Shopping Centers

Investing in Shopping Centers

By dictionary definition, a shopping center is nothing more than a sheltered area designated as retail space, but this doesn’t accurately describe the industry’s diverse nature. According to the International Council of Shopping Centers (ICSC), a shopping center is a group of retail and other commercial establishments that is planned, developed, owned and managed as a single property, with on-site parking provided. From there, shopping centers are broken into two categories—malls and open-air centers—with several subsets.

Malls

Regional Centers: These are your typical shopping malls. This center provides general merchandise (a large percentage of which is clothing) and a varity of other service businesses. Its main attraction is the combination of anchors, which may be traditional, mass merchant, discount or fashion department stores, with numerous fashion-oriented specialty stores. Regional centers have parking along their perimeters and stores are connected by a common walkway.

Super Regional Center: These are basically super-sized malls. Everything is the same, except there’s more of it. There are more anchor tenants, more variety in stores. Super malls pull a larger population base and the parking is structured to accommodate the sheer size of the mall.

Open-air Centers

According to the ICSC, an attached row of stores or service outlets managed as a unit, with on-site parking usually located in front of the stores and common areas that are not enclosed is known as an open-air center. Open canopies may connect the storefronts, but an open-air center does not have enclosed walkways linking the stores. Open-air centers come in six different shapes and sizes: neighborhood centers, community centers, power centers, theme/festival centers, outlet centers and lifestyle centers.

Neighborhood Centers: These shopping centers are designed to service the needs of consumers in the immediate neighborhood. Supermarkets anchor almost half of these centers, while nearly a third are home to major drug stores.

Community Centers: These are similar to neighborhood centers, except bigger. Supermarkets and super drug stores often anchor community centers, but this is where you’ll also see the big box stores like Wal-Mart and Best Buy.

Lifestyle Centers: These shopping centers are often found near affluent residential neighborhoods. These spaces cater to the lifestyle pursuits of the surrounding neighborhood and typically include upscale restaurants and amenities such as fountains. This is where you’ll often find Starbucks, bookstores and other accompanying retailers.

Power Centers: These are shopping centers dominated by several large anchor tenants, including discount department stores, warehouse clubs, or “category killers,” which offer a variety of related merchandise categories at very competitive prices (think Lowe’s or Home Depot). Some of the anchor tenants may be in freestanding, unconnected facilities.

Outlet Centers: This type of property consists of manufacturers’ and retailers’ outlet stores selling brand-name goods at a discount. These centers typically lack an anchor tenant, however, certain brand-name stores may serve as magnet tenants. The primary trade area for these centers stretch 25 to 75 miles and they typically utilize 10 to 50 acres of land.

As in any commercial real estate investment, you’ll also want to pay particular attention to a shopping center’s cap rate. A capitalization rate, or “cap rate,” is a ratio of net income and capital cost. It is calculated by taking the net operating income (NOI) for the building and dividing by the purchase price. For example, a building purchased for $1 million that generates $100,000 in net operating income has a cap rate of 10 percent.

When valuing properties it is useful to think of the cap rate the same way you would look at a rate of return for any other investment. The higher the cap rate, the higher the rate of return on the investment, but also the higher the perceived risk. Cap rates vary depending on the location, size and history of the property. Once a cap rate is determined, it is divided by the NOI to determine the value of the property. For example, a shopping center at a 7 percent cap rate with $140,000 NOI will be valued at $2 million dollars.

Besides cap rates and cash flow, you’ll want to look at another aspect of a potential shopping center purchase before signing on the dotted line—location. The location and accessibility of your shopping center is what will make or break your investment in the long run.

The leasing options available for shopping malls are the same as any lease in commercial real estate: the gross lease, modified gross lease and triple-net lease. Gross leases usually benefit the lessee the most. The renter only has to pay rent, while the owner of the property is responsible for paying all other expenses such as utilities, repairs, insurance and taxes. A triple-net lease is the opposite of the gross lease, where all burdens of taxes, utilities, maintenance and rent are the responsibility of the tenant. A modified gross lease is between the two – the tenant and the property owner share some of the costs (such as the tenant paying rent, utilities and taxes while the owner is responsible for building maintenance and upkeep).

More often than not shopping center leases are triple-net. The expenses, like utilities and taxes will often be capped with administrative fees capped at a certain percentage. The lease are anywhere from three years to thirty, often with renewable options. Anchor tenant spaces are typically much less expensive on a square foot basis than small shop space, as the anchors draw the customers into the mall that then shop at the smaller stores.

Malls and other large shopping centers may not have been in your crosshairs as a potential investment. They’re big, they’re expensive and usually require a long-term commitment – much longer than your typical single- or multi-family residential project. Being the landlord of a even a small mall involves dealing not with the single mother and elderly couple, but with very large corporations as tenants and their layers of management. Financing may also easily be the largest monetary commitment you’ve made as an investor, as the purchase price for shopping centers can reach into the tens of millions of dollars.