Available: Southeast Missouri Dollar General Portfolio

Sperry Van Ness | Fiducia Properties is pleased to announce the availability of a six-store Dollar General portfolio in Southeast Missouri. These assets are outstanding retail investment properties and are the subjects of modified gross leases with Dollar General (DG).

The stores are located in the St. Francois County communities of Bismarck, Bonne Terre, Desloge and Farmington and the Stoddard and Bollinger County communities of Marble Hill and Advance, respectively.

The entire six-store package is offered at an attractive $2,400,000 which provides the successful investor with an outstanding 10.4% capitalization rate. In addition to the attractive cap rate, the portfolio asking price amounts to a paltry cost of less than $48 PSF.  Other features include outstanding store sales and staggering numbers returned by percentage rent clauses in the lease. Although being offered as a porftolio, the six stores may also be acquired individually for a small basis point premium.

Please contact us toll free at 888-879-2083 for additional information, or follow this link ( http://docs.svn.com/Southeast Missouri DG Portfolio ) to acquire an offering memorandum on this excellent opportunity.

The Curious Case of Sherwin-Williams

Sherwin-Williams stores have long been considered desirable real estate investments--and for good reason. The company has been around since the conclusion of the Civil War. Since then, it has grown to become one of the largest chemical, paint and coatings companies in the world. Besides its longevity, Sherwin-Williams’ debt is rated "A" (recently upgraded from "A-") by Standard and Poors (S & P). As a real estate investment, Sherwin-Williams retail properties possess many attractive qualities. They are viewed as very stable assets and are generally available at attractive price points--many under $1 Million. Further, the stores are typically located in stable markets at strong locations.

Despite these positives, Sherwin-Williams stores, as a real estate investment commodity, are somewhat difficult to quantify. If currently shopping for a Sherwin-Williams store to add as a last minute stocking stuffer, one might find offering capitalization rates in a range of anywhere from 6% to 10%. This wide range creates somewhat of a schizophrenic trading environment if trying to accurately value a Sherwin-Williams asset. It then becomes somewhat difficult for buyers and sellers to agree upon fair prices and capitalization rates for the investments.

"The stores have a very high lease renewal rate," said one investor, justifying the lower cap rates observed in the marketplace. "I've been told that Sherwin-Williams renews something like 97-98% of store leases," he said. Another factor that seems to drive Sherwin-Williams cap rates lower is the overall scarcity of product. The company does not operate as many stores as many retailers so the universe of potentially available properties is somewhat smaller. Beyond this factor, relatively few of the stores in existence ever come to the market.

While these factors might explain the low end of the cap rate spectrum, they do little to explain the higher end. After all, the lease renewal rates of the stores, very favorable S & P rating, and product scarcity should keep the cap rates of Sherwin-Williams stores down in the 6-8% range. But what explains those stores offered at 8%+?

"I think the (cap rate) diversity can be explained by looking at the wide range of real estate choices found among Sherwin-Williams properties," said another Sherwin-Williams investor. Indeed, this may explain much. It is estimated that approximately 2/3 of the business done in a typical Sherwin-Williams is from contractor sales. Consequently, some Sherwin-Williams stores may not be located at "Main and Main." Since for many Sherwin-Williams is a destination, in some cases the company's stores may thrive in convenient but not necessarily first tier locations. Some of these stores may be located in even what would be considered quasi-industrial locations, rather than trophy retail locations. Whereas retailers such as Walgreen's, Wal-Mart, etc. have no room for error in their real estate decision-making, Sherwin-Williams may in fact be able to survive and thrive with some sub-standard locations due to their reliance on contractor and other non-impulse customers. Such locations, however, may end up being penalized in the net lease marketplace from investors unwilling to buy what they would consider to be inferior locations at low cap rates.

Other factors that might balance out the favorable investor sentiment for Sherwin-Williams properties are the shorter-term and double-net nature of the company's leases. Typically the base term on the company's leases are 10 years and typically the landlord with have modest responsibilities with grounds maintenance, roof, and structural. These factors undoubtedly scare off some investors which might pay lower cap rates otherwise. It has undoubtedly kept many institutional investors away from the product.

Although difficult to pigeon hole as an investment commodity, Sherwin-Williams stores still provide an excellent investment choice for the smaller commercial real estate investor. Many can be purchased at excellent costs per square foot and at reasonable capitalization rates. Although one must evaluate the real-estate specific characteristics of each offering carefully, the eventual Sherwin-Williams investor should be rewarded with a long-term, stable tenant for years to come.

Cap Scratch Fever

Flu season is among us, and many are protecting themselves by heading to their doctor or pharmacy for annual vaccinations. Unfortunately, no immunization exists for a malady affecting many commercial real estate investors. That malady is something we call Cap Scratch Fever (CSF), an affliction affecting legions of investors on myopic quests for ROI.

The first noticeable symptoms of CSF occur when investors toss a comprehensive investment strategy into the wind and only look at a property's capitalization (cap) rate. A quick survey of Loopnet reveals that many single tenant assets can indeed be acquired at prices boasting cap rates well up into the teens. These yields are being offered for a reason, however, as many of the assets are fraught with downstream risk.

Some examples include Dollar General stores which occupy retrofitted, earlier-generation properties (see above photo). Many such stores are being offered for sale at very attractive cap rates. However, since these older properties do not fit into the Dollar General prototype, the company has in some cases abandoned such properties in pursuit of new, relocated, build-to-suit stores which fit into the company's overall brand and development strategy. This has included stores with uniform size (approximately 9,000 S.F.), off-street parking, and consistent architectural elevations (the prototype). No one can blame Dollar General for wanting consistency in its real estate. However, this pursuit has left many investors holding vacant, older properties with residual values which fall well short of the numbers at which they were acquired.

Fortunately for investors, CSF, while dangerous, is not terminal. Recovery rates are quite high for patients who do not tarry and are rushed by police escort to see a competent commercial real estate professional. If a competent commercial real estate professional is not found within your HMO or PPO, then we suggest you follow these homeopathic steps when attempting to rid yourself of CSF:

1. When evaluating a high cap rate deal, evaluate and forecast the property's residual value. Ask yourself what the asset would be worth if and when the tenant vacates the building. Can the building be leased or sold to other users at prices relatively close to the price you're paying for the current income? If a huge chasm exists between the two, then the risk may be too great.
2. Consider looking beyond the cap rate by digging a little deeper. Consider running an internal rate of return  (IRR) analysis with a future sales price at a level below the acquisition price. As an example, if the building is held for 4 years and sold at 75% of acquisition, is it still a reasonable risk given this "worst case scenario."
3. Put your "tenant cap" on. What are the advantages and disadvantages of the tenant staying and/or leaving? In some cases the store manager or district manager or real estate representative may provide valuable information. Beware of this information, however, as often store managers are the last to know what the company's plans may be for your investment.
4. Understand the market rents in the area. Is your net leased asset commanding rent that is out of whack with other available properties in the area? If so, this is a red flag.

Hopefully by following this regimen you'll find the symptoms of CSF will slowly fade away, and you will no longer be fighting the urge to make bad investments.  If you have personally overcome a dehabilitating case of CSF yourself, please post a comment as we'd like to learn how you overcame it.

Factors Impacting Capitalization Rates

I was recently asked to respond to the following question: What factors are taken into consideration when determining capitalization rates on triple-net investment deals?

To answer this question comprehensively, we'd need more time that it will take to analyze tonight's election results. And what's worse, we'd probably be just as boring. But let's give it a whirl--in an abbreviated sense….

Capitalization ("Cap") rate differentials are driven by a variety of factors, but perhaps most notably by the tenant's creditworthiness and thus its ability to fulfill the terms of its lease obligation(s). That's why we see lower capitalization rates, and thus higher relative prices, for solid, national, and recognizable tenants such as Wal-Mart, Walgreen's, and Sherwin-Williams. The converse is true when dealing with lesser known, financially weaker, or even suspect tenants. Investors will typically demand higher cap rates, and thus lower relative prices, for assets leased to a mom-and-pop operation. The mom-and-pop might have a stellar business plan and possess market dominance, but its lack of a track record and deep pockets will penalize it in the marketplace. Too many questions exist regarding the tenant's ability to perform. Combine a lack of track record with a suspect business plan and the cap rates will catapult into the stratosphere. Imagine looking at a sale-leaseback offering from Looney Larry's Liposuction Clinics…. What sort of cap rate reward would you require to weather the risk posed by relying on a monthly rent check from Looney Larry?

Once an investor is satisfactorily comfortable with the tenant's ability to perform, other factors will be evaluated in determining a cap rate. A key factor will be the length of the primary or "guaranteed" lease term. Usually the longer the guaranteed term, the better, although some investors may disagree in that long-term leases may lack protection against inflation. Walgreen's, besides its excellent reputation and financial strength, also usually provides 25 year primary terms. Such leases are typically rewarded in the investment community in the form of lower caps/higher prices. Investors will simply pay a premium to take as much uncertainty out of their investment as possible.

Other factors can be categorized as "real estate specific" and "geographic." These categories may bleed into one another a bit. By real estate specific we might think of things like the overall cost per square foot of the asset or the age and condition of the building. To understand these factors let's assume we have two brand new Pizza Huts for sale. They're located in two similar but different markets. Suppose the land cost at one of the locations was higher than the other and consequently the one with the higher land cost was for sale for $500 per square foot (PSF) while the other was offered at $400 PSF. One would expect the cap rate to be slightly lower for the lower cost PSF building because the overall risk of the investment would be perceived to be slightly lower.

Perhaps a better example would be two Pizza Huts in the same market where one was a new build-to-suit while the other was placed in a renovated, 30-year-old building. Presumably investors would accept a lower cap rate for the newer building because the underlying real estate is perceived to be of higher quality and expected to enjoy a longer useful life.

Geographic factors can be macro or micro. Macro factors would account for cap rate differentials among regions of the country. California, for instance, will typically command a lower cap rate/higher price for an investment than its counterpart in say, Fargo. Micro factors include location factors within a specific community. Is the location "Main and Main" or is it a second tier site where one would have to rely on advance GPS technology to find it? Presumably the Main and Main location would have more residual value and thus command a higher price/lower cap rate.

While these factors should not be considered exhaustive, they will probably be found in most investors' decision-making matrix. We may have missed something, so if you're an investor, know an investor, or simply play one on television, please leave us some feedback in the "Comments" section below. We'll all benefit from your expertise.

And with that we'll get you back to the election results. We sincerely hope you've approved of this message.

Triple Net & Send Me the Check!

There’s a new player seated at the triple-net investment table, and its ante is being tossed-in from sales of dental floss, shop rags, and Spam to moderate-income Americana. The player, Dollar General Stores (NYSE:DG), is no stranger to the real estate investment community, but until this year its leases had mainly been attractive only to local, regional, or “one-off” purchasers. That changed in early 2010 when DG rolled out its latest investment product—the 15-Year NNN lease. These leases, which require no landlord responsibilities, have attracted sizable attention from institutional and national investors which had previously viewed DG leases as too cumbersome, unpredictable, and/or management-intensive.

“Most REITs, private equity groups and pension funds are not equipped with the infrastructure to manage large portfolios of double-net leases, thus they have not invested in Dollar General properties in the past,” said Wes Forlines, a broker with Tri-Oak Commercial in Atlanta. “The new triple-net lease structure has opened the door to a new pool of investors—the large institutional buyers,” said Forlines.

Dollar General’s foray into NNN deals is viewed as a positive for both the company and the investment community. The current NN format, which for the last couple of years had been DG’s flagship, requires landlords to be reimbursed for taxes and common area maintenance (DG has typically paid insurance directly) while also saddling landlords with roof, HVAC, parking lot, and structural “major repair” and replacement responsibilities. The absence of these responsibilities will now make Dollar General properties viable candidates for even the most passive investors.

The new NNN deals will be even more drastically different than much older DG leases—those entered into prior to 2000. Many of these properties operate under gross or modified-gross lease formats, where landlords are saddled with all or almost all of the costs of operating the real estate. Many of these were struck with only five or seven year original base terms and are now operating in option periods. Many of these landlords, saddled with most if not all of the property responsibilities, are now dealing with mounting maintenance expenses and increasing real property taxes, among other costs.

“Last winter was unusually harsh, and we incurred higher than average snow removal costs,” said one SVN/Fiducia Properties client—an Iowa DG landlord. “I also spent $60k on roof and HVAC replacements for my stores,” said the same landlord. Another one of our clients, the owner of multiple Kansas Dollar Generals, agreed: “I’ve dealt with a number of costs such as taxes, insurance, and major repairs that I wouldn’t have had in a NNN lease,” said the client. “Sometimes I become weary of dealing with some of the landlord responsibilities.”

If, or how soon, these gross leases will be replaced is unclear. Dollar General has demonstrated a commitment to move into more prototypical construction, but with over 8,000 stores in 35 states, it’s unlikely that shift will occur overnight.

The move should help Dollar General by enhancing the success of its preferred developers. “There were so few preferred developers that could sell their finished units for enough money with the NN lease to make the effort worthwhile, so they were starving and dropping out,” said Peter Colvin, a Sperry Van Ness broker in Grand Rapids, Michigan. “So, DG listened and adjusted their leases where necessary to keep their preferred developers healthy with product that could be financed and sold,” said Colvin.

What sort of premium would an investor expect to pay for a NNN Dollar General over that offered in a NN lease? When scanning the marketplace, it appears investors are willing to let go of approximately 50 basis points to be able to sleep easier at night for 15 years of relatively worry-free check-cashing. This might be the difference between an 8.5% asking cap rate for 15-Year NNN stores vs. a 9.0% asking cap rate for a similar deal with a 15-Year NN lease. Both Colvin and Forlines support this notion, although Forlines speculates a larger differential and cap rate “compression” for NNN DGs once the deals become more popular. Currently the 50 basis point premium appears to be reasonable, as the difference in purchase price between NN and NNN stores, both with NOI of $80k, would be a little more than $52,000.

It appears investors will continue to have both choices, as new Dollar General leases are not exclusively NNN and many new NN leases remain in the marketplace. Geographically the NNN deals at this time seem to exist primarily in the Sunbelt, with a handful trickling into the Midwest. Geographic distribution may depend on a variety of things, most notably the geographic concentration of preferred developers and Dollar General’s priorities in new store development.

For now, there are a variety of opportunities for all investor types, as value-added deals flow into the marketplace. Many opportunities for higher cap rate acquisitions exists for those willing to endure the risks associated with Dollar General’s gross and NN leases and the relocation risks which accompany non-prototypical stores (those less than approximately 9,000 SF with no off-street parking). However, we believe the NNN deals will gain traction as investors seek to shed themselves of the uncertainties that are linked to shorter-term and management-intensive leases.

Despite the lease term and type, Dollar General should continue to fill an important niche in the investment marketplace. That niche—national credit for under $1 Million and at less than $100 PSF—should continue to be a reasonable play in this current recessionary environment.

Total State Tax Revnues Increase Slightly While Others Continue Decline

Yesterday our post highlighted a report by The International Council of Shopping Centers and Goldman Sachs which documented slowing chain store sales growth during the week ending July 10, 2010.

Today we feature a post which purports to have a slightly more positive outlook. The Rockefeller Institute reported yesterday that total state tax revenues increased for the first time since 3Q 2008. Apparently by total state tax revenues the Rockefeller Institute meant the aggregate of all 50 states revenues.

Overall this news may not be so positive. Many (33) individual states still report declining tax revenues and all state revenues appear to be below pre-recession levels. Some states even realized double digit declines. The report also shows local tax revenues continue to decline. 

To read the entire report please follow this link: http://www.rockinst.org/pdf/government_finance/state_revenue_report/2010-07-13-SRR_80.pdf

ICSC Reports Chain Stores Growth Slowed During Recent Week

The International Council of Shopping Centers (ICSC) and investment bank Goldman Sachs reported today that the growth of retail sales at chain stores slowed during the most recent week. The findings were documented in the ICSC-Goldman Sachs Chain Store Index which reported a 1.5% decline in store sales growth for the week ending July 10, 2010.

The overall growth was still positive, measuring 3.2% over the same period last year. To view more information from ICSC please follow this link: http://www.icsc.org/homepage/research_article.php?id=171

About ICSC: Founded in 1957, the International Council of Shopping Centers (ICSC) is the global trade association of the shopping center industry. Its 60,000 members in the U.S., Canada and more than 80 other countries include shopping center owners, developers, managers, marketing specialists, investors, lenders, retailers and other professionals as well as academics and public officials. As the global industry trade association, ICSC links with more than 25 national and regional shopping center councils throughout the world.