Del Taco at 51 East Ramona Expressway in Perris, California, recently sold at a 4.07 percent cap rate — a record-low cap rate for a single-tenant Del Taco in Riverside County. | Courtesy a representative of Hanley Investment Group Real Estate Advisors

Getting the Best Yield Amid SoCal’s Low Cap Rates

Carrie Rossenfeld Finance & Capital Markets

There are ways to secure higher yield, even in a low-cap-rate environment like SoCal. As SoCal Real Estate recently reported, according to a recent report on cap rates during the first half of the year released by a representative of CBRE, SoCal cap rates in most property sectors (including industrial, retail, multifamily, and some hotel markets) are the lowest among major markets.

We spoke with Val Achtemeier, EVP of CBRE Capital Markets in the Debt & Structured Finance Group in Los Angeles, about what is leading to these compressed cap rates, how investors can secure the best yield in this market, and why office cap rates aren’t as low in the region as in others.

Val Achtemeier | Courtesy a representative of CBRE

SoCal Real Estate: SoCal is exhibiting extraordinarily low cap rates in a variety of property sectors. What is leading to these compressed rates?
Achtemeier:
There are a few factors leading to cap-rate compression in the SoCal region. One is the fact that there is unprecedented liquidity in the market as investors are trying to get placed in quality investments. The overall liquidity for U.S. real estate is extremely robust. Also, the SoCal region continues to be at the top of investors’ appetites: the yield is very desirable for investors who are trying to get into the market. They may be expanding their portfolios and seeking the larger assets here.

From an industrial perspective, when you look at the Southern California Logistics Center in particular, it’s clear that SoCal is one of the best markets for logistics. Growth potential and NOI growth are robust, and people are looking beyond basic cap-rate measurements to consider overall risk/reward. As it relates to industrial, cap rates are dipping below 4 percent, driven by investors’ belief in strong, solid NOI growth.

How can investors secure the best yield in this market given these low cap rates?
We’re seeing some investors take on partial redevelopment or repositioning risk. Some people are focusing on redevelopment or development to boost returns by enhancing or reconfiguring assets to increase their appeal. There’s a strong appetite on the office side for core-plus and value-add investments, which involve changing the aesthetics or architecture of a property and investing capital to reposition it and boost returns.

Some investors are doing true redevelopment or development to boost yield. As core returns can be low, they’re stepping out more on the risk spectrum to get a higher level of return. Some investors are also taking some vacancy risk with the belief that they can reposition or re-lease the property up. If they see a fair amount of rollover rent coming up, they feel they can boost yield if they step into a greater risk profile. Investors are being creative and looking at risk-adjusted returns. And some investors on the West Coast are looking to secondary markets like Las Vegas or Reno, while others are staying in SoCal and focusing on improving the rent roll or physical aspects of the property to boost yield.

Why is the office sector not following suit with so many of the other property sectors here in terms of low cap rates?
The office sector in SoCal is not quite as white-hot as the industrial and logistics sector, but we’re still seeing solid investor appetite for office here. It’s stable vs. declining. If you look at risk-adjusted returns, there’s so much belief that rental rates will increase dramatically on the industrial side, especially since capex requirements on this property sector are generally lower than on office. On the office side, investors place larger bets that are much more capital intensive. There’s solid demand for office, but cap rates are not declining at the same level as in the industrial sector.

What else should our readers know about this topic?
I feel as though the SoCal market is validated. There’s high demand from both domestic and foreign capital for all property types, and investment sales are decent. There are a lot of bridesmaids looking for the right opportunity, looking to place capital. The bridesmaid factor is real; it’s influencing the next round of quotes: when you come in second or third on a deal, you ask yourself, “What can I do next time to win?”

Winners really have to have a good forecast and vision of the asset. It’s a very competitive environment. With multiple rounds of quotes and bids, offers are getting fully vetted, so to win you have to have a strategy that’s well outlined, taking in the macroeconomic factors and the market. You need to know your stuff to win. People are educating themselves more. They’re trying to forecast where the puck is going, where tenant and capital demand are going. You have to be firing on all cylinders to make sure you understand everything. We get a lot of questions now on rental-growth forecast. Part of that is positioning the asset to really maximize its potential, and that strategy influences how far investors can push.

Also, we’re seeing a lot more portfolio activity and entity-level activity. Sometimes, you have to look beyond the individual transaction to an investor’s overall strategy. Some investors have to close certain deals in order to enter the SoCal market. There’s also a lot of M&A activity, so often there is something going on behind the scenes that’s influencing a transaction. It’s not necessarily about just one transaction, but it could be part of an overall strategy to increase an investor’s SoCal presence.

There will be a lot of mega transactions coming up, which is part of a larger trend as well. There are a lot of large transactions going on this year, and the reasons behind them are not readily transparent.