Mixed-Use Development vs. Retail...wrong move?
Got a new position with a Retail Developer after about 4 years at a small shop doing Mixed-Use, Historic Rehabs, and small Multi-Family infills. I figured after doing MU/MF, they all become similar from a bullet-point view. But retail tenants would have different wants/needs, so I thought it'd be beneficial to add retail to my portfolio.
But how tough is retail, really? MU tends to be the sexy product right now which is where I was, but I would think retail would be more complex. What are some complexities that you'll learn in retail that you can't/won't learn in MU/MF?
1. When you say retail are you predominantly looking for open-air grocery-anchored suburban deals, or are you looking at any closed-air sites?
2. Underwriting: The way you're physically underwriting the deal varies in complexity across products. I'm sure if you have some exposure in Mixed-Use that you've been able to touch Argus; however, in retail, you'll be living and breathing Argus outputs. As a developer, you'll need to be dangerous and understand Argus to a degree in terms of NNNs, RCD sensitivity, etc. but depending on the shop you won't necessarily need to reinvent the wheel/ may have an in-house Financial Services team responsible for the Argus runs. You're still always solving for Development Yield regardless of your product. Argus is significantly more nuanced than Excel but it isn't as catastrophic as people on here make it out to be. I came from MF/Residential (luxury condos, 2 over 2s, THs, and SFD) and those products are significantly easier than Retail, Office, or Mixed-Use IMHO.
3. Trade area: You'll find very quickly a deal can pencil/ bust based on what side of the freeway you're on or how "over retailed" the current trade area is. In grocery-anchored development, you'll need to be cognizant of all of this before you start sending out LOIs. Having a good broker and understanding basic traffic patterns (hire a decent traffic planning firm or purchase data from one -- broker data in OMs is always a bit rosier) is key to nailing this aspect. Going back to being "over retailed" in a trade area, say you're developing for a Trader Joe's that has a few inline retail users and outparcels, you'll need to understand what's around to solidify your strategy in determining best use (i.e. if there's 10 nail salons in a 2 mi radius, maybe don't go with a nail salon). A lot of this is common sense but it's still something to think about.
4. Relationships: I feel like all products in Real Estate touch on this concept but nothing reaches to the level of this in Retail. You need to lease up a center and not negotiate against yourself in terms of rent reductions, more TI/WB before the deal is even executed. Having a Landlord rep broker or a good leasing team that can bring things across the finish line is vital to the overall success of a center. You need to be thoughtful on the other uses in the center and not just the anchor/junior boxes.
5. Tenant Risks: Think about the climate we're currently in with e-commerce. Are you leasing that ~3,000 SF end cap to a new fad restaurant concept or an apparel user with zero online presence -- both come with risks but both are inherently different. Restaurants typically have a significantly higher WL package in terms of TI/WB as opposed to say a LuLuLemon. If the concept sucks, you'd hate to hold the bag and take a hit 1-2 years down the line on a 10 year lease when the music stops and this "new" concept isn't the hot girl at the dance anymore. As long as the Amazons of the world and other big box retailers perpetuate the acceleration in 2-day and next day delivery, Soft goods retail will always have that stink of it being "replaceable".
TL;DR -- Retail in singularity is significantly tougher than MF, Office, Residential, Self-Storage, Senior Living, etc., but I could just be biased. I could go on for days but these are just the quick items.
Awesome feedback.
Saw that you're a developer at a major REIT. In terms of the managing the development process for retail, what are some of the more complex issues that you came across that probably wouldn't have shown up in SF/MF (I realize it's a full blown question, but a couple of examples would work)? In most of the MU I've done the retail portion was all spec so the development process for that was simple.
Also, could you clarify "RCD Sensitivity" and "WB"? Couldn't find on google and didn't use Argus at current firm since it's a small shop.
Yup, not a problem.
That's a tough question as most of the Mixed-Use/suburban i've done have had extremely nuanced issues that could seep into other product types (i.e. it was all one parcel at one point through 1 owner 70 years ago and the owner pieced off different parcels and rezoned prior to selling; as a result, has created various easement issues with unhappy HoAs). The anonymous user hit on REAs which you'll find for large big box anchors and if you JV with say a MF partner that builds a precast parking structure that houses both retail and MF parking (one of many quick examples).
RCD Sensitivity: RCD stands for Rent Commencement Date which you'll see the schedule for in the first few pages of a lease. Some leases don't have typical 2.5% YoY escalation as some may start 1-12 months $15/SF below what you underwrote but eventually get there in say year 36-48 months with the intent to escalate beyond 2.5% say at 5% past the 36-48 months -- potentially due to COVID or other factors. Some leases are also % deals with proceeds on a % above sales at a negotiated breakpoint.
WB or White Box: So in Retail there's TI(Tenant Improvement) which you'll see sometimes as TIA (Tenant Improvement Allowance), which for the layman is an outlay of cash to the tenant -- this can be extremely confusing at times depending on your firm as they'll sometimes get a bit more granular and break this out for tax purposes. White Box is typically used to cover hard costs pre-TI. For example: you're delivering a shell to a grab and go sandwich user and they need demising walls, electrical stub-in, and plumbing rough-ins based on the work letter.
Other things that make retail underwriting different: co-tenancy scenarios, percent rent structures, and CAM structures that can be a real pain in the ass to underwrite. If you are developing larger shopping centers there is a high likelihood that you will be selling off pad sites or parcels to various other entities, so you are going to have to deal with REA's and CCR's.
To the poster above: retail giants don’t always use argus. Excel is ten times more friendly for the complexities of retail. Especially on the development side
More places use it than places that don't.
Not from my experience... nor the partners of the projects I've been on...
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