As Black Friday and Cyber Monday have come and gone I find myself thinking back to the evolution of retail from my perspective as a commercial real estate professional. Looking back over the last few years I have become more active in retail property through the assumption of responsibilities for retail assets in Southwest FL. In that role, the increased amount of online and mobile retailing has created some anxiety about the future of retail properties as a whole, driven by the headline news reports of book stores and other traditional physical retailers closing locations. While this is a cause for concern and reflection, I believe there are a few common sense, but very important elements that allow for not only preserving but also growing a retail asset.
First, is tenant mix. As traditional consumption based retail continues to be affected by retailers like amazon, having a community staple that your community will consider a rallying point is vital. This is somewhere people meet, and is typically a local sports bar, pub, or family restaurant, (as explained in The Good, Great Place by Ray Oldenburg). Then surrounding it with, service based retailers such as nail salons, hair salons, other varieties of restaurants, or a gym tends to create a vibrant, frequently visited center, because each has a high number of annual visits from the immediately surrounding community each year. However, all business are not created equal, nor are all communities. Although a key component, simply having the right tenant mix will not lead to ultimate success.
Second is ownership; better tenants come with strong personal credit and strong businesses plans. When an investor considers the capital outlay associated with acquisition, leasing fees, tenant improvements, and vacancy, its apparent how important it is to search for tenants with ownership or franchisees that will stand behind the business with an appropriately strong corporate guarantee or personal guarantee. While the lease is already a contract to pay rent, the guarantee really adds a level of security beyond a simple lease to a single purpose entity. In turn, this also will have a favorable impact on lending terms if the guarantee offers appropriate security, and the lease is well structured.
Third, better communities attract better, more well capitalized tenants. First today’s substantial risk of a rising CAP rate environment dictates any savvy investor looks beyond average 2-3% annual rental increases. It simply doesn’t get the job done. What is needed are jumps in rental rates and business quality by being able to choose from an increasingly better pool of businesses who want to be in the building. A strong investment strategy identifies assets that are solid, then looks at local demographics as the leading indicator to shore up confidence that future leasing will grow rents and values beyond a typical 2-3%. The strongest potential tenants are analyzing the demographic and psychographic trends, so you should be too. It’s just a lot simpler, and more cost effective, to let something happen around you, versus the other option of actively improving the identity of a building through the risk of investing in capital improvements. However sometimes it’s worth it, so an analysis should always be thought through.
Finally, if you really want to preserve capital and beat the market, value investing is so important. For those who are not familiar with the term; value investing is really the acknowledgment that you make all your money on the buy through purchasing what is existing, and getting the upside for free. These assets are not easy to find, but they do exist, often times because a current ownership structure is long standing and has become complacent. They see the asset performing as they need it to, and are either not willing to push for something better or are unknowingly accepting less.
To put it simply, ensure you buy what you’re getting cheap by digging in an analyzing the true value of each part of the building to make sure HVAC, leasable square footage, floor plan configuration, tenant sales per square foot, future rents, and competing properties are accurately accounted for. Next, confirm that future opportunity exists through redevelopment or adaptive reuses uses such as office, medical, etc. and that it is lucrative. A further consideration of value investing is political will, both locally and nationally. Macro-issues such as tax treatment, entitlement reform, social security growth, and other national issues can affect the amount of discretionary income the local community has to spend on a service or at a retail shop.
All in all, local service based retail is not dead, nor dying, but investing in, managing and leasing towards a successful project does require more thought and analysis than before. Simply looking at the surface metrics and future rental streams should not generate the same confidence that they did when there was more padding in returns. Now there is far less margin for error than there once was as asset inflation has taking hold over the last few years.