Buying a Shopping Center 101 – Part 2

Uptown photo - downsized

Naples’ Uptown Center. In 2013 we assisted the buyer in purchasing this active retail center.

Last month we looked at dozen factors for first time buyers of retail centers to consider. Here are twelve more factors to keep in mind when you are starting your due diligence.  Some are obvious and some perhaps you hadn’t thought about.

The list isn’t in any particular order of importance.  This is not a checklist that all items need to be ‘correct’ or perfect.  The important thing is that you take the findings in consideration on the price of the property and the risks moving forward. There is no right answer, only answers that impact price and risk:

  1. Exclusive clauses. Determine which leases have exclusive use clauses and how restrictive they are.  Many times these aren’t really an issue, because in the real world you aren’t going to have two beauty salons (for example) in the same small strip center.  In that example the scope of the exclusive could be more of an issue. For example if the exclusive restricted the center from having a nail salon because the beauty salon’s exclusive language was too broad, then that could be a problem
  2. Relocation and Co-Tenancy Clauses. It is always important to have the ability to relocate a tenant to make way for a larger tenant or an expanding tenant, so check to make sure the leases have a relocation clause buried in it. You should also be wary of co-tenancy clauses. It is rare for leases in smaller neighborhood centers to have a co-tenancy  clause, but it can be more typical in grocery anchored centers and fashion centers that have national tenants. The co-tenancy clause would allow the tenant to cancel their lease or have their rents drastically reduced if the anchor tenant leaves or if the overall center’s occupancy should drop below a preset level.  If you have a lot of tenants with this lease clause then there can be the potential for a severe domino effect.
  3. Two factors here, the code required parking requirements and the real world requirements.  The applicable government will typically have different parking requirements depending on the tenant use. Grocery stores, gyms, restaurants, and medical uses are all examples of uses that often require a higher parking ratio.  Ideally you want your center to be adaptable to be able to have all of these uses to varying degrees and not be limited by your parking code requirements. A matrix study should be performed.  Not surprisingly real world conditions can often differ from what the code says….be aware of how that effects the center.
  4. How old is it, when was it last replaced, remaining useful life, type of roof system.  The roof is going to be your biggest capital cost over the long run so factor that in and take good care of the roof through ownership.
  5. For shopping centers typically the individual rental units have their own and separate units.  While tenants are typically responsible for the HVAC units that theory doesn’t always hold water.  If the HVAC unit is already 12 years old and you have a new tenant in the space don’t expect him to pay (or you to collect) for a replacement one year into his new lease. At a minimum be aware of the ages and conditions of all the units, preferably there’s a schedule.
  6. Check into the zoning to see what types of limits exist for the possible uses. As broad as possible is best, the ability to have medical and restaurants are particularly important.
  7. Type of Leases. There are two main types: triple net leases and gross leases.  Most investors prefer triple net (NNN) leases, because of the legal ability to pass through all the operational costs. This can be particularly important if you are buying a center and the real estate taxes go up substantially due to reassessment. With a gross lease you won’t be able to pass this added cost on to the tenant and will have to absorb that extra cost.
  8. Security Deposits. Make sure that you account for security deposits that the seller may be holding and that it is reflected in your closing statement. If not you are going to be responsible for refunding security deposits that you didn’t get credit for.
  9. Tenant sales. It is best if you can get sales history for the tenants.  This is often not possible for conventional strip centers, but is more likely for centers that have percentage rent clauses.  A  quick check (by tenant) of occupancy cost (rents) versus their gross sales will give you a good glimpse of the health of the tenants. If the tenant’s occupancy costs are running above 15% of their sales then they probably aren’t making any money.
  10. Credit versus non-credit tenant. In the perfect world having your center 100% filled with solid credit tenants would be great. There are certainly some strong shopping centers that have zero credit tenants, plus credit tenant can go bankrupt or close down territories just as easily sometimes.
  11. How Financeable. If you are looking to finance your center, all of the issues above are going to be factored into the ability to get financing and the cost of money.  Credit tenants, established tenant histories, and strong and enduring leases are the cornerstone.
  12. Lastly, consider your exit strategy and length of your holding period. Commercial real estate is traditionally a fairly slow moving and stable asset and best to held for the long term.  Real wealth has been created by many through taking the long view…but personal situations and market conditions can change.

If you would like further elaboration on any of these topics please feel free to contact me. If you are looking to buy (or sell) your commercial real estate it is important that your broker understands all of these factors and more.

Dougall McCorkle
Premier Commercial Inc. – lic. Real estate brokers

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