This just in... Carlos and others will enjoy - Posted by ray@lcorn

Posted by Bob on November 30, 2004 at 19:41:55:

>If you get the grocers to talk, ignore the overage rent spiel, build the pro forma on a base rent lease and
>structure with five year raises.

If I understand this correctly, you’re saying to go with high base rent leases (no overage rent) for grocery tenants? Any other traditionally base+overage tenants you would apply this advice to?

This just in… Carlos and others will enjoy - Posted by ray@lcorn

Posted by ray@lcorn on November 20, 2004 at 12:51:14:

Hi gang,

The Torto-Wheaton Research site (, registration required) just posted an article that dovetails our discussions a couple of weeks ago about where the market is headed.

I’ve copied the article in full below. The order information for the full report can be found on the TWR site as well.


November 19, 2004 Volume 5, Number 44
Navigating Through the Winds of Change
Raymond G. Torto, Principal & Chief Strategist

Torto Wheaton Research, Principal Real Estate Investors and Real Estate Research Corporation have joined together for the second consecutive year to create the industry?s most comprehensive annual forecast report for U.S. real estate market conditions ? Expectations & Market Realities in Real Estate: 2005.

This report is unlike any other in the industry in that it combines the econometric expertise of TWR, the survey research and practical real estate consulting work of RERC, and the superior hands-on transaction expertise of Principal. By pulling together the qualitative views of the real estate community with rigorous quantitative analysis, this report offers a unique and unparalleled vision for the real estate industry.

This year?s report ? Navigating Through the Winds of Change ? analyzes the secular and cyclical forces driving the U.S. real estate market and shows how changes in these forces are affecting market dynamics and investor behavior. Among other things, it examines how the economy is affecting real estate usage and how capital flows have saved the day thus far. In addition, it compares the risk and return associated with office, industrial, multifamily, retail, and hotel properties to those of alternative investments.

Below we summarize Chapter 10 of the report giving the long-term outlook for real estate returns.

The Outlook for Real Estate Returns

  • During the past 10 years, there has been a significant variance in total returns among the core property types. Apartment properties have posted the highest average total returns, followed by office and industrial, with retail coming in last place.

  • Performance attribution analysis (using TWR?s Capital Market Database) shows apartments with a significant share of total return attributable to capitalization rate compression, particularly during the last 4 years. Office and industrial properties, on the other hand, generated a majority of their 10-year returns from growth in net operating income (NOI), with only a limited contribution from capitalization rate reductions. As a result, capitalization rate changes explain most or all of the outperformance of the apartment sector relative to the office and industrial sectors during this 10-year period. Despite recent strong performance on an absolute basis, grocery-anchored retail returns trailed other property types over the 10-year period, due in part to low capitalization rates and high retail prices at the start of the period.

  • More recently, falling capitalization rates have been a more critical and consistent contributor to total returns across all property types, more than offsetting deteriorating occupancy and rent declines. Our assessment is that both structural and cyclical capital market forces have contributed to the significant levels of capitalization rate compression.

  • Capitalization rates do move with interest rates, but not on a one-to-one basis. As interest rates gradually rise and fundamentals improve, we expect capitalization rates to experience some upward, although uneven, pressure.

  • Although properties with competitive disadvantages or located in weaker markets could see capitalization rate increases in the range of 50 to 100 basis points over the next 12 to 18 months, better-positioned, higher quality properties and those in stronger markets will likely experience much smaller, if any, increases in capitalization rates. However, additional downward pressure on capitalization rates seems unlikely for most property types, given the significant current compression in spreads over the risk-free rate.

  • Going forward, Torto Wheaton Research forecasts 10-year total rates of return for the overall real estate market to range from 7.5 to 9.0 percent, or about 400 basis points lower than over the past decade. In order for future returns to equal past returns, real estate would need to make up for lower current going-in yields with higher future appreciation. Such a scenario is unlikely, however, given the projections for a ?measured? but not spectacular recovery.

  • Grocery-anchored retail investments are expected to generate the highest total returns of the four major property types during the next 10 years, due in no small part to the superior performance of retail rents during the jobless recovery.

  • The apartment and office property sectors are in a close race for second place in terms of future returns, although for different reasons. While apartments will see near-term improvement in income, this will be partially offset by expected capitalization rate increases. Coming off a currently depressed rental base, office returns will be primarily driven by a rebound in rental levels in the latter part of the 10-year holding period.

  • Total returns for industrial properties are expected to slightly lag other property types due to new construction and technology-driven shifts in user demand. This will result in a delayed recovery as the industrial market works through its record- high vacancies.

  • Although future real estate returns are unlikely to outperform relative to the past decade, specific investor portfolios certainly have the potential to outperform the broader market. While market and property type selection are clearly important elements of a successful investment strategy, significant value can be added at the individual property management and leasing level, as well as by active portfolio management.

  • In addition, the inefficient capital- and management-intensive nature of real estate creates opportunities for investors to generate returns higher than the market. Such opportunities simply do not exist in the stock and bond markets.

  • Real estate has truly come of age, as increasing numbers of institutional and retail investors have found this asset class to be an excellent match with their demographically driven need for income and capital preservation, as well as a wise diversification from stock and bond market volatility. Bottom line?real estate?s risk-adjusted return outlook remains quite solid as it continues to offer excellent relative value.

Re: This just in… Carlos and others will enjoy - Posted by tom

Posted by tom on November 23, 2004 at 20:42:02:


i have really enjoyed your information in this and in the other threads. very timely for me, just when some of these questions were forming in myself.


Re: This just in… Carlos and others will enjoy - Posted by Carlos

Posted by Carlos on November 22, 2004 at 21:29:37:


I posted a reply earlier, but it seems to have vanished. Anyhow, thanks for posting the article. It was very interesting, and supported several of your points, and one or two of mine too.

I am thinking of looking into the concept of developing some grocery-anchored retail. (I was actually already thinking about it before reading the story) But, I’m not sure where to start. Have you (or anyone else here) done this? If so, any tips?


Re: This just in… Carlos and others will enjoy - Posted by ray@lcorn

Posted by ray@lcorn on November 23, 2004 at 12:11:33:


Glad you enjoyed the article… its always fun to see what the academics are thinking. I should have mentioned that TWR has crossed the line from being purely objective third-party observers. Their new partnership with CBRE places them squarely on the supply/sell side. I notice a much more optimistic editorial tone than in the past.

And to expand their 3rd point, I think the effects of higher rates are going to be more unequal than they will be able to track, since they use mostly REIT and institutional ownership data for their numbers. “A” and strong “B” properties in strong markets will see little change; but weak "B and “C” properties are already weakening in asking caps. But I still don’t think an increase in long term rates of much more than 100bps is in the immediate future? driven by deficits, not the Fed? and not enough to quell demand.

Re grocery anchored retail… I’ve done a bunch of that, but the climate for new development in metros the last five years has been very, very spotty. Somewhat better in secondary, tertiary and rural markets. W-M is killing even the bigs (e.g. Kroger, Food Lion, Harris-Teeter) in my area (SE)… can’t speak for the rest of the country other than what I read and hear anecdotally…

H-E-B in TX is developing new stores-in-a-store concepts, and a few other regionals are also getting on the same bandwagon. Kroger has a neat upscale prototype they’ve tested for the last couple of years… w/wine shops, deli/bakery/catering ops, etc… Most are sticking to neighborhood strips, very little demand for new free-standing stores or big box… the warehousers (Sams, Costco) are pressing them on that end… upscale is the only market left to migrate to, and Target is giving them a run there, boosting grocery items over 10,000 SKUs now… good news is the Sears/Kmart deal is likely to pull Kmart away from grocery… time will tell. I do expect to see some new grocery concepts rolled out at ICSC in Vegas next May. The grocers are fighting for survival, and won’t go down without a fight.

As always, demographics are the key for new strip development… the trend is for locations between big population centers and the nearest W-M… trying to cut them off at the pass… looking for tenant mix in the “lifestyle center” categories, fitness-crafts-boutique… hits the upscale market segment, which in my opinion is where the opporunity is… the dollar stores and drugstores are going free-standing, also adding groceries, so they are competition now rather than good partners… grocers will pay more psf if brought to the party late, after the other anchors are committed. They know they ain’t the draw anymore, so they follow rather than lead. If the market is big enough to justify, better to design for two or three medium size anchors (~20T-30T sf each- perfect for fitness clubs which draw heavy traffic), more flexibility in tenant mix, less problem with co-tenancy clauses for the inlines. If you get the grocers to talk, ignore the overage rent spiel, build the pro forma on a base rent lease and structure with five year raises.