, the SunTrust Park development is located near many national credit tenant QSRs and big box retailers, which will reap the benefits.

The Midtown area north of Downtown will see the largest population increase in the coming years with multiple high-rise apartments currently under construction. Like the stadium developments, these apartments will promote better tenants, rents, and store sales in the area. The edges of the city will see the largest growth as developments sprawl to accommodate population growth. The area has the fourth highest population growth in the country, with half of Atlanta’s population having relocated to the outer city limits since 2010.

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Miami Fort Lauderdale Palm Beach Population Growth by Average Number of People Per Year = 80,334 2016 Total Population Estimate = 6,066,387

South Florida is one of the hottest markets in the country right now – and we are talking about more than just the weather. Sunny beaches, golf courses, vibrant culture, and technology jobs are fueling the growth.

Numbers released by the U.S. Census Bureau show as the 4th fastest growing state in the U.S. The Miami - Fort Lauderdale - Palm Beach metropolitan area is now the eighth most populated MSA in the nation, recently surpassing six million people for the first time.

These three counties have shown rapid and sustained growth over the past half-decade. Just under 500,000 new residents have been seduced by the golf courses available in the Palm Beaches, the towering condos and waterfronts of Broward County, and the bristling and colorful street life of Miami-Dade’s Little Havana and beaches.

percent rise the past five years and now has a population of just under 1.9 million. Miami-Dade County — the most populous county in Florida — and Palm Beach County, each grew at 7.8 percent to 2.69 million and 1.42 million, respectively.

Since 2010, Miami’s downtown population has risen 6.5 percent annually, while the entire city grew 1.8 percent, and Dade County 1.4 percent. In 2016, 63 percent of new residents moved into the city due to growth in the greater downtown areas. The cost of living in Florida is attractive as it is an income tax-free state. In addition to the tax benefits, South Florida is developing state of the art transportation systems to support population growth and fuel employment opportunities. Florida East Coast Industries (FECI) has announced plans to build a $3 billion, 235-mile express train system that will eventually connect Orlando to Miami.

Broward County led the growth spurt with an 8.5

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Los Angeles Long Beach Anaheim

Economically speaking, Los Angeles is one of the world’s powerhouses and an international hub that makes up one of the highest populated MSAs in the United States. The Los Angeles MSA encompasses the Counties of both Los Angeles and Orange County and is home to 88 incorporated cities including the likes of Long Beach and Anaheim. Overall, the Los Angeles MSA holds a population that exceeds a staggering 13 million residents and 19 million in the greater region. Even with the growth rate of 3.75 percent, the population has increased by an astounding average of 77,888 people per year. Given the MSAs expansive population growth, robust economy, and appeal to business, the Los Angeles MSA is an investors paradise.

Considering businesses are attracted to the top-notch talent that large MSAs draw in, it is no surprise that the Los Angeles MSA houses a tremendous number of both start-ups and established companies. The City of Los Angeles alone is home to seven of this year’s Fortune 500 company headquarters. Some of the largest employers include entertainment companies such as Walt Disney, Warner Brothers and Sony Pictures, engineering giants like Northrop Grumman and Boeing, and large medical institutions such as Kaiser Permanente. Adding to the already prominent business market, Los Angeles also holds the second busiest port in the country recognized for generating more than one billion a day in economic activity.

Along with many other markets in California, Los Angeles has fostered a culture of innovation, and tech giants have expanded to create “Silicon Beach,” which houses over 500 tech start-up companies as well as some of the biggest moguls in the business – Google, Yahoo!, YouTube, Snapchat, and Facebook. The newly found start up culture retains talent, attracts new business, and creates a culture of innovation that fosters future growth and demand.

Further providing a constant flow of new residents and talent to the job market, Los Angeles is home to 129 colleges, including some of the most established

Population Growth by Average Number of People Per Year = 77,888 2016 Population Estimate = 13,310,447 established universities in the country. University of Southern California (USC) and University of California, Los Angeles (UCLA) both boast over 40,000 in total enrollment per year. The universities appeal not only to the U.S. but international students that drive further foreign investment into the area.

Famous for its Hollywood allure, dynamic nightlife, and enchanting amusement parks, when it comes to tourism, Los Angeles is one of the most visited cities in the country. Los Angeles County alone has broken its record of visitors six years in a row. In 2016, LA County received 47.3 million tourists, up by four percent from the year prior and is expected to rise. Sustainable tourism provides steady outside investment and inflows into the area that spin the wheels on countless industries – hospitality, entertainment, and retail to name a few. The mayor of Los Angeles, Eric Garcetti attributed tourism as a primary driver that helped create more than 140,000 jobs and start 150,000 businesses since 2013 alone.

The Los Angeles MSAs diverse mix of billion dollar industries, growing population, and flourishing tourism all help to protect against downturns in the market and generational use in the case a tenant may vacate. The high-density market filled with endless attractions and opportunity makes Los Angeles a very safe investment for real estate.

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Washington Arlington Alexendria

Population Growth by Average Number of People Per Year = 77,554 2016 Population Estimate = 6,131,977 The Washington District of Columbia Metropolitan Statistical Area is made up of three major cities; Washington D.C., Arlington, and Alexandria. These are some of the most robust cities in the country when considering job security and livability. The area has experienced just under a nine percent increase in population from 2010 to 2016.

Families building a life in the D.C. MSA are seeking employment, specifically in the U.S. government, and as defense contractors or tourism providers. These jobs have good security and longevity, an aspect which makes investors feel comfortable in multifamily investments.

Therefore, investors looking for acquisitions should focus on the state’s capital. This is the “hub,” or controlling market of that entire state. Understanding that the capital of any state is the most secure, the capital of the United States of America is especially attractive.

D.C. MSA in hopes of relocating their headquarters.

Given the overpopulation in D.C., most large companies have located to surrounding areas. The food giant, Nestle recently relocated their headquarters to the D.C. suburb, Arlington. As a result, this has affected many other companies under the Nestlé umbrella such as Häagen-Dazs, Baby Ruth, Lean Cuisine and dozens more. This move has brought over 750 new jobs to this already prolific market. The proximity of suburbs to the nation’s capital gives businesses a connection to both consumers and stakeholders in D.C. The demographics of the D.C. area are also attractive, as most are well educated and experienced. 71 percent of Arlington residents age 25 and older have a bachelor’s degree or higher, making this a corporate recruiter’s dream. The County of Arlington launched a $700,000 public-private partnership fund last year to lure tech startups to the area in an effort to capture the younger, educated population from the top universities across the country. This tactic further enhances the population boom in the area.

Large companies are also looking to the Washington

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7 Phoenix is the largest city in Arizona, and combined with the surrounding metropolitan area, is often called the “Valley of the Sun.� The population increased 45.3 percent from 1990 through 2000 (compared to a national average of 13.2 percent) and has grown another 11.8 percent from 2010 to 2016. The U.S. Census Bureau estimates that by 2030 the population of Phoenix will grow to 2.2 million while the population of the metro area will reach 6.3 million, which is up from the current 4.66 million. Phoenix has consistently ranked as one of the fastest growing economies in the U.S. with a population growth of four percent per year for the past 40 years.

Unlike other large MSAs, Phoenix has affordable prices due to the inventory of parcels available for future development in the surrounding areas. There is plenty opportunity for growth and little regulation hindering development.

Arizona is friendly to businesses

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Phoenix Mesa Scottsdale Population Growth by Average Number of People Per Year = 76,087 2016 Population Estimate = 4,661,537

and has a highly skilled labor force with low operating costs and a minimal risk of natural disasters.

This MSA has focused on expansion through planned infrastructure; new freeways, light rail lines, as well as the new automated transportation system at the Sky Harbor International Airport called the PHX Sky Train. In addition to the built-out infrastructure and planned growth, Phoenix has the most solar power per capita, ranked second for annual solar installation. This surge of alternative resources makes it less expensive for property owners and families without being constrained by energy costs. Because of the ease for business owners and lack of constraints, whether it be resources or regulation, Phoenix continues to have a perfect storm for growth.

UPS, Indeed.com, and Intel Corp have announced plans in 2017 that will create nearly 12,000 new jobs in the Phoenix region. In June

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alone, 222,000 jobs were created according to the U.S. Bureau of Labor Statistics. Additionally, Phoenix is home to Arizona State University- Tempe, with 75,000 students, this region takes affordability into consideration and continues to change its landscape in a positive direction.

The city is in a multifamily construction boom with no sign of slowing down. The average units delivered for new multifamily construction has already surpassed the Phoenix MSA 20-year average with 5,448 project units being delivered this year. Population increases, affordable housing, and new multifamily developments occur because of business growth and are continuing to create demand for retail, in turn providing security for real estate investment.

Seattle Tacoma Bellevue Population Growth by Average Number of People Per Year = 58,359 2016 Population Estimate = 3,798,902

The Seattle Metropolitan Statistical Area is one of the fastest growing and most highly sought-after areas in the United States. The Seattle MSA made up of Tacoma, Bellevue, and Seattle has seen significant job growth and creation over the past few years. Also, similar to Florida and Texas, Washington State is a tax-free income state, a great benefit to attracting families and those looking to boost their yearly income.

Despite being described as gloomy and wet, Seattle has experienced a three percent year over year growth rate. This rise in population is mainly due to the low cost of living. The average price to rent a one bedroom apartment is around $1,302, compared to Los Angeles which averages $1,730. The median home price in the Seattle metro area is $414,000, compared to the Bay Area which holds at $834,000.

Besides low cost of living, another

factor drawing in people to the Seattle MSA is employment opportunity. In conjunction with the low cost of living and higher earning potential, Millennials and families are moving to the Seattle MSA for employment. Technology companies have had the greatest impact on employment, especially software engineers and other computer related industries. When adjusting for the cost of living, the average engineer’s salary is $180,000 compared to $134,000 in San Francisco. The dollar stretches much further in Seattle, often one and a half times more as other major metros on the west coast, such as Los Angeles and San Francisco.

Many large companies are choosing to move from Silicon Valley to Silicon Cloudy, and have set their roots in the Pacific Northwest. Amazon currently occupies over eight million square

8 feet of prime office space in Seattle, earning the city the title of “Biggest Company Town in America.” Alaska Airlines, which has seen a steady 4.2 percent growth from 2015 – 2016, and just acquired Virgin America also chose Seattle for their headquarters. Additionally, other giants such Starbucks, Zillow and Microsoft are all located in Seattle.

Expedia recently announced their plans to spend $1.2B on a new headquarter in Seattle. The firm is looking to have the 40-acre former Amgen site up and running in 2019.

The steady influx of well-known companies can attest to the certainty and security when investing in the Seattle MSA. Given the dramatic population increase and the tax friendly environment, Seattle proves to create opportunities that provide generational wealth through real estate investment.

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According to Forbes, Austin is a rising star, as it has “become the nation’s superlative economy over the past decade.” Austin’s population growth is largely driven by a strong rate of net domestic in-migrations. Between the span of 2014 to 2016, Austin ranked the highest in the rate of net domestic in-migration out of 53 of the largest metropolitan areas in the nation at a ratio of 16.4 residents per every 1,000.

With a 19.82 percent increase in population growth from 2010 to 2016, Austin claims the title of the highest percentage growth of any of the top ten MSA’s we covered.

Robert Kaplan, president of the Federal Reserve Bank of Dallas, said, “Since 2000, the average rate of population growth has been almost a full one percentage point higher in Texas than in the U.S. as a whole”. Because of the influx of people, the City of Austin has the strongest retail occupancy rate among all the major markets in the

Austin Round Rock Population Growth by Average Number of People Per Year = 54,792 2016 Population Estimate = 2,056,405 country, sitting at 96 percent.

These growth rates and numbers make sense when you dig deeper into what’s causing people to move to the area...jobs! Of all the U.S. metro areas from 2008 to 2014, Austin received the most companies fleeing California, tallying up to a total of 99 companies. Of those 99 companies that migrated to the Austin Metro, 86 are a part of the City of Austin.

What makes Texas special, and more specifically Austin, is the diversification of the economy.

The educated proportion of its population between 25 and 44 years old is 43.7 percent, well ahead of the national average of 33.6 percent. Although this number is somewhat below the traditional “brain center” cities of the Northeast and the West Coast, many of the companies who have moved to Austin are tech companies. Home to over 4,700 high-tech companies, Austin is often referred to as “Silicon Hills,”

or the new Silicon Valley. Since 2000, employment in the Austin area grew 52.3 percent which is fifteen percentage points higher than Houston or Dallas-Ft. Worth, two cities that are also on our top MSA list.

All in all, Texas is one of the best states to own real estate in. The major MSA’s: Dallas Ft. Worth, Houston & Sugarland, and Austin Round Rock are people magnets and have experienced major growth in the population of the educated millennial households that are starting to have children.

Unlike other top MSAs, Texas has the room to expand, the resources to do so, and the business-friendly environment to support and sustain it. Whether it’s new development in the suburbs or redevelopment of major malls, the Austin & Round Rock MSA has solidified itself as an MSA you need to own real estate in.

For more information regarding where to make your next investment, please contact:

C h u c k E va n s C H U C K . E VA N S @ M AT T H E W S . C O M (310) 919-5841

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Je f f M i l l e r

J E F F E R Y. M I L L E R @ M AT T H E W S . C O M (424) 220-7263

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A n d r ew G r o s s A N D R E W. G R O S S @ M AT T H E W S . C O M (310) 955-1773

Your next great investment is just a click away.

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SAN FERNANDO VALLEY R E P O R T

The San Fernando Valley region of Los Angeles is a vast real estate market encompassing more than 260 square miles, and home to about 1.8 million people. This urbanized valley contains diverse real estate holdings, including thousands of multifamily properties, both rent controlled and non-rent controlled buildings. The purpose of this market report is to analyze the current state of the San Fernando Valley multifamily real estate market and take a look at the past 10 years and where this market may be going.

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If we were to ask what inning of the real estate cycle we are in, we can start by stating that the San Fernando Valley market has been incredibly strong over the past seven years. The years 2010 to 2017 have featured a steady rate of growth after one of the worst economic disasters in many years. During this period, we have seen high trading frequencies and rising prices. When we look at these numbers more closely, we can see where we stand and attempt to see where we are going.

Analyzing the Past to Understand the Future To try to determine what the next ten years may bring, it is helpful to look at the last ten years. In 2007, the multifamily real estate market was prospering.

That year, the San Fernando Valley volume hovered around one billion, with an average cap rate of 5.5 percent and an ask-to-list differential of about four percent. Unfortunately, the bottom dropped out of the real estate market when the recession hit in 2008. Almost immediately, prices fell drastically, and cap rates rocketed up to an average of 6.5 percent.

From 2008 to 2010, the vacancy rate remained high, hovering around 6.5 percent, as did sales volume which stayed around 500 million until 2010 when the economy began to recover. By 2012, sales volume had surpassed a billion.

The recovery was relatively slow to start. The San Fernando Valley real estate market didn’t gain strength until 2011 when major economic factors began to align in a way that meant for a better multifamily real estate market. The job market started to recover first, especially in the industries most important to the San Fernando Valley, such as manufacturing, finance, technology, and entertainment. During this period, many individuals and families were still recovering from losing their homes to foreclosure during the recession and were displaced from their single-family

Cap Rate

San Fernando Valley Source: CoStar 7

6

5

4

’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17

YTD

homes. This lead to an increased demand for rentals which drove up rental prices in prime markets and lower-income individuals and families were being forced into lesser markets in greater numbers. At the same time, there was an availability of cheap money in the form of lower interest rates, along with an increase in demand for multifamily investments from the investor community, which then led to rising price points for multifamily investments, causing cap rates to reach an all-time low. These trends continued into the market we know today.

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Current State of the Market As of 2017, there have been noticeable changes in the San Fernando Valley market. The sales volume of multifamily properties has decreased significantly from $2.5 billion between January to July 2016 to just $1.2 billion during the same period this year. Despite this decrease in sales volume, prices are at an all-time high because of continued competition for multifamily assets, low inventory, and still historically low-interest rates.

Also, rental rates continue to remain strong, and vacancy rates remain at an all-time low. All these factors are stirring up a lot of uncertainty in the market, as investors ask themselves, how long can the market sustain its current state?

The Outlook It’s hard to know what the future holds, of course, but it is likely that rents will begin to hit a ceiling in the near future. One indicator of this is because job growth seems to be slowing, with several sectors, like retail, information, leisure, hospitality, and healthcare, showing sharp reductions in job numbers so far this year. California is not known as a business friendly state. We’re seeing businesses move headquarters and operations out of the state, and the full impact of that is still unknown.

According to the Los Angeles Times, in 2017, retail businesses have cut 13,900 jobs, the information sector is down 1,900 jobs, and healthcare, leisure, and hospitality are failing to create as many jobs as they have been in past years. That means residents with low incomes do not see much income growth.

In addition to this, residents living in Los Angeles pay nearly half their income in rent rent, and seven compared percent to Los of theAngeles nationalresidents averageworking of 4.7 full percent, time are seven also percentthe below of Los poverty Angeles line residents comparedworking to the full-time national are livingofbelow average 4.7 percent. the poverty These line. statistics These statistics point to point a market to athat market most that likely most will likely not will continue not continue to see to see sustained sustained growthgrowth in rents. in rents.

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Dollar Volume San Fernando Valley Source: CoStar

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD

$0

500M

1B

1.5B

2B

Put simply, there is a rent ceiling in the San Fernando Valley, and there is a strong chance that the region has run head-on into that ceiling. The factors relating to where the market is today will ultimately drive lenders to pull back on providing capital to the market place. In return, this will begin to slow down deal velocity, while also increasing the cost of capital. There is a likelihood that rental prices will stabilize and find a plateau when they settle down. Many buyers in today’s market are buying out of speculation that rental rates will continue to increase, helping inflate the current pricing we are seeing today. Once rental rates plateau, the marketplace will have to adjust, and we should expect deflation of these aggressive prices.

To keep the market buoyed, one factor that will help is the continued population growth in the Los Angeles metropolitan statistical area. The high demand should help keep the rental market stable. Also, land prices are relatively high, and the need to hire local labor and incorporate affordable rental units has kept development in the multifamily market slow. We don’t expect a large crash anytime soon, but we expect the market will experience a relatively slow “deflation” as it sees counteracting forces in tapering rental rates and stabilized housing demand.

Another aspect to be accounted for is the rise in interest rates. Interest rates are expected to rise by a quarter-point by the end of 2017, and three more times in 2018. With higher debt costs impacting investors, investors have become more cautious, and the buyer pool is expected to shrink, especially for premium priced assets. Furthermore, with rising interest rates, cap rates are expected to rise as well as pricing adjusts.

To add to the uncertainty of rising interest rates, new proposed tax laws have been added to the mix. The new proposal, issued by the current administration, would reduce the existing seven tax brackets down to three, with rates of 10 percent, 25 percent and 35 percent. These numbers increase the current top tax rate from 33 percent up by two percent and lower the bottom tax rate of 12 percent down to ten percent.

Additionally, the proposal would nearly double the current standard deduction rates we have today. The key element to a successful tax reform is doing away with some of the special-interest freebies that are disguised as tax breaks. The current administration will strive to make that happen. A crucial component of the tax reform will focus on the tax deduction for interest payments by corporations and businesses.

Dropping corporate taxes from 35 percent to 15 percent should incentive corporations to strongly invest in their current infrastructure and employees.

Transactions

San Fernando Valley Source: CoStar 1000

800

600

400

200

0

’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17

YTD

GRM

San Fernando Valley Source: CoStar 15

12

9

Y’07 Y’08 Y’09 Y’10 Y’11 Y’12 Y’13 Y’14 Y’15 Y’16 Y’17

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On the upside, as one of the largest metropolitan areas in the United States, there is no slow down in the Los Angeles MSA’s population growth. Since the 2010 census, Los Angeles has experienced an influx of almost half a million people. Such population growth protects against investment risk and downturns in the market because the demand will always remain high and demand will help to stabilize the market. In conjunction with high demand, the barriers of entry for new development remain high as well, and new multifamily developments are slow, causing little threat to the current supply. Entitlements are hard to get; the cost of land is tremendous, and returns are low. With the passing of the measure JJJ ballot initiative, builders of most large projects are required to construct affordable housing and pay prevailing wages on the construction site, thus delivering low to no value returns. We are starting to see the slowdown in the market already, and if

the trend for 2017 continues, total development will fall just short of 2016’s numbers.

As far as the San Fernando Valley multifamily outlook goes, we are in the twelfth inning of a nine-inning game, and anything can happen. The outlook remains favorable, but as history proves that nothing lasts forever, we can anticipate deflation of the current market. For investors, we expect properties with good fundamentals (desirable locations, near schools and jobs) will incur the least amount of market adjustment. Investors looking to capitalize on the inflated multifamily market may look to take their equity to other asset classes such as office, retail or industrial – in pursuit of higher returns. For the long-term investor, it is still an opportune time to capitalize on equity and move into a multifamily asset that has the capability of increased appreciation over time – as we believe the San Fernando Valley still has a very bright future ahead.

Price Per Unit San Fernando Valley Source: CoStar 250K

200K

150K

100K

50K

0

2007

2008

2009

2010

2011

2012

2013

2014

2015

For more information regarding your multifamily investments, please contact:

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Daniel Withers

Aaron Guido

daniel.withers@matthews.com 818.923.6107

aaron.guido@matthews.com 818.923.6111

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2016

2017 YTD

W E RUN

YOU R BUSINESS

W IT H T H E F UT UR E I N M I N D

• 24/7 Maintenance • Rent Collection & Cash Management Financial Reporting & Accounting • Define optimal maintenance plans

• Vendor Maintenance & Coordination • Tenant Screening & Credit Checks •

Evictions and Collections

• Create multi-year budget

M A T T H E W S TM P R O P E R T Y M A N A G E M E N T

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E -COMM ERCE T RANSFORMIN G DEMAN D IN T H E IN D U STR I A L CR E S ECTO R

By Alexander Harrold Exploring the role e-commerce is playing in today’s industrial space, how it has molded the new core industr ial proper ty model, and what the future looks like for the industrial sector.

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2017 is turning out to be another solid year for industrial real estate. Property values are at an all time high, and demand is superseding supply. According to CoStar data, current vacancy rates for industrial properties are at 5.4 percent, declining over 140 basis points from Q4 of 2016, and are at the lowest level since the dot.com boom era of the early 2000s. Since 2011, rent per square foot has been on a steady rise in the industrial space.

As of August 2017, industrial properties exceeded an average of $5.30 per square foot in rent and can be expected to continue rising with the same trajectory. Over 65 million square feet were absorbed in the first half of 2017 and over 63 million in the last quarter of 2016.

Of the 65 million square feet of industrial real estate absorbed in the first half of 2017, 57 percent is classified as distribution and warehouse space. This overwhelming demand for distribution and warehouse space can be attributed to recent years’ shifts in consumer spending and the explosion of e-commerce. Increased consumer spending online correlates directly to the wave of industrial space needed to store and distribute the influx of inventory being moved.

For this reason, as the popularity of online consumer spending increases, so will the value of industrial real estate in this space.

Industrial Real Estate Vacancy & Rental Rates 16%

$5.40

Industrial Warehouse and Distribution Centers Absorption, Deliveries & Vacancy rates 100

20%

80

18%

60

16%

40

14%

20

12%

0

10%

-20

8%

-40

6%

-60

4%

-80 14%

$5.20

07 08 09 10 11 12 13 14 15 16 17 Absorption

12%

$5.00

10%

$4.80

8%

$4.60

6%

$4.40

4%

08 09 10 11 12 13 14 15 16 17

Vacancy Rate Source: CoStar

Rental Rate

$4.20

Deliveries

2%

Vacancy

Source: CoStar

“ T h i s o v e rw h e l m i n g demand for distribution and warehouse space can be attributed to recent years’ shifts in consumer spending and the explosion of e-commerce.”

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E-COMMERCE: THE CATALYST

Demand for industrial real estate has doubled in the past three years due to a shift in consumer spending preferences. In a recent study, BigCommerce found that 96 percent of Americans have made an online purchase at some point in their lives, and 80 percent have done so in the past month. According to a survey of 5,000 online shoppers, conducted by the United Postal Service (UPS), consumers say that they have made more purchases on the internet than in stores for the first time in history. The National Retail Federation projects e-commerce to grow by 8 to 12 percent in 2017 alone, compared to just 2.8 percent for overall retail. This movement is expected to continue gaining momentum as millennials and generation Z take hold of the consumer market in the coming years.

With a rise in online purchases, came an increase in parcel shipping. Pitney Bowes’ 2016 Parcel Shipping Index unveiled the massive influx of parcels due to the growth of e-commerce.

The index revealed that in 2015, volume grew by 3.6 percent, and is expected to grow at an annual rate of five to seven percent through 2018. Altogether, U.S. businesses spent $85 billion on parcel shipping, up by 1.2 percent from 2014. Amazon alone, reports spending in excess of $5 billion a year contracting with the United States Postal Service (USPS), United Postal Service (UPS), and FedEx. Moving forward, it is a necessity for e-tailers and their logistics partners to invest in the expansion of new warehouse and distribution space in order to house and deliver the influx of inventory.

THE EFFECT – AN INCREASE IN DEMAND FOR WAREHOUSES AND DISTRIBUTION CENTERS The shift in consumer spending and rise in parcel shipping is leading to a dramatic increase in demand for warehouse and distribution space. Global bank, Jeffries, estimates that e-commerce retailers need three times as much warehouse space as brick-and-mortar retailers, presenting a huge window of opportunity for warehouse landlords, especially industrial REITs. Nationally, the rental rates for warehouse space rose by more than ten percent in the past year. Owners and developers of industrial property outfitted for warehousing and distribution are in a great position to profit from the rise in demand.

FedEx and UPS have been quick to respond to the influx of parcels. The two courier giants announced that they are now offering new routes that were historically only provided by the 110 |

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United States Postal Service (USPS). Having less central parcel destinations, these routes have the longest lengths of haul and are more expensive to deliver to. Companies such as UPS and FedEx generally declined service to these zones or slapped on a heavy surcharge fee to the delivery price, commonly leaving the routes solely to USPS. But, with the growth of e-commerce and increasing customer needs, the demand for these local deliveries have risen, giving FedEx and UPS a reason to supply and turn a profit. The phenomenon is being felt in the industrial distribution and warehouse space as the two largest private sector couriers look to expand their growing footprint across the nation.

The FedEx Footprint Revenue of

665 20 6,350 1,200 +550 36 1,800 1,200

+$50B World Service Locations North American Distribution Facilities Authorized Ship Centers FedEx Express Stations Ground Stations Ground Hubs FedEx Office Locations FedEx Onsite Locations & More

Recognizing the opportunity e-commerce has presented, small e-commerce stores are popping up every day, and traditional brick-and-mortar stores are catching on as well. Unfortunately, these companies are at a disadvantage and it is not easy to master what the internet giants have been able to do. Many find themselves faced with logistic challenges of housing, distributing, and delivering merchandise in the timely manner consumers have become accustomed to. Aware of these challenges, FedEx has found a way to further extend their breadth of services and capitalize.

Currently in pilot phase, “FedEx Fulfillment” is reconfiguring its warehouse facilities and offering to accommodate housing for third-party inventory. FedEx already has advanced inventory and product processing systems in place that smaller retailers can’t afford.

From here on out, FedEx’s only challenges in launching “FedEx Fulfillment” are tweaking its internal processes, marketing its services to retailers and small businesses, and of course purchasing the industrial space that will be needed to sustain their endeavor.

home or office. While a portion of the inventory is merchandise developed or owned by Amazon, the majority is third-party sellers who contract with Amazon to store and deliver their goods to consumers.

There is undoubtedly a need for more space in the industrial sector in order to fuel the developments and changes emerging from the rise of e-commerce. Developers are responding with market-specific products, which include omnichannel fulfillment centers larger than 500,000 square feet in markets that offer access to the nation’s key population centers. While Dallas Fort-Worth, California’s Inland Empire, Chicago and other areas that feed major metropolitan markets are experiencing significant growth, the hottest growth rates are in secondary markets in the Midwest that serve as distribution hubs for e-commerce.

The Challenged: Smaller Warehouse Properties On the flip side, owners of smaller warehousing and distribution centers are experiencing declining demand. E-commerce companies need room to grow, and can fuel their growth with venture capital funding. Warehousing and distribution facilities that are under 100,000 square feet now lack the minimum footprint needed.

Another challenge smaller warehouses face is that their income is not enough to fund expansion build outs or to make investments in costly Warehouse Management System(WMS) installations, even though failing to do so risks obsolescence.

WHAT YOU SHOULD LOOK FOR - THE NEW INDUSTRIAL PROPERTY MODEL The Outlook As with all matters in commercial real estate, the big winners are those who meet the specialized requirements:

» PROX I M I TY TO MAJOR POPULATI ON CENTERS » EASY ACCESS TO MAJOR TRANSPORTATI ON CORRIDORS » HEAD- ROOM Up to 40-foot high clearances are necessary for specialized racking and material handling equipment to expedite delivery

» PRE- CONFI GURED Highest demand is for warehousing facilities with state-of-the-art inventory management systems in place

» NO DOWN- TI M E Back-up generators, AC, cross-dock configurations, big trailer parking areas to ensure uninterrupted operations

» SUPER- SI ZED 150,000 SF or larger Amazon, the e-commerce behemoth, has paved the way for the new industrial property model. They already have 70 fulfillment centers featuring high-tech management systems, and employ more than 40,000 full-time workers. Much of Amazon’s phenomenal growth is based on its ability to deliver merchandise fast – often the same day – which requires real estate that is proximate to the “last mile” distance from a fulfillment center to a consumer’s

Many experts believe that the recent years of growth in e-commerce and warehouse demand are not cyclical, and predict that this is the beginning of a growth trend set to continue for many more years.

The traditional giants such as USPS, FedEx, and UPS will not be the only companies expanding in this new sector. When demand rises in the marketplace, history has proven that new challengers will arise to compete for the overflow of business. While some can question whether Amazon would jump into an industry as competitive as shipping and delivery, the e-commerce company has already made moves indicating their ambitions. Amazon has 4,000 trailer trucks emblazoned with the Amazon logo and leases over 40 cargo planes to transport goods between their warehouses and distribution centers. Amazon’s recent $13.7 billion purchase of grocery chain, Whole Foods, indicates the company is more than willing and capable of taking on new challenges. If they were to venture into this space, Amazon would require an incredible amount of additional real estate.

At the rate e-commerce is growing today, the need for square footage in the industrial sector will only increase, further igniting the demand for the new industrial property model.

As the new model requires significant investments to build out the large facilities desired, it remains to be seen how smaller warehouse and distribution centers will respond.

For more information regarding industrial properties, contact:

alexander harrold e alexander.harrold@matthews.com p 310-919-5790 M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

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NEIGHBORHOODS MOVING:

NEW L.A. MARKETS TAKE THE FIELD

BY C H A R L E S W R I G H T

Suddenly and surprisingly, investors who normally seek assets in areas like Koreatown and Hollywood are now focused on pouring money into upcoming markets like South Central L.A. and Boyle Heights.

Investors are looking to these areas to capitalize on rent controlled buildings, which have untapped upside. The savvy investors, normally buying in Koreatown or Hollywood, have the ability to realize this opportunity, when mom and pop owners in these areas are unaware. The competition has led to premium prices for sellers in South Central L.A. and Boyle Heights, even if their current rents are low.

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BIG DEVELOPMENTS AHEAD Recently, South Los Angeles and the Eastside have experienced a wave of developments that have attracted investors into these areas: U S C ’s U n i v e r s i t y V i l l a g e Described by the LA Times as “Disneyland meets Hogwarts,” the 15 acre, $700 million construction, built in order to bring together the university and the surrounding neighborhood, is the biggest development in the history of South L.A. This student housing and retail center features Trader Joe’s, Target, Amazon, Bank of America locations, and over 14 restaurants to dine in. “The village is the first major investment to come to South L.A. in a long, long time,” says Los Angeles Councilman, Current Price. “In fact, it’s spawned other transformational developments in the area.” Values of neighboring multifamily properties will flourish as people will want to live near this social experience hub.

S e a r ’s M i x e d U s e T r a n s f o r m a t i o n The historic Sears building in Boyle Heights, 10-story 1.8 million square foot complex , is being converted into a multi-use development. According to plans filed with the City of Los Angeles, the project will include: 1, 0 3 0 apartments

95,000 square feet of commercial space

200,000 square feet of office space

250,000 square feet of retail space

“It sits over 22 acres of land, and the building is 1.8 million square feet, and that by itself is a community by itself; a town by itself,” says developer Izek Shomof, who purchased the building in 2013. His goal is to create a complex of stores, lofts, restaurants, and creative space to transform the property into a “hub of

the community” again. This sizable development will not only increase the tenant demand in Boyle Heights, but create immense advantages for investors in this market.

L . A . ’s T r a n s i t L i n e s With over a million riders, L.A.’s Metro transit system is also a factor playing into increased investor interest in South L.A. and the Eastside. In 2016, Measure M passed, giving Metro $120 million to build new rail lines, busways, bike paths, and new roads.

Los Angeles is heavily investing in its transit system, with surrounding neighborhoods growing increasingly desirable to investors. “These neighborhood changes are also beginning to happen in Boyle Heights and parts of South Los Angeles,” Paul Ong, Director of UCLA Luskin’s Center for Neighborhood Knowledge.

“Preferences—in terms of where one wants to live, and what type of lifestyle people want to lead—are changing... and when those things are changing, there’s going to be change in the urban landscape, with neighborhoods becoming more attractive to people’s interests and therefore to investors.”

The NFL Invades L.A .

With the relocation of the St. Louis Rams and the San Diego Chargers to Los Angeles, construction has begun on the $2.6 billion, 80,000 seat Inglewood stadium.

The future sports district will include 298 acres of entertainment including a 6,000 seat concert venue, a 300 room hotel, retail, offices and housing. This entertainment complex is not only a major boon for the city, but could mean huge upside for both developers and investors in South L.A.

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LOOKING AT THE NUMBERS According to CoStar, South Central L.A. has been hot as demonstrated by the numbers. During the 2014 to 2016 cycles, South Central L.A. saw more than a 42 percent hike in transaction volume, while sales increased more than 49 percent. Average price per square foot has also increased more than 32 percent, while cap rates dropped by 14 percent. Performance for the area thrashed Koreatown and Hollywood by substantial amounts.

Yet South Central L.A. doesn’t hold a candle to the performance of Boyle Heights. During the same 2014 to 2016 period, transaction volume for this area increased a staggering 107 percent, while units sold rose a dramatic 184 percent. However, the values per unit did not fare as well as South L.A., increasing 15 percent, but cap rates fell more than 30 percent.

TRANSACTION VOLUME % C H A N G E ( ‘ 14 - ‘ 1 6 ) SOURCE: COSTAR 12 0 10 0 80 60 40 20 0 -20 -40

South Central LA

Koreatown

Hollywood

Boyle Heights

.

AV E R AG E C A P R AT E S % C H A N G E ( ‘ 14 - ‘ 1 6 ) SOURCE: COSTAR 40 30 20 10 0 - 10 -20 -30

South Central LA

Koreatown

Hollywood

Boyle Heights

UNITS SOLD % C H A N G E ( ‘ 14 - ‘ 1 6 ) SOURCE: COSTAR 200 15 0 10 0 50 0 -50 - 10 0

South Central LA

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Hollywood

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Boyle Heights

One of the main drivers of the new market appeal is the fact that many Investors are getting priced out of Hollywood and Koreatown. South Central L.A. and Boyle Heights are more affordable and have much higher cap rates. This is all great news for owners in Boyle Heights and South Central L.A., as they are able to sell their property for a premium even though they have rents that are well below market.

%CHANGE IN CAP ( 1 H ’ 1 6 - 1 H ’ 17 ) South Central LA

-8.20%

Koreatown

13.16%

Hollywood

0%

Boyle Heights

-14.04%

HOW DO THEY DO IT? What does this mean for owners in Boyle Heights and South Central L.A.? Owners are only able to raise rent three percent a year due to strict Los Angeles Rent Control Laws. For example, if there is a one -bedroom unit owners have rented out for $800, but market rents in the area are $1,600, owners are missing out on 100% rental income increase in their unit. An investor seeking to capitalize on that upside will offer a “cash for keys” tenant buyout to the existing tenant, later refurbishing the unit, and re -renting it at market rate.

Flipping these rent-controlled units increases yields dramatically for investors.

I T ’S A L L V O L U N TA R Y The “cash for keys” tenant buyout ordinance passed in late 2016 has been scrutinized recently, as many who are loyal to their neighborhoods are concerned over gentrification issues – although many times this is a politicized strategy. The fact is that all “cash for keys” transactions are voluntary by the renters of the units. Tenants are not forced to vacate their units, and the landlord is permitted to provide a disclosure notice with all the tenant’s rights throughout the process.

Additionally, all city policies toward rent controlled buildings remain in effect until specific factors are met.

Neither the seller nor the buyer can give the tenant of a rent-controlled apartment, and a 60-day notice to move due to a sale.

W H A T ’S N E X T ?

Based on recent commercial permits issued for the Boyle Heights and South Central L.A. regions, one can expect that 2018 will see an accompanying surge in the value of all Boyle Heights & South Central L.A. real estate. These neighborhood’s convenient locations and affordable housing, combined with the boom of surrounding developments, will result in an influx of multifamily investors looking to capitalize on the robust growth of these L.A. markets currently taking the field.

For more information regarding where to make your next multifamily investment, please contact:

CHARLES WRIGHT charles.wright@matthews.com 310.295.4374

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Invest Now & Save Later:

5 Simple Steps to Save on Your Property Expenses A recent study by the Building Owners and Managers Association (BOMA) found that, on average, 15 percent of a property owner’s expenses are spent on repairs and maintenance. Of that 15 percent, nearly half is spent on preventative maintenance. But the study suggests that more proactive steps should be taken by owners to design and implement preventative maintenance plans in order to save costs over the life of the property.

If an owner does not have a preventative maintenance plan, expenses are more than likely to be costlier in the future, according to the study from BOMA. An owner should be allocating between 4.5 percent – 7.5 percent of annual operating costs to preventative maintenance annually. If not heeded, owners are now at risk for an increase in repair expenses later. Preventative maintenance techniques have proven to avoid system failure, downtime, and extend the life of mission-critical, high-cost equipment and systems.

FACT: A preventive maintenance plan will prevent equipment failure before it ever happens.

We know for certain that preventive maintenance keeps operations running smoothly and prolongs the life of expensive equipment, while reducing overall maintenance costs. With so many obvious benefits to performing preventive maintenance, the real question isn’t whether you should do preventive maintenance, but how to implement an effective preventive maintenance plan.

Preventive maintenance plans are similar to property insurance policies. And like insurance policies, a good preventive maintenance plan will minimize the negative effects, and expenses, of any unforeseen circumstances affecting high-cost equipment or systems. But also like insurance policies, it is up to the owners and investors to implement a plan to stay ahead of emergencies. After all, an insurance policy did not come with your property – you had to figure out the right coverage, shop around, and then organize the best companies to implement the plan. The same is true for preventative maintenance plans.

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5 1

Steps to a Good Preventative Maintenance Plan

get the right people in place

To organize a worthwhile preventive maintenance plan, you need to have the right people, with the right tools, and the right strategy. A skilled team will include top management, maintenance managers, maintenance technicians, and those who understand the way your system operates. This could include people from departments not usually associated with maintenance, like data processing, accounting, and craftsmen.

You may not need input from each of these people at every step of the process, but it’s important to have them on your management team so you get important feedback.

2

3

set goals for your preventative maintenance plan

Your property manager and task force, should set goals you hope to achieve at your property. Goals must include regularly met scheduled inspections and cleanings, responding quickly to tenant complaints or concerns, keeping detailed records of work performed on systems with dates and part numbers, regular training, good relationships with vendors who repair systems beyond your team’s skillset, etc. Having goals creates organization and control – two vital variables in successful maintenance plans.

take inventory of your assets

Go through your facility and inventory all equipment you are considering including in the preventive maintenance plan. Tagging equipment as you go will help track records and part numbers if emergencies arise. A good preventive maintenance software program can greatly assist in this task and pay dividends when important details are needed when emergencies suddenly show up.

EXAMPLE:

Approximately nine out of ten HVAC system failures are a result of dirt, rust, excess moisture, environmental contaminants, etc.

You avoid this issue through proactive maintenance – like regular cleanings and inspections. If you find that your HVAC system is not functioning efficiently, it may be a sign the entire system might fail. And as we know, a system failure is the worst-case scenario.

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5 steps (cont.)

4

decide up-front the details of your plan with an expert

Make early decisions on what will go into your property maintenance plan with the assistance of experts. Determine the health of each piece of equipment with an outside vendor before making decisions on the overall plan. This is vital to cover aging assets, as well as getting a thirdparty viewpoint and opinions.

5

schedule long & shortterm preventative maintenance

Secure as many of your high-cost, highpriority pieces of equipment on a regular preventive maintenance schedule. But keep in mind you do not have to do it all at once. Your tasks should be directed to how the unit might fail, and your goal should be to prevent as many failures as possible. Start with one piece of equipment and add as you go. Using the first piece of equipment, create a schedule for the year, broken down into daily, weekly, monthly, quarterly, bi-annual, and/or annual tasks.

Continue with each piece of equipment until everything has a long-term plan.

Now that you have planned your year, you can easily create weekly plans for your maintenance team.

Good preventive maintenance tasks should be performed during pre-arranged equipment downtime, but remain flexible for work that comes in from inspection or reactive situations. Always remember that your tenants are the true priority, and they will notice your short-term efforts and create a positive attitude toward the team.

Reactive vs. Proactive Maintenance: Which Are You Using?

There are two types of maintenance strategies employed by owners today; reactive maintenance and proactive maintenance. Reactive maintenance goes by the theory “if it isn’t broke, don’t fix it,” a strategy that can sometimes save money short term, but more often ends up costing more in the long run. Proactive maintenance, contrariwise, employs the strategy of using skills, goals, and techniques to ensure that systems never fail. Proactive maintenance is performed routinely, and thoroughly, to avoid costly fixes in the future. Ask yourself which strategy you employ.

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Repair vs. Replace One example of proactive maintenance often overlooked is that of repair vs. replace. A team should always weigh the cost of replacing an item - versus just temporarily fixing it.

It’s not necessarily the cheapest way to maintain a property, but it is essential for stabilizing long-term cash flow. However, more times than not, budgets get in the way of necessary replacement parts or systems that will require long-term repair costs outweighing the original cost of replacing the asset in the first place. This is where accountants can help in determining the best plan long-term.

The Next Steps to Take The first task to complete when creating a solid maintenance plan is realizing your assets inventory and value. Log equipment and serial numbers, appraise aging equipment and the cost to replace them near-term, then evaluate repair-cost histories to forecast future budgets. Hire a professional management team skilled in maintenance techniques to consult you on short term versus long term strategies. This expert will pay dividends for years while you watch your costs come down, tenant satisfaction rise, and less frequent emergencies.

For more information regarding your property management needs, please contact:

Minnie Allison

minnie.allison@matthews.com 214-692-2047

Tim Woods

tim.woods@matthews.com 310-919-5725

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IS THIS PROPERTY C O R P O R AT E LY GUARANTEED? – NOT FOR LONG… BRADEN CROCKETT

& ANDREW IVANKOVICH

“Is this property corporately guaranteed?” - This is often the first, or at least the most frequently asked question by net lease investors and for a good reason. The default risk of a corporate company is thought to be significantly lower than a smaller franchisee. The coveted corporate guarantee was what the net leased industry was founded on, but today, guarantors for net leased assets come in all shapes and sizes. The guarantor on the lease can range from single unit entity guarantees to franchisee guarantees, to personal, and finally, corporate guarantees.

However, one emerging trend is threatening to change the status of corporate guarantees, which prompts the question: When is a corporate guarantee not always destined to remain a corporate guarantee?

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NC

S HI

EE

TE A OR EED P T R CO RAN A GU

To answer this question, we propose another question: if you are an owner of a corporately guaranteed location, who is operating the business? Most investors’ responses, would be “the corporate tenant.” However, if you are the owner of a Quick Service Restaurant (QSR) or even a Casual Dining Restaurant, this is more than likely not the case.

have been a great strategy as operators realize they can generate a higher return through operations than the return generated from the real estate. Additionally, Franchisors have found that by selling the business operations to their franchisees they can substantially increase their profit margins and benefit from an increased equity multiple.

The answer is that a corporate lease is not destined to be a corporate lease when the investment is guaranteed by corporate, but operated by a franchisee.

This trend has rapidly accelerated in the past 15 years and has been enacted by a vast majority of the largest franchisors such as McDonald’s, Carl’s Jr, Hardee’s, Wendy’s, Burger King, Dunkin’ Donuts, Arby’s, Sonic, Buffalo Wild Wings, KFC, Pizza Hut, Taco Bell, Applebee’s, Denny’s, and IHOP.

This situation of a corporation guaranteeing the lease, but a franchisee operating the business primarily originated through:

1

A Sale-Leaseback Strategy: Where a Corporate Tenant sells the real estate while leasing it back from the investor.

2

National Franchises enacting a “Refranchising Initiative.

These strategies are nothing new to Wall Street, as equity holders of these companies continually seek to increase returns and profit margins. Sale-Leasebacks

However, this poses an interesting dilemma for net leased investors who currently own a property leased by corporate. If the franchisor’s goal is to increase their valuation multiple, wouldn’t the valuation multiple increase if the franchisor was no longer liable for the lease (debt) obligations of their franchisees? In theory, this would reduce a franchisor’s balance sheet obligations, thus reducing the risk of the company resulting in a higher valuation multiple.

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SHIFT FROM CORP ORAT E TO FRANCHISEE While simple in theory, in practice, it is much more difficult for a franchisor to remove themselves as the guarantor on the lease until the lease ends. At this time, the franchisor has leverage because they no longer have any lease obligations, and without a tenant, a landlord is much more likely to agree to signing a new lease or addendum solidifying the franchisee as the new guarantor. On top of losing a credit tenant, the franchisee will often want to renegotiate the rent down to market. The franchisee acquired these lease terms when they purchased the operations from corporate and thus never agreed to the rent amount when it was negotiated.

Even though a landlord may lose the credit of their tenant and receive a reduction in rent, this often makes sense for a landlord because their income stream is uninterrupted and they do not have to incur hundreds of thousands of the expenses associated with releasing a space. Additionally, Landlords are usually comfortable with the tenant since they have been operating at this location for years before the lease came up for renewal.

What many landlords often do not recognize is the dramatic effect this outcome can have on the equity of their investment. The average cap rate difference between a corporate and franchise guarantee is 78 basis points (BPS). Holding all else constant, this results in a loss of $100,000-$250,000 depending on the percentage increase of the cap rate. If the rent is also reduced, this results in a significantly larger loss.

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HOW TO KEEP A CORP ORAT E GUARANT EE: The only forms of leverage a landlord will have are the strength of their location (irreplaceable location, paying rents in-line with market, etc.) and the operators’ performance of their site. A landlord must be able to justify that the rent they are receiving is in-line with the market in order to demand and ultimately receive a corporate extension. However, the corporate entity will only continue to guarantee the lease, if this site consistently reports strong store sales. If the location is strong, but the sales are not, then corporate will be less likely to continue guaranteeing the lease even if the franchisee wants to remain at the site. Ultimately, it all comes down to the sales performance. The problem is a large chunk of QSRs do not report store sales, which leaves landlords in the dark. This scenario is comparable to investing money into a stock and not having access to their quarterly financials. At the expiration of the lease, these landlords will be stepping into the negotiating ring blindfolded.

Tenant

# of US Locations

# of Corporate Locations

Targeted % of Corporate

Targeted Corporate Locations

Carl’s Jr. & Hardee's

3,733

224

6%

3,509

94%

5%

187

6.10%

6.88%

-0.78%

Wendy’s

6,500

975

15%

5,525

85%

5%

325

5.95%

6.69%

-0.74%

Burger King

7,500

50

0.67%

7,450

99%

5%

375

6.15%

7.00%

-0.85%

Sonic

3,500

350

10%

3,150

90%

5%

175

6.10%

6.92%

-0.82%

Buffalo Wild Wings

1,237

1,113

90%

124

10%

60%

742

6.12%

6.93%

-0.81%

KFC

4,500

1,035

23%

3,465

77%

2%

90

6.25%

7.02%

-0.77%

Pizza Hut

7,908

1,186

15%

6,722

85%

2%

158

N/A

N/A

N/A

Taco Bell

6,444

1,031

16%

5,413

84%

2%

129

6.05%

6.90%

-0.85%

Applebee’s

2,018

20

1%

1,998

99%

1%

20

6.15%

6.95%

-0.80%

TGI Friday’s

247

0

0%

247

100%

0%

0

N/A

N/A

N/A

IHOP

1,566

16

1%

1,550

99%

1%

16

6.22%

6.77%

-0.55%

McDonald's

14,146

2,829

20%

11,317

80%

10%

1,415

N/A

N/A

N/A

135

0

0%

135

100%

0%

0

N/A

N/A

N/A

195,741

47,353

24.19%

148,388

75.81%

24%

46,978

N/A

N/A

N/A

-

-

15.85%

-

84.15%

8.71%

-

6.12%

6.90%

-0.78%

Famous Dave's BBQ Top 100 Chains Average

% Operated # of % Operated by Franchised By Corporate Locations Franchisees

10 Year 10 Year Corporate Franchisee Difference Avg Cap Avg Cap

FOR MORE INFORMATION CONTACT A MATTHEWS™ REPRESENTATIVE: BRADEN CROCKETT braden.crockett@matthews.com (214) 692-2040

ANDREW IVANKOVICH andrew.ivankovich@matthews.com (214) 692-2037

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QA &

with Brian Krebs Managing Director of Barrington Capital Corp.

State of Financing:

Single Tenant Net Lease Investments How does financing for Single Tenant Net Lease investments (STNL) vary from the rest of CRE? Financing for single tenant net lease investments varies quite a bit when compared to the other primary product types. When a lender is considering a financing request for a single tenant net leased investment, the lender will first analyze the tenant and location of the property to determine if the request falls within their lending parameters. A big part of the underwriting process is assessing the risk associated with the potential transaction. Assuming the deal falls within their lender’s parameters, they will then price the rate to accommodate for the associated risk, taking both the tenant’s creditworthiness and location into consideration.

When you have a single tenant, vacancy is not diversified, therefore, a lender will put more weight on underwriting the tenant as opposed to a multi-tenant asset where the tenant base and overall risk is diversified. Financially stable credit tenants are generally viewed as less risky which leads to favorable lender pricing. Properties with smaller and less financially stable tenants are viewed as a higher risk and more difficult to finance which is reflected in both the pricing and leverage offered by the lender.

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Multi-tenant properties typically have a more diverse tenant base, therefore not all tenants present concern to the lender. Underwriting will be focused on the larger tenants in particular the credit, sales and remaining lease term.

For example, a retail center with ten tenants, five which are financially strong, the weakness of the other five tenants does not weigh as heavily on the terms in which the lender is comfortable to extend. The financial strength and credit worthiness of the five tenants make up for the risk imposed by the others.

How is this sector performing compared to last year?

Overall transaction volume has slightly decreased for the single tenant net lease sector. However, the amount of properties financed has increased year over year. Primary factors behind this are the fact that many short-term loans with terms ranging from three to five years are coming to maturity and need to be refinanced. Additionally, investors are always looking to increase yield and take advantage of historically low interest rates as well as extending the term and security of their investment.

Which property types do you consider the most resilient at this point in the cycle and why?

When evaluating which property types will perform in the coming years, we should take a closer look at the overall economy and where each asset class fits in. Properties that service growing industries will outperform those that are servicing declining sectors. For example, with an increase in e-commerce activity, we expect industrial warehouses and distribution centers to perform very well over the coming years. On the other side, you have large big box retailers that will need to redesign the way they do business to remain competitive.

How is Barrington Capital Corp (BCC) helping STNL agents and investors with the challenges seen in financing for these assets?

Our team is very involved with assisting agents who specialize in single tenant net lease investments. From the time book and records are received, to when the property is listed, our team is heavily involved and in many cases, plays an integral role in determining the pricing of the asset. A buyer generally will consider what financing terms are attainable and how that will affect the overall return prior to making an offer. I view our team as much of an investment advisor as a mortgage banker for both sales agents and investors to benefit from.

Brian Krebs

brian.krebs@barringtoncapcorp.com (949) 777-5988

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A U T O P A R T S

ADVANCE AUTO PARTS

AUTOZONE

O’REILLY AUTO PARTS

Credit Rating

BBB-

BBB

BBB+

Market Cap

±$9B

±$13.8B

±$15.53B

2016 Avg Cap

7.09%

5.60%

6.03%

2017 Avg Cap

7.35%

5.90%

6.15%

Corporate or Franchisee?

Corporate

Corporate

Corporate

Typical Price Range (New)

$1,500,000 - $2,500,000

$1,200,000 - $1,700,000

$1,300,000 - $3,300,000

5.25% - 6.25%

4.50% - 5.50%

4.75% - 6.00%

15 Years

15 Years

20 Years

NNN

Ground

NN+

Flat, 5% in Options

Flat or 10% Every 5 Years

6% in Years 11 and 16

Average Store Sales

±$1,750,000

±$1,750,000

±$1,775,000

Report Store Sales

No

No

No

Moderate/Risky

Moderate

Moderate

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

Tenant Future Outlook Rating

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A U T O s e r v i c e s

FIRESTONE

GOODYEAR

JIFFYLUBE

NTB

TIRE KINGDOM

Credit Rating

BBB+

BB

-

-

-

Market Cap

±$9B

±$8.86B

-

-

-

2016 Avg Cap

7.09%

7.09%

6.60%

6.17%

6.24%

2017 Avg Cap

7.21%

7.43%

6.50%

6.12%

6.45%

Corporate or Franchisee?

Corporate

Both

Both

Corporate

Corporate

Typical Price Range (New)

$1,500,000 $2,500,000

$1,250,000 $2,000,000

$1,500,000 $3,200,000

$2,000,000 $3,800,000

$1,500,000 $2,000,000

Cap Rate Range (New)

5.25% - 6.25%

7.00% - 8.00%

5.20%

5.50% - 6.25%

6.00 - 7.00%

15 Years

15 Years

20 Years

15 Years

15 Years

NNN

NN

NNN

NNN

NNN

Flat, 5% in Options

10% Every 5 Years, 10% in Options

10% Every 5 Years

10% Every 5 Years

10% Every 5 Years, 10% in Options

Average Store Sales

±$1,750,000

± $1,150,000

±$700,000

-

±$1,550,000

Report Store Sales

No

No

Per Lease

No

Per Lease

Moderate

Risky

Moderate

Safe

Very Safe

Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

Tenant Future Outlook Rating

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BANK OF AMERICA

CHASE BANK

WELLS FARGO

BBB+

A+

A

±$230B

±$306B

±$279B

2016 Avg Cap

5.65%

5.00%

5.92%

2017 Avg Cap

5.85%

5.25%

5.75%

Corporate or Franchisee?

Corporate

Corporate

Corporate

Typical Price Range (New)

$2,000,000 - $5,000,000

$2,000,000 - $5,000,000

$2,000,000 - $5,000,000

4.50% -4.75%

4.50% -4.75%

4.50% -4.75%

20 Years

20 Years

20 Years

NNN Ground Lease

NNN Ground Lease

NNN Ground Lease

10% Every 5 Years

10% Every 5 Years

10% Every 5 Years

Average Store Sales

± $95,000,000 (Deposits)

± $90,000,000 (Deposits)

±$105,000,000 (Deposits)

Report Store Sales

FDIC

FDIC

FDIC

Moderate

Moderate

Moderate

Credit Rating Market Cap

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

Tenant Future Outlook Rating

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b i g b o x

GOODWILL

MATTRESS FIRM

TRACTOR SUPPLY

WALMART NEIGHBORHOOD MARKET

Credit Rating

Nonprofit

B+

-

AA

Market Cap

±$5.59B

±$3.8B

±$6.60B

±$227B

2016 Avg Cap

6.49%

6.75%

6.21%

5.10%

2017 Avg Cap

6.68%

-

6.28%

5.20%

Corporate or Franchisee?

Corporate

Both

Corporate

Corporate

Typical Price Range (New)

$2,500,000 $4,000,000

$2,000,000$3,000,000

$4,000,000 $7,000,000

$5,00,000 $13,000,000

5.5%-6.5%

6.25%-7.25%

5.75% - 6.25%

4.8% - 5.60%

15 Years

10 to 12 Years

15 Years

20 Years

NNN

NN

NN

Ground Lease

10% Every 5 Years

10% Every 5 Years

5% or 10% Every 5 Years

10% Every 10 Years

Average Store Sales

-

±$1,000,000

± $4,400,000

-

Report Store Sales

No

Per Lease

No

No

Tenant Future Outlook Rating

Safe

Moderate

Moderate

Very Safe

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

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APPLEBEE’S

CHILI’S

DENNY’S

IHOP

-

BBB-

-

-

±$757.64M

±$1.85B

±$825.90M

±$778.18M

2016 Avg Cap

6.22%

5.93%

5.98%

6.28%

2017 Avg Cap

6.30%

5.60%

5.86%

7.40%

Corporate or Franchisee?

Both

Franchisee

Franchisee

Franchisee

Typical Price Range (New)

$2,500,000 $3,000,000

$2,500,000 $3,250,000

$2,500,000 $3,250,000

$2,700,000 $3,650,000

Cap Rate Range (New)

5.75% - 6.25%

4.75%-5.25%

5.50%-6.00%

5.25%-6.00%

20 Years

20 Years

20 Years

20 Years

NNN

NNN

NNN

NNN

1%-2% Annually; 7.5%-10% Every 5 Years

10% every 5 Years

10% every 5 Years

10% every 5 Years

Average Store Sales

±$2,200,000

±$3,250,000

±$1,650,000

±$3,250,000

Report Store Sales

Per Lease

Yes

Yes

No

Tenant Future Outlook Rating

Very Risky

Safe

Moderate

Moderate

Credit Rating Market Cap

Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

c e l l u l a r

AT&T

VERIZON WIRELESS

BBB+

BBB+ (S&P)

±$249.35B

±177.5B

2016 Avg Cap

6.65%

6.57%

2017 Avg Cap

6.70%

6.75%

Corporate or Franchisee?

Corporate

Franchisee

Typical Price Range (New)

$1,700,000 - $2,400,000

$1,250,000 - $3,500,000

5.75% - 6.25%

5.75% - 6.50%

10 Years

10 Years

NN

NN

10% Every 5 Years

5% - 10% Every 5 Years

Average Store Sales

-

-

Report Store Sales

No

No

Risky

Safe

Credit Rating Market Cap

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

Tenant Future Outlook Rating

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DUNKIN DONUTS

STARBUCKS

STARBUCKS TRUE LOGOS. GENERATED BY CHI NGUYEN (CHISAGITTA)

Credit Rating

-

A

±$5.02B

±$84.44B

2016 Avg Cap

5.50%

5.21%

2017 Avg Cap

5.55%

5.05%

Corporate or Franchisee?

Franchisee

Corporate

Typical Price Range (New)

$1,300,000 - $2,100,000

$1,650,000 - $3,000,000

5.00% - 6.25%

3.75% - 5.25%

15 Years

10 Years

NNN

NNN

10%

10%

Average Store Sales

±$850,000

±$1,150,000

Report Store Sales

Yes

No

Tenant Future Outlook Rating

Safe

Very Safe

Market Cap

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

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c o n v e n i e n c e

7-ELEVEN

CIRCLE K

WAWA

AA-

BBB

Private

±$14.2B

±$33.81B

±$9B

2016 Avg Cap

5.44%

7.03%

4.90%

2017 Avg Cap

5.72%

6.70%

4.95%

Corporate or Franchisee?

Corporate

Both

Corporate

Typical Price Range (New)

$1,200,000 - $3,000,000

$2,000,000-$4,000,000

$5,000,000 - $8,000,000

4.50%-5.25%

5.00%-5.75%

4.25%-5.00%

15 Years

20 Years

20 Years

NNN

NNN

Ground Lease

Rent Increases

10% Every 5 Years

5% Every 5 Years

5-8% Every 5 Years, Starting Year 11

Average Store Sales

±$1,780,000 (inside sales only)

±$1,500,000

-

Report Store Sales

No

No

No

Tenant Future Outlook Rating

Safe

Safe

Very Safe

Credit Rating Market Cap

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New)

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DOLLAR GENERAL

FAMILY DOLLAR

BBB

BB+ (S&P)

±19.15B

±$16B

2016 Avg Cap

7.48%

7.41%

2017 Avg Cap

7.56%

7.44%

Corporate or Franchisee?

Corporate

Corporate

Typical Price Range (New)

$1,250,000 - $1,800,000

$1,000,000-$1,500,000

6.25%-7.00%

6.00%-6.75%

15 Years

15/10 Years

NNN

NNN/NN

10% in Options or 3% in Year 11

10% in Year 11, and Options

Average Store Sales

±$1,600,000

±$1,350,000

Report Store Sales

No

No

Moderate/Safe

Moderate/Safe

Credit Rating Market Cap

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

Tenant Future Outlook Rating

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d r u g s t o r e

CVS

RITE AID

WALGREENS

BBB+

B

BBB

±$79.53B

±$2.38B

±$84.7B

2016 Avg Cap

5.72%

6.96%

6.11%

2017 Avg Cap

5.92%

8.00%

6.48%

Corporate or Franchisee?

Corporate

Corporate

Corporate

Typical Price Range (New)

$4,000,000 - $12,000,000

$4,000,000 - $12,000,000

$4,800,000 - $13,900,000

4.85% - 5.25%

5.25% - 5.50%

5.25% - 5.50%

25 Years

20 Years

20 - 25 Years

NNN

NNN

NNN

Typically in Options Only

10% Every 10 Years

Flat

Average Store Sales

-

±$7,000,000

±$3,200,000 (Reported)

Report Store Sales

Per Lease

No

Yes

Safe

Risky

Safe

Credit Rating Market Cap

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

Tenant Future Outlook Rating

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BUFFALO WILD WINGS

CHIPOTLE

PANERA BREAD

-

-

-

±$2.05B

±$11.94B

±$7.16B

2016 Avg Cap

6.14%

5.14%

5.24%

2017 Avg Cap

6.25%

5.37%

5.41%

Corporate or Franchisee?

Both

Corporate

Corporate

Typical Price Range (New)

$2,300,000 - $3,600,000

$1,600,000 - $2,000,000

$2,500,000

5.50% - 6.00%

4.75% - 5.25%

4.75% - 5.15%

15 Years

10 - 15 Years

15 Years

NNN

NN, NNN, Ground Lease

NNN

7.50% Every 5 Years

5-12% Every 5 Years

5% - 10%

±$3,200,000

±$1,730,000

±$2,700,000 $2,900,000

Per Lease

No

No

Safe

Moderate

Safe

Credit Rating Market Cap

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New) Rent Increases Average Store Sales Report Store Sales (Yes/No) Tenant Future Outlook Rating

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7 |

137

g r o c e r y

ALDI

SPROUTS

TRADER JOE’S

-

Ba2

-

Market Cap

±$14B

± $3.1B

-

2016 Avg Cap

6.14%

4.83%

5.25%

2017 Avg Cap

4.5%

-

5.00%

Corporate or Franchisee?

Corporate

Corporate

Corporate

Typical Price Range (New)

$2,000,000 - $3,500,000

$9,000,000 $15,000,000

$11,000,000 $14,000,000

4.25%-5.25%

4.75% - 5.25%

4.50% - 5.00%

Typical Lease Term (New)

20 Years - GL; 10 Years - Fee Simple

15 Years

15 Years

Typical Lease Structure (New)

Ground Lease or NN

NNN

NNN

5-10% Every 5 years for GL; 5-10% in Options for Fee Simple

Flat, Increase in Options

10% every 5 Years

Average Store Sales

-

±$16,984,000

-

Report Store Sales

No

No

No

Tenant Future Outlook Rating

Safe

Safe

Safe

Credit Rating

Cap Rate Range (New)

Rent Increases

138 |

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

m e d i c a l

DAVITA DIALYSIS

FRESENIUS

Credit Rating

BB/Ba2

BBB-

Market Cap

±$12.14B

±$28.15B

2016 Avg Cap

7.17%

7.20%

2017 Avg Cap

7.07%

7.00%

Corporate or Franchisee?

Corporate

Corporate

Typical Price Range (New)

$1,300,000- $2,790,270

$2,000,000 - $3,500,000

4.91%- 6.25%

5.50%-6.00%

15 Years

15 Years

NN

NN

1-2% Year, 5% in Options

10% Every 5 Years

Average Store Sales

-

-

Report Store Sales

No

No

Tenant Future Outlook Rating

Safe

Safe

Cap Rate Range (New) Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

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q s r

BOJANGLES

BURKER KING

CARL’S JR

PANDA EXPRESS

PIZZA HUT

NA

B+

-

NR

Ba1

±$590M

±$18.81B

-

±$2.5B

±$25.5B

2016 Avg Cap

6.14%

6.15%

5.75%

6.17%

7.49%

2017 Avg Cap

6.06%

6.20%

5.87%

6.07%

7.05%

Corporate or Franchisee?

Both

Both

Both

Corporate

Both

Typical Price Range (New)

$2,500,000 $3,500,000

$1,800,000 $2,500,000

$2,000,000 $4,000,000

$1,800,000

$1,000,000 $1,500,000

Cap Rate Range (New)

5.25% - 6.25%

5.5% - 6.25%

4.75% - 7.00%

4.00% - 4.50%

6.00% - 7.00%

15 Years

20 Years

20 Years

20 Years

20 Years

NNN

NNN

NNN

NNN Ground Lease

NNN

7.5% Every 5 Years

10% Every 5 Years

10% Every 5 Years

10% Every 5 Years

5% Every 5 Years

Average Store Sales

±$1,800,000

±$1,250,000

±$1,411,000

±$1,237,000

±$700,000

Report Store Sales

No

Per Lease

Per Lease

No

Per Lease

Moderate

Moderate

Safe

Moderate

Very Risky

Credit Rating Market Cap

Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

Tenant Future Outlook Rating

140 |

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

q s r

ARBY’S

CHURCH’S CHICKEN

DAIRY QUEEN

DEL TACO

HARDEE’S

Credit Rating

-

-

-

B2

-

Market Cap

-

-

-

±$510M

-

2016 Avg Cap

6.15%

7.05%

6.40%

4.97%

5.99%

2017 Avg Cap

6.25%

6.75%

6.50%

4.35%

6.02%

Corporate or Franchisee?

Both

Both

Franchisee

Corporate

Both

Typical Price Range (New)

$1,300,000$1,600,000

$1,000,000 $1,750,000

$1,500,000$2,000,000

$2,500,000$5,000,000

$1,100,000 $2,200,000

Cap Rate Range (New)

5.25% - 5.75%

5.75% - 6.50%

6.00%-6.50%

3.75%-5.00%

5.50% - 7.50%

15 - 20 Years

15 Years

20 Years

20 Years

20 Years

NNN

NNN

NNN

NNN

NNN

10% Every 5 Years

7.50% Every 5 Years

10% Every 5 Years, and Options

10% Every 5 Years

10% Every 5 Years

Average Store Sales

±$1,000,000

-

±$600,000

±$1,100,000

±$1,054,000

Report Store Sales

Per Lease

No

No

Yes

Per Lease

Tenant Future Outlook Rating

Very Safe

Moderate

Safe

Safe

Moderate

Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

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141

q s r

CHICK-FIL-A

JACK IN THE BOX

M C DONALD’S

SONIC

TACO BELL

Credit Rating

-

-

BBB+

-

Ba1

Market Cap

-

±$3.24B

±$124.78B

±$1.1B

-

2016 Avg Cap

4.22%

6.15%

4.31%

5.99%

5.48%

2017 Avg Cap

4.15%

5.41%

4.32%

6.72%

5.92%

Corporate or Franchisee?

Corporate

Franchisee

90% Franchised (Corporate Guaranty)

Franchisee

Franchisee

Typical Price Range (New)

$2,800,000$3,700,000

$1,600,000$2,500,000

$2,250,000 $3,500,000

$2,000,000$3,000,000

$1,000,000$2,500,000

Cap Rate Range (New)

3.75% - 4.50%

5.25%-5.75%

3.75% - 4.25%

6.25%-6.75%

5.00%-5.50%

15 Years

20 Years

20 Years

15 Years

20 Years

NNN

NNN

Ground Lease

NNN

NNN

10% Every 5 Years

10% Increases Every 5 Years

10% Every 5 Years

10% Every 5 Years

10% Every 5 Years

Average Store Sales

±$4,000,000

±$1,530,000

±$2,600,000

±$1,284,000

-

Report Store Sales

Yes

No

Yes

No

No

Very Safe

Safe

Safe

Moderate

Very Safe

Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

Tenant Future Outlook Rating

142 |

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

q s r

EL POLLO LOCO

KFC

POPEYES

WENDY’S

NR

Ba3

B+

B+ (S&P)

±$521.2M

±$25.3B

±$28.36B

±$3.84B

2016 Avg Cap

4.94%

5.95%

6.30%

5.83%

2017 Avg Cap

4.80%

6.35%

6.38%

6.29%

Corporate or Franchisee?

Franchisee

Franchisee

Both

Both

Typical Price Range (New)

$2,650,000 $2,850,000

$1,550,000 $1,750,000

$1,750,000 $2,250,000

$1,250,000 $3,000,000

Cap Rate Range (New)

4.50% - 5.00%

5.25% - 5.75%

5.25% - 6.25%

5.00% - 6.25%

20 Years

20 Years

20 Years

20 Years

NNN

NNN

NNN

NNN

10% Every 5 Years

10% Every 5 Years

10% Every 5 Years

10% Every 5 Years

Average Store Sales

±$1,900,000

±$1,030,000

±$1,400,000

±$1,540,000

Report Store Sales

Yes

Yes

Per Lease

Per Lease

Tenant Future Outlook Rating

Safe

Moderate

Moderate

Moderate

Credit Rating Market Cap

Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

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143

distribution

sporting goods

ACADEMY OF SPORTS

FEDEX

Credit Rating Market Cap

Baa2 ±$57.74B

Credit Rating

-

Market Cap

-

2016 Avg Cap

6.60%

2016 Avg Cap

6.65%

2017 Avg Cap

6.87%

2017 Avg Cap

6.60%

Corporate or Franchisee?

Corporate

Corporate or Franchisee?

Corporate

Typical Price Range (New)

$5,000,000$40,000,000

Typical Price Range (New)

$8,000,000 $11,000,000

Cap Rate Range (New)

6.00% - 6.50%

Cap Rate Range (New)

Typical Lease Term (New) Typical Lease Structure (New) Rent Increases

15 Years NN 5% in Options

Typical Lease Term (New) Typical Lease Structure (New)

6.45% 20 Years NNN

Rent Increases

10% Every 5 Years

Average Store Sales

-

Average Store Sales

± $20,500,000

Report Store Sales

No

Report Store Sales

No

Tenant Future Outlook Rating

144 |

Moderate

M AT T H E W S T M | F A L L / W I N T E R 2 0 1 7

Tenant Future Outlook Rating

Very Risky

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