Analyze Retail Commercial Property?

Question

Fellow BPers,

I found a commercial retail property (strip mall) that I am interested in but I have no idea how to evaluate it. I've never done any strip malls before. How do I run the numbers? How do I know if this is a good deal or not?

Joel Owens · Answer

Hi Russell,

Lot's and lot's of metrics go into evaluating strip malls. I look at over 500 a week for clients all across the country.

Just like anything there are bad ones, okay ones, and really good ones.

A lot has to do with your goals. If you want to stay mostly passive then having all national tenants tends to give the most stability. Cap rate and cash flow averages drop for having that consideration.

When you move up to the next spectrum for yield you have some mom and pop to regional tenants mixed in with the nationals. The cap rate tends to be higher and the cash flow more. Occasionally a tenant will roll over in those types of centers. You will need TI's and leasing commission reserves for the new tenant to go into one of your spaces in the strip center.

Most risky is mom and pop dominated strip centers in far out suburban to rural locations.

You have to know if you have all gross leases, all NNN, or a mix of the two. Reviewing the lease abstract of each and every tenant is critical to analyze the risk exposure to the stability and cash flow stream of the property over time. Staggered leases is important so all of the leases do not come due at the same time. You want where if you experience a vacancy or two then your break even occupancy to service the mortgage after down payment is still below that. A lender as part of the appraisal will generally look at a "stress test" for  a center. That projects out what will happen if this event or that event happens down the road and what kind of reserves will need to be in place to weather a storm and still come out intact.

For national tenants I am okay with blocking of rents to go up every so many years. Not for mom and pop type tenants as you may never see the increases before they fail. We focus on destination type tenants ( karate schools, barber shops, hair salons, nail places, restaurants, doctor offices, environmentally friendly dry cleaners, etc. ). These are places people have to drop money for a service and they can't look around and then buy online cheaper. 90% of retail failures  last year were clothing and furniture store related so I avoid those like the plague. You also want diversity of the space size for tenant mix. You do not want one tenant taking up 50% of your center unless it's a very long primary term lease and a national tenant that has strong books and a solid financial rating.

Asking if the leases require disclosure of annual sales for each tenant is good to have as well. Especially if the tenant is a franchisee.

Couldn't even scratch the surface but but ran out of time to post more.

Hope it helps some.

Joel Owens · Answer

Hi Leighton,

That age could definitely have some issues. I would have to analyze the leases in place for gross,modified gross, NN, NNN. Any cam caps and are they cummulative or non-cumulative? Who is backing each lease? How staggered are the leases for when they come due? How much time left on primary for each lease? Do they report sales?

It goes on and on. I reserve that kind of due diligence for my clients only as I stay really busy. I help clients nationally.

I would get a good commercial retail attorney involved and a good commercial retail broker whatever you do.

I don't work on anything sub 1 million in price and preferably 2 million and above. It just depends how intensive the asset and property will be to evaluate for the time involved and my return.

Example: A property with 8 mom and pop tenants for 1.5 million. I would have to review 1,000 pages to get to closing for maybe 40k return. Ton of time versus 1 Starbucks lease selling for 2 million plus for 50k commission. I do work on some mom and pop but usually 3 to 4 million and up so check to me is 100k or more for my time.

As an investor and broker works on these for many years they learn how much work each type of property is within retail to get to closing. It's a function of time and return just like an investor calculates return on deals looking to purchase.

Joel Owens · Answer

10% is not low. It is a good number. If you have all national tenants and can hit 10% coc that is good. If you are talking an older strip center with mom and pop tenants the yield should be higher.

You can run the numbers from the profit and loss statements and CAM re-imbusements after base rent and management. If the seller has things like 5% vacancy and market is 10% then you adjust. If they have low reserves you adjust. If the rents are above market for the tenants you mark down to current rent levels to count income. If the management fee is low you add in a higher one.

You have to take the numbers they provide with a grain of salt. The leases you are looking for a lot more items than just the numbers. Seller will likely have you sign a non-disclosure before sharing anything with you.

What's the purchase price and how much are you trying to put down?

Leighton Chun · Answer

Thanks for all the info guys, i'm looking into a three unit commercial property with service orientated shops one being a national (HR&R). How concerned should I be about the age of the structure? The building was built in 1924. I'm looking at a old downtown area that's in a rural area, but is one of the few mall strips in the area. The numbers look really good but I'm concerned about the age of the building. Any thoughts or suggestions? @Joel Owens Thanks in advance for your thoughts on this.

Russell Gronsky · Answer

@Jamane Y., I decided to steer clear of the strip mall. Comes down to not having enough experience in commercial RE to see a prosperous end state. As I was told, the rule of thumb is to not move in anyone who can be outsourced to China or replaced by Amazon. That takes out a significant chunk of businesses that require office/retail/commercial space. Then I hear by 2025, 40% of the work force will be freelance and/or work from home...translation....no need for commercial space. And with the sheer number of spaces are and will be available in the future, there will be plenty of options for that gym or auto mechanic to move into so that will probably drive rents down.

Orrrrr....maybe I'm completely wrong and strip malls and office space will boom because of some new market force that will pop up. I have no idea, but I also don't have enough capital to burn on investments I don't understand inside and out.

Jamane Y. · Answer

@Russell GronskyJust wondering if you purchased the strip mall you were looking at several months ago. I'm looking at property that has retail and apartments above it. So I'm trying to figure how to analyze the property. Thanks in advance.

Jamane

Russell Gronsky · Answer

Purchase price is unknown right now. It's going to auction. Starting bid is $350K. I'm planning on putting down 20% but I need to figure out what is the threshold price to purchase so I can buy and stay profitable or stop bidding...and that's where analyzing the numbers comes in.

Russell Gronsky · Answer

I see. This strip mall is a 9 unit place in a C-class neighborhood. A few blocks from major, big box retailers (Sam's club, Ross, Safeway) and there are other strip malls around this one. Don't think there are any national chains in any of the units on this property but there is a local chain restaurant (3 restaurants in the local area) occupying one of the units. I'm going to email the owner and ask for copies of the leases so I can run some numbers.

You make it sound like 10% CoC is low. What is an average CoC return that I should be looking for as a rule of thumb? 15%? 25%?

Joel Owens · Answer

Sure Russell.

It all depends on what you are trying to do. Some of my clients want more turn key with national tenants.

For example they are doctors with no time to deal with anything or they are older and just want wealth preservation and 10% coc return for them annually is fine when they are already worth 5 or 10 million etc.

What price range and down payment you have makes a difference as well. The smaller size properties the closing costs tend to be higher versus the purchase price and loan and legal is higher. Additionally loan discounts rates are typically given the larger you go in loan size.

Russell Gronsky · Answer

Wow! Thank you @Ned Carey and @Joel Owens. This helps so much. Thank you!!

Analyze Retail Commercial Property?

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