Buying a Shopping Center 101

Uptown photo - downsized

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

OK, so you’re ready to buy your first retail center, or maybe you are already a seasoned owner who just wants a quick refresher course. Either way here are twelve factors to consider 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. What type of center is it and does it fit into the trade area and demographics of the region. What this means to suggest is that the property needs to serve the trade area with the types of goods and services that the population is looking for and can support. High fashion women’s stores sitting alone in a outlying suburban location is rarely going to work. Know the demographics of the trade area (typically 3 mile radius) and contemplate whether they are strong enough to support the tenants.
  2. Shopping center layouts are important to understand. The two most common shapes of a shopping centers are rectangular and ‘L’ shaped. If it is a rectangular center it is highly preferred to have the center directly face the main road and not be perpendicular to the road, thus losing all visibility of its tenants.  As the center grows in size and market dominance this because less of a factor.  The ‘L’ shaped center will have additional considerations. If the ‘elbow’ is filled in (and not two rectangular buildings coming together at a single corner) it is likely to have a bigger tenant space filling that gap. That space is likely to have very little frontage and as such will often have a high turnover risk and discounted rents. The dimensions of the tenant spaces are very important as well, both widths and depths. Ideally your width for small tenant spaces should be 20-25’ and depths should be 50-60’.  This would provide tenant spaces in the 1,000-1,500 square foot range, a sweet spot for most small retailers.  Spaces deeper than 75’ can be difficult to lease and are best suited to be combined for larger tenants.
  3. Access. Needless to say, access is highly important. A full signalized corner with ingress and egress in all directions is optimal, but that is becoming increasingly difficult to find. The County road engineers and the FDOT are always seemingly looking for ways to limit access not expand access, all in the name of making the roads faster and less congested.  When access is limited, you generally prefer to have better ingress than egress (if you have a choice), as you want your shoppers at least get into your center easily.  Try to find out from the local government what the likelihood that your access is going to at least remain ‘as-is’ rather than close down.
  4. Tenant Turnover. Find out the historical turnover of the center.  If it has experienced significant turnover it could be because rents are too high, new competition, or demographics not supportive of the level of retail in the trade area. Sometimes it can be because of poor (and often inflexible) landlords and managers.  Times of economic recessions are uncontrollable events that you just have to endure and hope you have solid tenants that make money.
  5. Vacancy Allowance. When you are preparing your underwriting you always need to factor in a vacancy allowance. Despite the selling broker’s claim that the center is 100% leased and the area only has a 3% vacancy factor, you’ve got to put in at least a 5-10% vacancy factor depending on the quality of the asset, because nothing is as it seems forever.
  6. Above market rents. Take a look at the rent roll and take note if any of the tenants are paying rent above what the general market rents are. Unless that tenant is on a very long term lease or has other circumstances making it hard for them to move out (more typical for medical offices and restaurants), discount your proforma back to current market rents.
  7. Rent roll increases. Your analysis is going to have to factor in the scheduled rent increase for each tenant.  If they are based on the CPI or unknown, don’t factor in 4 or 5% because the CPI hasn’t risen more than 2% per annum in the last 15 years!
  8. Rollover downtime. Even in the strongest of markets and times whenever you have a vacancy there is going to be some downtime to relet it and for the new tenant to ready the space. Generally four months in strong markets, to more than a year for less vibrant times. Accordingly adjust your analysis as such.
  9. Tenant improvements. In some cases the landlord is going to have to factor in outlaying tenant improvement dollars to attract and secure new tenants. This less so with retail rather than office buildings. Many strip centers won’t offer any tenant improvement allowances, but may instead give the new tenant a rent abatement period for a number of months. Market and property strength will be the guide.
  10. Grossed up rents. Watch out for tenants that are paying high rents. Often they are paying high rents because the old landlord gave them a lot of tenant improvement dollars and that is factored back into the rent that the tenant pays of the years. Starbucks is a good example of this historically.  Not surprisingly when the lease term is up watch out for those rents to fall back to market norms.
  11. Rent Payment History. As part of the due diligence efforts try to get at least a year’s worth of data on the timeliness of the rent payments by the individual tenants.  This will clue you in on future turnover and problem areas.
  12. Option rents. Tenants typically have renewal options. Often the rents will escalate during the option periods at the same rate as during the initial term. It is also commonplace, especially for national tenants, for the rents to be reset to ‘market rents’.  This is a little more likely also for office properties.  This type of rent structure can often result in rent reductions.  Sometimes it is a matter of ‘playing chicken’ with the tenant….does the tenant really want to disrupt its business by moving down the street….does the landlord really want to lose the tenant and try to refill the space with a possibly lower rental rate….

If you would like further elaboration on any of these topics please feel free to contact me, and check in next month for twelve additional factors to consider when purchasing your first retail center.

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

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