MJF002 RETAIL REAL ESTATE AS AN INVESTMENT CLASS

by Michael Flight

06.25.2018

A picturesque outdoor strip mall with a grocery store, department store and other retail stores from the view of the parking lot.

RETAIL REAL ESTATE AS AN INVESTMENT CLASS

This article was originally published on www.concordiarealty.com on July 2, 2018.

Retail Real Estate can be an excellent way to generate cash flow and wealth either full time or as an addition to any investment portfolio. Retail Real Estate as an investment combines financial security, long term stability, inflation hedging and tenant paid expenses along with the opportunity to be involved with food, fashion, capitalism and community development. Retail Real Estate has produced average annual returns of 10.8% over the past 20 years, according to the National Council of Real Estate Investment Fiduciaries (NCREIF) Index. That is higher than the 10.2% average returns produced by the four basic “Food Group” of commercial real estate types which include apartments, industrial, office and retail properties.

Despite a recent theme from the media about a brick and mortar retail apocalypse, Retail properties have a track record of delivering solid, stabile investment returns. As a matter of fact, Retail Real Estate is the asset class that has secured some of the highest price per square foot purchase prices of any type of commercial real estate (one notable deal is $31,000 per square foot – $2880 per square meter in 2014 by Chanel in New York City). Additionally, retail real estate has produced some of the highest rents in the world including New York City’s 5th Avenue with annual rents that average of $3,000 per square foot, Hong Kong’s Causeway Bay with average annual rents around $2,725 per square foot and London’s New Bond Street with average annual rents in 2017 around $1,720 per square foot.

You can invest in Retail Real Estate in a number of ways including active investment by purchasing a Shopping Center or Net-Leased Single-Tenant retail store, restaurant or service provider. Additionally, there are many other opportunities to passively invest in Retail Real Estate through shares in a REIT, Crowdfunding platforms, making loans or investing in private syndications.

Retail Real Estate is influenced by the state of the national economy, tracking with indicators such as corporate income and productivity increases, employment growth and consumer confidence levels. Local factors include state and local tax policies, regulatory regimes and pro-growth sentiment. Lastly, property specific factors include the property location, traffic flow; trade area population demographics, household disposable incomes and buying patterns. Retail Real Estate is 100% location, location, location on behalf of the property owner and 100% merchandising, merchandising, merchandising on behalf of he tenant.

Retail real estate provides for investment stability with leases of 5, 10 and even 20 years. The income is consistent (theoretically) and known for longer periods of time. Retail Real Estate leases are typically with “Chain Stores” or sometimes referred to as “National” or “Credit” tenants even though they can be a strong regional retailer or even a dominant local retailer with 10 – 20 stores in a metropolitan area. These tenants are typically publicly traded and/or “Investment Grade” with credit ratings at least BBB- or higher by Fitch and Standard & Poor or Baa3 or higher by Moody’s. Since the rent is guaranteed by financially strong tenant you have a higher expectation of the rent being paid at the beginning of the month, each and every month of the lease. You won’t have the opportunity to take advantage of major swings in rental rates because they are locked in however some leases adjust at 1 or 5 or 10 year intervals according to the Consumer Price Index (CPI).

Most retail leases are also Triple Net (NNN) meaning he the tenant pays in addition to rent the real estate taxes, building and liability insurance and maintenance of the parking lot, sidewalks, landscaping and other items that would be considered “common areas” or areas utilized by customers. With NNN leases the tenant also typically pays for all their own utilities and maintains the interior of their premises plus regular scheduled maintenance (not replacement) of HVAC systems. The acronym TIM (Taxes, Insurance, Maintenance) is used to remember NNN.

In addition to the tenant paying rent and expenses, some leases have a Percentage Rent Clause where a tenant pays a percentage of their gross sales. Percentage Rent creates alignment between the tenant and the landlord in a shopping center because the landlord is incentivised to create the best collection of retailers to produce higher sales volumes for all the tenants. The Percentage Rent is usually structured to kick in after a tenant achieves a specified amount of sales. Once the tenant’s sales exceed the “Break Point” the tenant will pay the extra Percentage Rent on a monthly basis or at the end of the year.

Retail Real Estate can either be Shopping Centers or Single-Tenant properties. In either case, you will typically see both types of properties clustered at the intersections or along major arterial streets. Retail Real Estate thrives on traffic, access and visibility.

Shopping Centers are an efficient way to distribute goods and services to people living in a geographic area. They concentrate a complimentary assortment of things people need into a convenient place to obtain them. Shopping centers also provide community gathering places to get merchandise, food and a sense of community. When man first settled into cities it was the same reasoning: cooperation and specialization provides a wider assortment of goods at typically less cost to consumer.

Shopping centers can be malls (enclosed or open air) which tend to be larger size (more square footage of leaseable area and total land area) surrounded by parking. The other type of shopping center is the strip center (or classier “Open Center”) which typically have parking in front of the stores with the storefronts having street visibility. Strip centers can be as small as two stores side by side or up to fifty stores in a U shaped configuration along a main street.

Another popular retail real estate investment is the Net-Lease Single-Tenant retail property lease to a national credit chain store (think Walgreens, CVS, Advance Auto, and Dollar General, etc.); restaurants: including Quick Service Restaurants (QSR or Fast Food) through fine dining; bank branches (Chase, PNC or Bank of America); medical (dialysis, dental and emergency care); health clubs and many more options. Single-tenant retail properties can be stand alone or actually located within a shopping center on an out-parcel or out-lot in the parking lot of the shopping center.

A type of retail real estate growing in popularity is urban street front retail (sometime known as High Street Retail on the best shopping streets in gateway cities). Street front retail typically does not have parking but can be one to a cluster of stores extending a city block. Many street front retail properties are the commercial condominium portion of a larger residential or office building located in an urban center or neighborhood.

A rare form of Net Lease is called the Absolute Net Lease in which the tenant pays all the NNN items, plus the costs of maintaining and replacing the building including roof, walls, HVAC systems and structural components. An investor will more commonly find an Absolute Net Lease in the form of a Ground Lease. For example, we have had a number of shopping centers where we had excess land in the parking lot. We chose to do a Ground Lease with restaurants, car washes and even a supermarket because you as the property owner take on less risk. There is no construction risk, there is no risk of paying for special use equipment and again, the tenant pays for maintaining the building, grounds, utilities, taxes and any other expenses plus pays you monthly. For this reduced risk and because the tenant has to spend more of its own capital, the investor will be paid less rent.

Shopping centers and retail real estate “Bricks and Sticks” are getting lots of negative attention because of the growth of online shopping “Clicks”. Online retail sales will be competition for physical stores but will also be a valuable contributor to a retailer’s overall sales and profits because the best retailers will have a “Multi Channel” strategy. As of this writing, traditional retailers are increasing online promotions and online only retailers are opening physical stores to provide a place to “touch, try and buy”. There are many goods and services that cannot and may never be sold online such as medical, restaurants, entertainment and service providers like dry cleaners. There is also something to be said about the community life and social aspect of shopping centers. When done right, Retail Real Estate is a place for people to gather, meet, see and be seen. Lastly, to get same day and same hour delivery service many retailers will be using their store footprint as last mile distribution centers to get products to consumers in the fastest way possible. Amazon just invested a lot on money in Whole Foods to have a physical presence with their customers.

A few areas of concern with retail real estate investments are:

  1. Shopping centers and retail real estate requires a higher level of experience and specialized knowledge about retail store operations and merchandising.
  2. Retail Real Estate investors need to develop relationships with retailers and the retail real estate brokers who specialize in tenant representation.
  3. Retail real estate can sometimes require major capital investment if you need to replace a tenant (brokers fees, costs to white box and tenant improvement costs).
  4. Changing retail landscape with internet and retailer bankruptcies. As described above, retailers are constantly evolving which means retail real estate will need to evolve with them.
  5. Retail Real Estate can be highly correlated to unemployment and consumer sentiment.

Retail Real Estate has constantly evolved from the traders at the city gate a few thousand years ago to the Roman Agora to the middle eastern bazaars to the middle ages fairs to the Galleria Vittorio Emanuele II in Milan to Country Club Plaza in Kansas City to the Forum Shops at Caesars in Las Vegas to the somewhat creepy Amazon Go store that monitors your every move and purchase.

Retail Real Estate properties run the gamut from large Super Regional Malls and Urban Vertical Malls to Power Centers, Lifestyle Centers, Grocery Anchored Strip Centers to Single-Tenant Net-Leased investments. Retail Real Estate has historically generated higher investment returns than other major commercial real estate property types. Retail Real Estate has achieved the highest per square foot rental rates and sales prices. Retail Real Estate can be located in some of the most exclusive areas in the world, think Rodeo Drive, to a Dollar Store or Discount Grocery located in a rural town providing staple goods to a community that does not have an abundance of material wealth.

Retail Real Estate as an investment combines wealth creation and cash flow with long term stability, inflation hedging and controlled expenses along with the opportunity to be involved with food, fashion, merchandising and community development.

“Trade your expectations for appreciation and your whole world changes in an instant.” – Tony Robbins

Michael J. Flight

Principal at Concordia Realty Corporation
CEO & Co-Founder of Liberty Real Estate Fund
Co-Founder & Chief Strategy Officer of Invest On Main
Co-Founder of Blockchain Real Estate Summit

Michael J Flight was named the Godfather of Blockchain Real Estate by Forbes Crypto Editor Dustin Plantholdt. Michael achieved that distinction by co-founding Liberty Real Estate Fund, the World’s First Net Lease Security Token FundTM and creating the Blockchain Real Estate SummitTM. More recently, Michael has co-founded Invest On Main (IOM.ai) the Real Estate & Alternative Asset marketplace of the future and AcceleratedLaw a faster, more affordable way to create and tokenize securities offerings!

Michael is a real estate entrepreneur and real estate tokenization pioneer who is an expert in retail real estate investment, redevelopment and real estate on the blockchain. He started his commercial real estate career in 1985, and then co-founded Concordia Realty Corporation in 1990, which continues to partner with some of the world’s most well-known banks, insurance companies, hedge funds and institutional investors in many successful investments.

Michael is a real estate entrepreneur and Blockchain Real Estate evangelist who is an expert in retail real estate (Shopping Centers and Single-Tenant Net-Leased) investment, redevelopment and real estate on the blockchain. He has an extensive record of value-add shopping center redevelopment and with partners Merchant Equity Group, LLC as a pioneer in de-malling (repurposing enclosed malls). Michael has been active in commercial real estate over the past 35 years.

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