Retail Shopping Center Evaluation

[John Green]

I am looking at doing my first commercial real estate deal and I'm wondering if it is common to put a risk factor, based on vacancies, when evaluating the purchase price. In other words, the shopping center I am looking at is currently 100% occupied but has dealt with some vacancies over the past couple of years. When figuring NOI and Cap rate do you assume the shopping center is 100% occupied or do you put a risk factor on it, say 15%, which is about equal to one spot being vacant. Does that make sense?

[Joel Owens]

AI review about 1,000 retail properties a week for clients.

A buyer can underwrite whatever they want but if someone is calculating NOI at 25% reduction for center you would get laughed at hysterically. Typical market vacancy in warm belt states is about 5 to 10%. Obviously if a retail center has less tenants then a single unit empty might be 7 or 8% instead if it goes dark. I look at OM for stated NOI to see if management fee Is customary for building size and the market and if they are taking out reasonable vacancy that would be seen in the appraisal for underwriting with a loan. Basically I am looking for PUFFING by the seller or the listing broker trying to justify the stated NOI and asking price.

Do centers keep all tenants over a 10 year hold? It is rare but sometimes with national tenants it can happen or an A location even with mom and pop tenants if rents per foot before cam are lower and do not tax tenants businesses models as much to stay profitable. Make sure and look at roof and parking lot. Those can run into the hundreds of thousands of dollars or more depending on property size. Even if tenants reimburse landlord typically pays out of pockets and gets it back over time. This is why for my clients I like to negotiate credit from the seller to get at closing to make the repairs and replacements needed soon for the property. That way tenants do not pay for it and buyer does not pay for it.

Look at current rents for the center as if they are above market in place rents and tenants go out you could have an income drop for the property. Sometimes landlords gets inflated rents for TI credits so they then can try and sell for higher price showing more income. You have to watch for that. Retail properties can be very lucrative but you have to know what to watch out for.

Warm belt states tend to have more expansive growth and if a space goes dark if under 10k sq ft in size there is generally a waiting list of tenants to go in in desirable areas if your location is good and rents are reasonable for the market. Cold belt states can still have good areas they just have more dead areas in between where people are moving away to the warm belt states for retirement. Those centers can sit for awhile as you had overbuilding and now a population decline and a small list of tenants wanting to enter that market or expand current foot print in a declining market.