A Changing Market Calls for a Striking Investment Structure

The retail real estate market proved resilient through the pandemic and continues to show signs of growth as consumers continue to demand a hybrid shopping model, including a brick-and-mortar experience and online purchasing options. However, as today’s market is undergoing a long and uncertain correction due to the rapid increase to the cost of debt and equity, values for all investment properties have declined.   Stronger and healthier operating performance from existing shopping centers due to unwavering consumer spending has contrasted the value drop in the retail sector, creating a tension  between investor demand, higher cost of capital and strong operational performance, which has contributed to the 80% drop in retail transactions from Q1 22 to Q1 23.

 Why Now?

Shopping center operators who would like to sell their properties are not willing to accept “lower values” as they benefit from increasing cash flow due to stronger operations and (grandfathered) lower fixed debt.  Driven by the resiliency of retail, existing capital remains vigilant for attractive retail investments.  Underwriting must reflect today’s cost of capital which creates a gap  between the bid and ask, decreasing the viability of a fee simple investment strategy as some of the underlying debt from these properties comes due.

Why Ground Lease?

Bridging the gap between the bid and ask can be effectively handled through bifurcating the real estate between the land and the improvements through a long-term ground lease. Thus, creating a leasehold interest and fee simple interest for the same property under one respective bundle of rights spelled out in aground lease document. This structure provides a way for buyers and sellers to meet on value in the form of Lessor and Lessee, creating a mutually beneficial outcome for both – the new investor will be able to meet investment yield hurdles and the operator will get cash now without compromising the value of the property.