Purchasing a shopping center could be one of the best investments you make. However, many times investors get carried away with the property and buy at too high a price, leaving very little for the bottom line. Understanding what makes a shopping center profitable and maintaining discipline throughout the purchase process is key to a successful investment.
There are several areas to address that can affect the overall value of the building both in short term and long term strategies. Although a CAP rate is a good way to start tackling an offer, it's not the end all in valuating a property. Sometimes coming in at a lower CAP rate initially may actually result in a better return than a property with a higher CAP for a number of factors.
Let's start with the fact that not all properties are created equal. A 7% CAP on one building isn't necessarily going to guarantee the same 7% CAP on another. When you factor in the condition of the building, location, growth potential, quality of the leases, and even management, you will soon see how easily your profits can swing one way or the other.
With this in mind, I've put together a list of items that are commonly missed or overlooked by even seasoned investors. Throughout the years, consulting with property owners, I've heard just about everything. So the issues below are a mix of the basics and not so basics that could make you rethink your investment strategy.
Traffic Counts: Retail is primarily driven by vehicle traffic. In some areas, like South Beach, foot traffic is king, but for the most part, when looking at Shopping Centers, vehicle traffic is a serious factor to consider. Basically, vehicle traffic counts are the arteries that produce the necessary flow of foot traffic that keeps a shopping center going. Is there a magic number that will ensure success? Not necessarily, but more is always going to be better than less.
Although traffic counts are very important, location, in some instances, can be another positive factor in lieu of the sheer number of cars passing by. An example would be a neighborhood center servicing a few communities. Although there isn't a high vehicle count, the mere location provides a steady customer flow. Why drive two miles when you have a shopping center two blocks away. This, of course, is a risky move, but some good deals could be found if the right mix of conditions are met.
If you want to give yourself all of the advantages possible, aim for a road with 50,000 plus cars per day. An example of this is Bird Road here in Miami. You have six lanes between two major highways providing plenty of vehicle traffic. There is no lack of demand along this corridor and it's only going to get stronger in the future.
Leases: If you're buying a building and using 5 to 10 year forecasting models, it may be a problem if all of your tenants are month to month. When a shopping center operates this way it's typically a sign of high turnover rates.
If you have leases that are long term, i.e. 3 to 5 years, with yearly increases, it gives you a bit of an incentive to purchase something that has proven demand and future growth. Leases that don't have yearly increases built in could be a sign of a stagnant market and limited to no growth in the area.
The lease terms are also critical. If your goal is to redevelop the property, it’s going to be difficult if your tenants have multiple renewal options or if there is no language regarding demolition or remodeling by the landlord. Unfavorable exclusivity clauses can also be a challenge to work with depending on the terms. When it’s time to lease, you could find yourself in a tough spot if those exclusivity clauses don’t allow the flexibility needed to properly lease up the building.
Building Layout (Visibility): Here's a typical scenario. L-shaped building on busy intersection, high traffic counts, solid end cap units, and a well maintained infrastructure. So what's the problem? Well, there's a gas station built right on the corner that covers all or most of the visibility to 70% of the shopping center.
What does this mean to you? Well, it could very well mean the difference between $25 per sq foot or $35 per sq foot. After all, a retail tenant is paying a premium for exposure. So, with limited exposure, comes limited earning potential.
This doesn't necessarily mean that the building is not a good buy, however, it's important to understand what you’re getting yourself into, especially when running your numbers. This particular building would then require a much different growth strategy than that of a building with direct frontage.
Zoning: Here’s another problem to consider. Zoning can seriously limit your ability to lease out your building. Not only that, it also affects your development potential.
How important is Zoning? Let’s take for example two similar zoning districts here in Miami Dade County. BU-1 and BU-1A. Let's also use a grocery store as an example for a use. With BU-1 you can build a grocery store up to 4,000 sf. Any larger, and you then have to be in a BU-1A zoning district. In other words, this could make the difference between a family owned grocery store or a national tenant.
Zoning also impacts redevelopment potential, resale value, vacancy rates, and overall marketability of the property. Having a thorough understanding of the various zoning districts could help you in deciding on more valuable "hidden gems" just on re-development potential alone.
Certificate of Use: A certificate of use is your assurance that the business is legally operating in your shopping center. The C.U. process includes an inspection from Building and Fire to ensure that not only the use but the space itself is compliant with zoning. It’s always a good idea to get copies of all C.U.’s for a building as an extra added assurance of compliance.
Two key factors to consider. First not all buildings are managed the same, and second, not all tenants have a current C.U. So how does this happen? The county inspectors can't be everywhere and they do miss certain locations. It hasn't been unusual for me to find buildings with tenants that don't have a current C.U. in place. A short visit to your local zoning department is all you need to get a current copy of every C.U. for the building.
Property Condition: Probably one of the most important factors, if not the most important factor next to location, is property condition. Although every contract will include a due diligence period to allow time for a proper inspection, it’s what you do with that information that is key. Remember what I said about discipline.
Here is a typical scenario. You've been looking for a property for the past 6 months and even placed a few offers only to be rejected. Finally, you get to the point where you agree on a number but the property’s condition isn't up to par. It’s tempting to downplay the issue just to make the deal happen, but this can be a costly game to play.
Always keep in mind, what was the other owner's problem will now be your problem. So why pay for someone else's problem? If the property needs $100k in repairs, guess where that's going to end up in negotiations? And of course, every situation is different, but it’s something that can’t be glossed over.
Roof: The roof can represent a problem in more ways than one. Depending on the type and make-up of the roof system, a re-roof job could easily eat into a big chunk of your profits. Also, if a landlord can't tell you when the roof was last replaced, it's an instant Red Flag.
And don't think that re-roofing is all the same. What do you think will happen if you’re getting into an older building with asbestos found in the roof system? Now that simple roof job can possibly double in a blink of an eye.
Why? For starters, the roofing material has to be taken to a special facility for processing and transported by special trucks specifically used for contaminated material. You then have to deal with quarantining the work area along with all of the inspections and testing that go along with it. So, always pay special attention to the roof.
Is the Property on Septic or Sewer? I know it's hard to believe, but in Miami Dade County alone, there are over 25,000 properties still on Septic Tanks. Depending on how well the building has been managed in the past and stuck with its approved uses could mean the difference between a successful rental property or a total disaster.
Let's put it this way, today, there are building owners with properties on Septic systems that can't change uses in their buildings because of water use restrictions by the Health Department and DERM. Not only that, but even if they wanted to connect to the sewer they can't. The sewer line is a mile away and the property isn't large enough for a larger Septic Tank to account for all of the flow. So, if your water consumption is already over the allowed limits and the Septic tank is undersized for the building, your options are very limited.
How does this happen? It’s a combination of changes in building code, grandfather clauses, and management. A building could have had an addition built many years ago, was grandfathered in, now that grandfather clause isn't recognized for A, B, or C reasons, and you end up with a non-compliant building.
Parking: One of the most neglected areas I see is parking. Parking, for lack of better example, is the heart of the shopping center. And yet, I see developers treat parking more as a nuisance than an absolute requirement for profitability and sustainability of the shopping center.
Unless you're in an area with plenty of municipal parking, what good is having Class A tenants paying top dollar if you can't accommodate all of the clientele. As an example, if we apply Miami Dade County Code, a healthy shopping center will provide enough parking for Retail use which is 4 per 1,000 sf plus an additional 10% for flexibility.
If there is a restaurant, it's good to know what the customer service area is since the calculations for parking will go by this figure rather than the entire restaurant area. Restaurants eat up 1 parking space for every 50 square feet of customer service area. So how important is parking? Very important.
Gyms, schools, and basically any uses that lend themselves as “places of gathering” eat up parking faster than most other uses. It’s always good to double check these uses against code requirements to make sure the building didn't just slip through the cracks.
In summary, the issues referenced above all influence the profitability of your investment property. These are just some of the more common things to look out for that could have an immediate or even long lasting effect on your profits. That's the reason they made my list and should be strongly looked at to ensure you're not in trouble later on.
There is no magic formula that works in all scenarios. Every building is different and will carry its own characteristics. By understanding this, and applying this information accordingly, you will find yourself in a much better position to profit from your investment.
Again, it's not just coming in with the ideal CAP rate and ignoring all of the other factors. Remember, "a well informed investment allows for a well-rounded investment which allows for a balanced investment. "
www.allrealtymanagement.com
If there is someone you know that's in the market to purchase or sell their shopping center, my firm would be very interested in offering a free consultation.
There are several areas to address that can affect the overall value of the building both in short term and long term strategies. Although a CAP rate is a good way to start tackling an offer, it's not the end all in valuating a property. Sometimes coming in at a lower CAP rate initially may actually result in a better return than a property with a higher CAP for a number of factors.
Let's start with the fact that not all properties are created equal. A 7% CAP on one building isn't necessarily going to guarantee the same 7% CAP on another. When you factor in the condition of the building, location, growth potential, quality of the leases, and even management, you will soon see how easily your profits can swing one way or the other.
With this in mind, I've put together a list of items that are commonly missed or overlooked by even seasoned investors. Throughout the years, consulting with property owners, I've heard just about everything. So the issues below are a mix of the basics and not so basics that could make you rethink your investment strategy.
Traffic Counts: Retail is primarily driven by vehicle traffic. In some areas, like South Beach, foot traffic is king, but for the most part, when looking at Shopping Centers, vehicle traffic is a serious factor to consider. Basically, vehicle traffic counts are the arteries that produce the necessary flow of foot traffic that keeps a shopping center going. Is there a magic number that will ensure success? Not necessarily, but more is always going to be better than less.
Although traffic counts are very important, location, in some instances, can be another positive factor in lieu of the sheer number of cars passing by. An example would be a neighborhood center servicing a few communities. Although there isn't a high vehicle count, the mere location provides a steady customer flow. Why drive two miles when you have a shopping center two blocks away. This, of course, is a risky move, but some good deals could be found if the right mix of conditions are met.
If you want to give yourself all of the advantages possible, aim for a road with 50,000 plus cars per day. An example of this is Bird Road here in Miami. You have six lanes between two major highways providing plenty of vehicle traffic. There is no lack of demand along this corridor and it's only going to get stronger in the future.
Leases: If you're buying a building and using 5 to 10 year forecasting models, it may be a problem if all of your tenants are month to month. When a shopping center operates this way it's typically a sign of high turnover rates.
If you have leases that are long term, i.e. 3 to 5 years, with yearly increases, it gives you a bit of an incentive to purchase something that has proven demand and future growth. Leases that don't have yearly increases built in could be a sign of a stagnant market and limited to no growth in the area.
The lease terms are also critical. If your goal is to redevelop the property, it’s going to be difficult if your tenants have multiple renewal options or if there is no language regarding demolition or remodeling by the landlord. Unfavorable exclusivity clauses can also be a challenge to work with depending on the terms. When it’s time to lease, you could find yourself in a tough spot if those exclusivity clauses don’t allow the flexibility needed to properly lease up the building.
Building Layout (Visibility): Here's a typical scenario. L-shaped building on busy intersection, high traffic counts, solid end cap units, and a well maintained infrastructure. So what's the problem? Well, there's a gas station built right on the corner that covers all or most of the visibility to 70% of the shopping center.
What does this mean to you? Well, it could very well mean the difference between $25 per sq foot or $35 per sq foot. After all, a retail tenant is paying a premium for exposure. So, with limited exposure, comes limited earning potential.
This doesn't necessarily mean that the building is not a good buy, however, it's important to understand what you’re getting yourself into, especially when running your numbers. This particular building would then require a much different growth strategy than that of a building with direct frontage.
Zoning: Here’s another problem to consider. Zoning can seriously limit your ability to lease out your building. Not only that, it also affects your development potential.
How important is Zoning? Let’s take for example two similar zoning districts here in Miami Dade County. BU-1 and BU-1A. Let's also use a grocery store as an example for a use. With BU-1 you can build a grocery store up to 4,000 sf. Any larger, and you then have to be in a BU-1A zoning district. In other words, this could make the difference between a family owned grocery store or a national tenant.
Zoning also impacts redevelopment potential, resale value, vacancy rates, and overall marketability of the property. Having a thorough understanding of the various zoning districts could help you in deciding on more valuable "hidden gems" just on re-development potential alone.
Certificate of Use: A certificate of use is your assurance that the business is legally operating in your shopping center. The C.U. process includes an inspection from Building and Fire to ensure that not only the use but the space itself is compliant with zoning. It’s always a good idea to get copies of all C.U.’s for a building as an extra added assurance of compliance.
Two key factors to consider. First not all buildings are managed the same, and second, not all tenants have a current C.U. So how does this happen? The county inspectors can't be everywhere and they do miss certain locations. It hasn't been unusual for me to find buildings with tenants that don't have a current C.U. in place. A short visit to your local zoning department is all you need to get a current copy of every C.U. for the building.
Property Condition: Probably one of the most important factors, if not the most important factor next to location, is property condition. Although every contract will include a due diligence period to allow time for a proper inspection, it’s what you do with that information that is key. Remember what I said about discipline.
Here is a typical scenario. You've been looking for a property for the past 6 months and even placed a few offers only to be rejected. Finally, you get to the point where you agree on a number but the property’s condition isn't up to par. It’s tempting to downplay the issue just to make the deal happen, but this can be a costly game to play.
Always keep in mind, what was the other owner's problem will now be your problem. So why pay for someone else's problem? If the property needs $100k in repairs, guess where that's going to end up in negotiations? And of course, every situation is different, but it’s something that can’t be glossed over.
Roof: The roof can represent a problem in more ways than one. Depending on the type and make-up of the roof system, a re-roof job could easily eat into a big chunk of your profits. Also, if a landlord can't tell you when the roof was last replaced, it's an instant Red Flag.
And don't think that re-roofing is all the same. What do you think will happen if you’re getting into an older building with asbestos found in the roof system? Now that simple roof job can possibly double in a blink of an eye.
Why? For starters, the roofing material has to be taken to a special facility for processing and transported by special trucks specifically used for contaminated material. You then have to deal with quarantining the work area along with all of the inspections and testing that go along with it. So, always pay special attention to the roof.
Is the Property on Septic or Sewer? I know it's hard to believe, but in Miami Dade County alone, there are over 25,000 properties still on Septic Tanks. Depending on how well the building has been managed in the past and stuck with its approved uses could mean the difference between a successful rental property or a total disaster.
Let's put it this way, today, there are building owners with properties on Septic systems that can't change uses in their buildings because of water use restrictions by the Health Department and DERM. Not only that, but even if they wanted to connect to the sewer they can't. The sewer line is a mile away and the property isn't large enough for a larger Septic Tank to account for all of the flow. So, if your water consumption is already over the allowed limits and the Septic tank is undersized for the building, your options are very limited.
How does this happen? It’s a combination of changes in building code, grandfather clauses, and management. A building could have had an addition built many years ago, was grandfathered in, now that grandfather clause isn't recognized for A, B, or C reasons, and you end up with a non-compliant building.
Parking: One of the most neglected areas I see is parking. Parking, for lack of better example, is the heart of the shopping center. And yet, I see developers treat parking more as a nuisance than an absolute requirement for profitability and sustainability of the shopping center.
Unless you're in an area with plenty of municipal parking, what good is having Class A tenants paying top dollar if you can't accommodate all of the clientele. As an example, if we apply Miami Dade County Code, a healthy shopping center will provide enough parking for Retail use which is 4 per 1,000 sf plus an additional 10% for flexibility.
If there is a restaurant, it's good to know what the customer service area is since the calculations for parking will go by this figure rather than the entire restaurant area. Restaurants eat up 1 parking space for every 50 square feet of customer service area. So how important is parking? Very important.
Gyms, schools, and basically any uses that lend themselves as “places of gathering” eat up parking faster than most other uses. It’s always good to double check these uses against code requirements to make sure the building didn't just slip through the cracks.
In summary, the issues referenced above all influence the profitability of your investment property. These are just some of the more common things to look out for that could have an immediate or even long lasting effect on your profits. That's the reason they made my list and should be strongly looked at to ensure you're not in trouble later on.
There is no magic formula that works in all scenarios. Every building is different and will carry its own characteristics. By understanding this, and applying this information accordingly, you will find yourself in a much better position to profit from your investment.
Again, it's not just coming in with the ideal CAP rate and ignoring all of the other factors. Remember, "a well informed investment allows for a well-rounded investment which allows for a balanced investment. "
www.allrealtymanagement.com
If there is someone you know that's in the market to purchase or sell their shopping center, my firm would be very interested in offering a free consultation.
written by: Victor A. Abreu