Buyers Beware: Bank Branches Going Bye-Bye

November 21, 2012

For well over a decade now, stakeholders have strived to address actual and potential impacts of online commerce on all manner of "bricks-and-mortar" real estate assets. We've already seen cataclysm within certain property profiles - such as those configured for bookstores, travel agencies, electronics dealers, video rental shops and the like.

Small-cap retail-property investors and financiers may now want to pay more attention to a particular category that's still attracting plenty of capital - but may face daunting challenges later this decade: bank branches. Although the banking sector in the near-term continues rebounding from the huge hit it took with the Great Recession, longer-term fundamentals may give investors pause.

Combine the ever-emerging migration to online banking generally with the advent of banking by mobile device - and throw in expected financial-services consolidation - and demand for branch facilities is destined to diminish. Dramatically, by some counts.

In fact, researchers at global corporate real estate services giant Jones Lang LaSalle are projecting that as much as half the branches in modern industrialized economies will become surplus properties within a decade. Or at least they'll look and function a whole lot differently than they do today.

As the JLL authors succinctly conclude: The age of the big bank networks in the developed world is drawing to an end.

As JLL documents, big branch networks ultimately are on the wrong side of both costs and convenience. Not only do so many branches necessarily occupy prime real estate, serving customers through these labor-intensive facilities isn't exactly cheap - especially compared to ever-improving online alternatives.

The report cites last year's ForeSee Results Online Banking Study in calculating that it costs banks $65 to open a new account in-person at a branch - compared to just 15 cents via cyberspace. No wonder the expectation is that personal servicing will increasingly be handled through 24-hour videoconferencing capabilities from call centers rather than at branches (and perhaps through links from downsized branches to call centers).

The ForeSee survey also specifies that 55 percent of US banking customers already prefer processing transactions online - literally twice the rate of those preferring to visit branches. And there appears to be little likelihood this disparity will reverse course - especially given that US online activity lags what's already observed in Western Europe - and even Poland and New Zealand.

So why would passive net-lease investors still buy well-positioned branches at sub-5 cap rates - as is occasionally the case today (mid-5s to 6 are more typical)? As savvy net-lease investment pros are quick to point out, the banking sector's propensity for securing top-notch retail locations presents a major clue.

Such sites boast "strong residual value," and hence can typically be retrofitted for a number of alternative uses if a bank opts not to renew upon expiration, says Randy Blankstein, president of net lease specialty broker Boulder Group.

"Most banks have done a great job positioning themselves on or near Main Street (in urban settings) and at out-parcels of well-located shopping centers" anchored by popular grocers Walmart, Lowe's and the like, agrees Andrew Fallon, assistant vice president with specialty advisor Calkain Cos.

"So from the real estate fundamentals standpoint, these kinds of locations minimize risk."

Nor will branch network downsizing occur overnight - and JLL's shrinkage projections could prove at least a bit premature. While Blankstein acknowledges that many banks are indeed committing to new leases that are five or 10 years shorter than they were just a few years back - in many cases terms still run 20 years.

No doubt there's a clear correlation between lease term in addition to corporate credit and specific location), and pricing.

A well-located Chase or PNC or Bank of America branch net leased for 20 years is probably going to trade in the 5s. But a FirstMerit Bank branch in Akron, Ohio with nine years remaining recently sold at an 8 cap.

The key risk factor to keep in mind is that in some cases a property's value can erode notably when the tenant leaves - even on Main Street. For instance local real estate player Alfred Sanzari Enterprises was able to pick up a former BofA Main Street branch in hometown Hackensack, NJ earlier this year for just $22.50 a foot.

It's likewise logical to conclude that industry consolidation will inevitably diminish demand for branch facilities. And so will burgeoning competition from non-bank providers of financial services - including big retailers like Walmart, Sam's Club, Costco and Home Depot.

The better news near-term is that network strategies today vary widely among individual banks. Chase continues to open plenty of new branches, as do regional players First Citizens Bank & Trust and First Niagara Bank. As Fallon observes, a lot of consumers still want to shake someone's hand when they apply for mortgages and auto and business loans.

And as JLL points out, many of the biggest banks simply have too much depreciation left in their branch assets, and contingent liabilities on their balance sheets, to immediately pursue wholesale disposal strategies. Nevertheless the research team concludes that many banks will simply synchronize branch eliminations with lease expirations - likely leading to accelerated closures during the second half of the 2010s and into the early-2020s.

Hence for small-cap players considering branch investments, perhaps the most fundamental risk-mitigation measure is, well, real estate fundamentals rather than corporate credit ratings, Blankstein stresses.

Yes, it definitely helps to research deposit activity at the branch in question before taking a plunge - but potential residual value years down the road is even more critical. "As with all net lease investments," Blankstein continues, "real estate fundamentals are a key aspect of due diligence."

Changes in consumer behavior are simply a part of modern life, adds Fallon. "At the end of the day with a net lease investment, you're going to own real estate - so it better be a piece of property you're comfortable with."

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