Every commercial property type has its own unique set of underwriting and investment criteria. While some of those criteria are common to most asset types, such as market rental rates, market occupancy rates, lease duration, and tenant credit strength, there are many criteria that are unique or specifically important to retail assets. If you are either buying or selling a retail property or if you are seeking investors or lenders, you should be prepared to be asked (and provide answers) to most of the following questions:
How are the tenants’ sales?
One of the first items both lenders and investors will naturally inquire about is for tenant sales data. Tenant sales are perhaps the easiest ways to gauge a retail tenant’s likelihood of maintaining tenancy at a retail property. More specifically, measuring sales as a ratio to gross rent will yield a tenant’s Occupancy Cost, sometimes referred to as a “Health Ratio” (Annual Gross Rent / Annual Sales = Health Ratio). For example, a Health Ratio of 8.0% may signal a strong location for a restaurant tenant, whereas for a discount retailer, 8.0% may be a red flag. In the case of a prospective development, it is helpful to have an understanding of the tenant sales in existing nearby properties.
Are there any co-tenancy clauses?
Retail tenants rely on consumer traffic and thus rely on other retailers at the shopping center to bring customers to the property and, ideally, to their stores. Tenants love being located next to “Anchor” tenants such as grocery stores because of the traffic they bring to the shopping center. However, they often rely on that traffic to such an extent that they determine that they cannot survive without the presence of that Anchor. Tenants are often successful in negotiating clauses into their lease stipulating that they may terminate their lease or pay significantly reduced rent if an anchor tenant vacates the shopping center. Tenants may also negotiate similar clauses if occupancy at the shopping center falls below a certain percentage (i.e. 65%). It’s easy to see how just one domino falling can set off a chain reaction of events leaving a retail property in a very bad position.
What are the demographics in the trade area?
Most retailers, just like any other business, have a target market, a customer profile whose spending habits match that retailer’s product/service offering. Some retailers may target 26- to 44-year old mothers with middle class incomes while other retailers may target young trendy singles aged 18 to 34. Retail tenants look at metrics such as population density, median household income, ethnicity, and average household size when evaluating potential locations. As a part of their due diligence, investors and lenders will evaluate the demographics against your business plan to make sure they are in alignment, particularly for new developments and redevelopments.
What are the traffic counts on the adjacent street(s)?
While some retail tenants are considered “destination retailers,” businesses for which customers seek out and travel longer distances to get to, such as a grocery store or a specialty electronics store, many other retailers are considered “impulse retailers,” such as coffee shops or gas stations / convenience stores that rely on vehicular traffic (or pedestrian traffic in shopping malls or walkable neighborhoods). Without strong traffic counts (15,000 to 30,000 vehicles per day) on the streets, the retail shopping centers fronts, the “impulse retailers,” may have trouble sustaining sufficient sales volumes.
How is the accessibility?
Even with ideal demographics and great traffic counts, if a shopping center is difficult to access, its chances of succeeding are greatly reduced. The easier a store is to get to, the more likely customers are to stop there. Retailers love to have a position on the “hard corner” of an intersection (i.e. frontage on both intersecting streets) with easy access to and from the property on both streets. As an example of how a change in accessibility can alter a shopping center’s fate, often when a highway is being widened the on and off ramps will be reconfigured or moved. A once thriving shopping center that benefited from great traffic counts on the frontage road can suddenly struggle to survive and attract tenants once the freeway off ramp is moved past the entrance to the shopping center, causing cars exiting the highway to have to make a series of circuitous U-turns to access the property.
The most successful investors and/or developers understand the finer details or nuances of all of their endeavors. Being able to provide answers to these types of questions to prospective investors or lenders will convey your competency and ability to successfully execute your business plan. At Metropolitan Capital Advisors (“MCA”), our team has extensive experience working with our clients to optimally present the nuances of their investments to the capital markets in all property types, from retail to multifamily to healthcare. If you are seeking capital for your investment property, please contact me at email@example.com or any one of our Senior Directors in our Dallas or Denver offices.