Retail IS/Acquisitions: What should you know?

Monkeys,

I have been told that retail "is its own beast" by a few family friends who work in CRE. Assuming this is true -

1) Are there any materials, links, references, tips, war stories, etc.... that could make the learning curve for someone starting out in retail IS/acquisitions more manageable?

2) Are there any insights that you wish you would have had before you started?

Thanks for any input!

  • BIT

Comments (11)

Jun 10, 2019

There are a ton of answers to this question... I'll throw in a contribution to get the ball rolling....

Something unique to retail is you usually have access to tenant sales numbers and can calculate what is known as either a "Health Ratio" or "Occupancy Cost Ratio" by dividing the tenant's occupancy costs (Rent, CAM, % Rent) over their sales. This gives you a good metric to gauge the "health" of a retail property and estimate whether tenants will renew, vacate, ask for rent reductions, etc.. Once you underwrite a few deals you'll develop a feel for for this and know how well a property is doing by skimming through the sales reports.

Jun 10, 2019

To expand on this further, you should compare the sales metrics per SF of that retailer to their national average and other properties in the state. For example one location might be getting $200/SF while the retailers average nationwide might be $500/SF. That should signal that the location is not doing well and they might be a risk for vacating.

On the occupancy cost, I will let the experts chime in but generally as a rule of thumb I have used 20% as the red flag threshold. Some types of retailers also have higher occupancy cost averages.

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Jun 10, 2019

Great point.

I have also typically used 20% as the red flag threshold. Certain tenants such as grocer anchors typically have very low occupancy cost in the ~5% range, so a red flag threshold for them could be more like 7-10%. Also, cash intensive businesses like nail salons might not be accurately reporting all their sales, so its not uncommon for them to be doing fine with a 20%+ occupancy cost.

Most Helpful
Jun 10, 2019

One important thing I have learned from leasing brokers as I have looked at acquisitions is that it's really important to think from the tenants perspective for each space. What type of tenant would occupy a space of that size (i.e. a pharmacy taking 10k SF vs a restaurant taking 2k SF). The size of the box determines the tenant pool since different retailers have different needs.

Who will be interested in that specific location? A retail box hidden on a side street might only interest smaller mom and pop retailers, so having a large box in a location like that might not make any sense.

Even if market rents are $100/SF (y'all have probably figured out these are all NY examples by now), but the tenants in that size only have a certain dollar amount they can afford for their business (going back to occupancy cost here), it doesn't matter what the market rates are if no tenants will be able to afford it.

If you have a large box that's best suited for a gym, grocery or pharmacy, but all of these already exist within a one block radius - who is gonna fill your space? Those types of tenants likely won't be intersted in moving in right next to their competiion. Really limits your potential tenant pool.

I'll let others expand on it, but the point I think your family friends were trying to make is that retail, more so than some other asset classes like resi, you really have to think about a lot more than just the numbers, thus making it its own beast. The numbers might make sense to you and your lender on the proforma, but if it doesn't make sense to the tenants you are targeting, you're in for a bad time.

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Jun 13, 2019
brosephstalin:

Even if market rents are $100/SF (y'all have probably figured out these are all NY examples by now), but the tenants in that size only have a certain dollar amount they can afford for their business (going back to occupancy cost here), it doesn't matter what the market rates are if no tenants will be able to afford it.

To add to this, depending on the tenants you're targeting, there are massive advantages to signing retail tenants at sub-market rents. I did a town center deal that included 75k SF of retail. We wanted the retail to be local and "authentic" so we consciously ignored big box stores and credit tenants in favor of boutique shops and chef-driven dining experiences. When placemaking, you don't want to overly burden these type of retail and restaurant startups with oppressive rent numbers before you have fully established your town center as a destination. Lower rents with strong % rent to capture upside allows them to get their feet under them and lowers their risk of failing, which hurts both your bottom line and the overarching feel of your community.

We opened at 98% occupancy with "below market" rates and have yet to regret a thing.

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Jun 15, 2019

Have you put permanent debt on the property? I am assuming its unanchored retail. Curious to know how the feedback has been from lenders on unanchored retail. Were you able to get terms like 10 year or longer term, 30 year amort, 75% ltv, non recourse?

Jun 10, 2019

The occupancy cost ratio is going to vary a lot as margins vary a lot, and an occupancy cost ratio of say 15 % on USD 15m turnover is something completely different than on USD 1m.

Unibail-Rodamco-Westfield and Klepierre report around 12-15 % on their shopping centers. URW's centers are some of the best in the world, and retailers typically go the extra mile to be present in their centers. Even if it means losing money. If a shopping center has an overall OCR of more than 15 % I would take a hard look at the numbers. This combined with poor turnover growth would be a red flag to me.

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Jun 13, 2019

REAs, ROFRs, purchase options, co-tenancy, restrictions/exclusives, kick outs, parking ratio, etc.

Jun 13, 2019
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