In this current down economy, weak consumer spending and paltry corporate earnings have forced some companies to slow or halt their expansion plans. As a result, many companies are focusing their resources on improving performance rather than on expansion. Retailers have been more careful in determining the profitability of new stores or markets. This trend has tightened the supply of available product.

Interest rates are at all time lows, but the economy is still lagging. Rates will certainly go up in the long term, but while they remain low, the downward pressure on capitalization rates should continue. Leveraged buyers are anxious to land a deal so they can lock in a low interest rate and compete with the cash buyer today.

There is more capital chasing fewer quality properties. Investors seeking replacement property to complete their Internal Revenue Service Section 1031 Tax Deferred Exchange have always had to pay market cap rates, but they have had no problem identifying suitable replacement property within their 45-day “replacement period.” If a buyer was serious, he could find any number of possibilities. Today, buyers are lucky if they can find one or two properties that fulfill their desires. The usual anxiety associated with the impending deadline has been raised to worrisome levels.

Now, with the increased competition coming from disgruntled equities investors, the typical multi-tenant or multifamily property investors and tenant-in-common investors are finding that product is scarce. Buyers today have far fewer choices, causing a feeding frenzy in the market. Some sellers are experiencing situations with multiple offers, offers over asking price and non-contingent offers.

While buyers fear potentially paying more than what they perceive a property is worth, writing a check to Uncle Sam is an unacceptable alternative. Buyers no longer have time to become educated on the subtle differences of lease terms and a tenant’s credit. Quick decisions are necessary to submit and negotiate letters of intent.

In all of the excitement, there is more room for errors. Some developers have expressed frustration toward buyers tying up their properties only to drop them later — opting instead for another property. Buyers also have been put off by some sellers who have raised their prices in mid-negotiation.

Until recently, cap rates in the major Midwest markets were higher than those available on either coast. That gap has narrowed in all but a few markets. Investors today are coming to terms with 7 percent cap rates and even mid 6 percent caps for some properties (ground leases and credit deals less than $1 million).

So what’s selling? Walgreens drugstores are. The company’s 25-year, absolute net lease is ideal for the most conservative buyer. Cap rates for these $3.5 million to $6 million investments are +/- 7.25 percent. Other popular chain drug retailers include CVS/Pharmacy, whose stores are usually bought in bulk and then individually resold with assumable high leveraged debt in place; and Eckerd Drugs (+/- 8.5 percent cap), a JC Penney subsidiary, which is starting to ramp up its expansion.

There also is a plethora of fast food and sit-down restaurants available at yields between 7 percent and 9 percent. Ground leases under restaurants can fetch as low as 6.5 percent. Investors are still interested in Starbucks, IHOP, Jack in the Box, Denny’s, Applebee’s, Chili’s, Taco Bell, Sonic, Captain D’s and many others. While several of these operators are not doing well financially, buyers have a familiarity with most chains, and they continue to write good leases.

General discount retail is also selling well. Family Dollar stores are selling for cap rates between 8.5 percent and 9 percent — depending on locations and lease type (NN or NNN). Dollar General yields are comparable. These properties are often priced between $500,000 and $800,000, making them appealing to a wide range of buyers.

Investors with several million dollars to invest — who had previously achieved higher returns because of the lack of demand — are experiencing the same lack of supply. Now, big boxes — such as Kohl’s and Lowe’s Home Improvement Warehouse — can trade in the mid to high 7 percent range.

Office supply stores, such as Office Depot, Staples and OfficeMax, have all experienced store closures. Lenders are very particular when making loans in this niche — wanting to confirm store sales and committing very conservative loan-to-values. Cap rates in this category are 8.5 percent to 9.5 percent.

Auto related retailers, such as Advance Auto Parts, Jiffy Lube, Tires Plus, Goodyear and CSK Auto are also selling. Developers of these investments have benefited from the tight market. Yields are down in the low 8 percent range in some cases. However, there is some investor concern that the deep discount chains, such as Costco, can undercut prices on tires and that automobile repairs have become too difficult for the layman.

Other popular investments in the $750,000 to $2 million range include Sherwin Williams (6.75 percent to 7.25 percent), Blockbuster Video with its new 15-year NNN lease (7.5 percent to 8 percent), Big 5 (8.25 percent to 8.5 percent), and Kindercare (8 percent to 8.5 percent). There are far fewer new single tenant developments with tenants such as Circuit City, Best Buy, PetsMart, Petco, Barnes & Noble, 7 Eleven, Kinko’s, Michaels and Pier 1 Imports.

For the time being, as long as there are 1031 exchange buyers, a lack of quality single-tenant property, low interest rates and a slumping economy, we will continue to see property trade at aggressive cap rates.

Barry Silver is a partner with SilverWillis Investment Real Estate based in Larkspur, California.

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