By Charley Babb
What once was an outlier real estate play has now become a significant commercial real estate asset class. Pad sites are much in vogue, as national retailers line up to occupy single-tenant outparcels in retail centers of all types. Couple that with increased interest from triple-net investors and you have the recipe for a boom in this heretofore unfashionable development niche.
Once upon a time, outparcels, or pad sites, were considered fringe areas, leftovers. Today they are the hottest commodity in commercial retail development. No longer are pad sites reserved primarily for gas stations and quick-serve restaurant chains. Property owners, from small independent owners to giant real estate investment trusts (REITs), are finding untapped value in the “excess land” that they already own. In addition, land surrounding shopping malls is going for a premium thanks to this wave of demand from retailers coast to coast.
For example, Kimco, a national REIT, is marketing pad outparcels in 29 states as a key value-creation strategy. “From a development perspective, it enables us to reposition retail buildings that have been underutilized with a more vibrant and current tenant mix – such as Chipotle, Mod Pizza and urgent care centers,” says Kimco’s executive vice president of asset management, David Jamieson. Some developers have even demolished inline space in an effort to reconfigure their centers in this pad-happy environment.
Tenants like the characteristics of traffic-generating anchors, ideal sight lines, superior exposure, access and captive parking. As such, they are paying higher rents than ever before for these “prime” locations. Net-lease specialty firms are reporting robust transaction volumes. National Retail Properties, a REIT specializing in diverse freestanding retail and restaurant buildings across 47 states, is 98.8% leased across their portfolio. Convenience stores comprise the largest share of properties at 17.7%, followed by restaurants at 15.9% and auto-service stores at 7.2%. In addition, upscale retailers are growing in their demand for outparcels and are willing to pay the rents necessary to move to the front of the line in lease negotiations.
One need not be a REIT nor even a developer to get in on this craze. The simplicity of stand-alone properties has long been a staple for small-time investors who wanted to own one of the three major drug store chains without the hassles of typical real estate ownership. But today, properties with myriad users of all types are also selling briskly. Investment-grade restaurant buildings costing less than $5 million with corporate guarantees are emerging as favorites among buyers. With safe and stable returns, such retail properties have evolved into a highly popular asset class. Values of net-leased assets, including outparcels, have increased to all-time highs as a result of extremely aggressive cap rates. A high degree of liquidity in secondary markets is also emerging.
Triple-net investors continue to prefer retail properties over office and industrial ones. Some credit this to their familiarity with the tenants, typically long initial lease terms, passive structures and lower total price points. Private capital, including exchanges, now dominates the net-lease market. They accounted for 60% of it in 2014 and that is trending even higher in 2015. Many baby boomer investors are demonstrating a desire to own their own store as a viable strategy for a portion of their investment portfolios. With retailers lining up to lease these sites, they are perceived as relatively safe investments, even if the current tenant might fail. And even at low cap rates, the returns can be an improvement over alternative income-producing assets in their mix.
From supply to demand to capital liquidity, pad site popularity is likely here to stay for quite some time. So, shall we go to your pad or mine?
The author, Charley Babb, is a Senior Director and Principal of MCA’s Denver office. Charley can be reached at CBabb@metcapital.com or 303-647-9032.