ARE COMMERCIAL CAP RATES RISING?

The transaction below may be an indication that cap rates on some commercial real estate may be rising.  For many months as interest rates have slowly risen on commercial real estate transactions the cap rates have not moved up accordingly.  This “cap rate compression” has been the source of much discussion and some have predicted that the cap rates would eventually rise to reflect higher borrowing rates. 

End of an Era?

Aug 1, 2007 12:00 PM

Developers Diversified Realty Corp. in late June announced the sale of 63 properties to Phillips Edison & Co. in a $603 million deal that was noteworthy for more than just its size.

In recent years, such a portfolio — with a total of 5.7 million square feet of properties — would have been gobbled up in a market with a seemingly insatiable demand for retail real estate. But Developers Diversified executives say they were surprised that only a handful of offers emerged for the portfolio. “I think the rate movement really woke people up and forced them to realize that there should be a spread between A-quality properties and those that are lower quality,� says Joe Padanilam, senior vice president of acquisitions with the company. The portfolio traded at a cap rate of 7.25 percent, 50 basis points above the national average. A year ago, Padanilam believes the portfolio might have been below 7 percent.

Many brokers say that investors across the country are starting to back off class-B and class-C properties even while action on class-A properties is heating up. “On the institutional sales side, people are getting more discerning about what they want,� says Philip D. Voorhees, senior vice president of retail investments with the international brokerage firm CB Richard Ellis, Inc.

The deal is the largest to date for Cincinnati, Ohio-based Phillips Edison, a company that has built a portfolio of 23.4 million square feet. Phillips Edison plans to apply its value-add redevelopment strategy to the centers, says Michael Phillips, the company’s president. The portfolio fits within the firm’s $275 million PECO Opportunity Fund III, which was created to target secondary markets in close proximity to primary metro markets.

Article from the August issue of Retail Traffic