Session Plan

Chapter Nine:– Retail and Office properties as an investment

alternative– Discuss two retail and two office cases– Mini-Case on the DCF

Office Vs. Retail

Customers of tenants in office space visit the property due to having appointments

Retail customers typically are spur of the moment visitors so the location is much more important for retail vs. office– Ingress: Entrance into the property– Egress: Exit from the property

Both should be clear, visible from the road, and located near major roads and other retail shopping centers

Office Characteristics

Class A, B, & C – specifies features based on construction materials

used, floor and roof structures, fireproofing, quality of interior finish/amenities, and location

Class A is typically skyscraper quality– Reinforced concrete framing, superior location and

access, good condition and professional management Class B is typically suburban office buildings, with brick

façade, and professionally landscaped Class C is typically older (15-25 years), block walls, notable

physical deterioration (or converted retail space)

Other Office Characteristics

Could be a medical office building– Should be located near the hospital

Could be a professional office building– Should be located in office park or in neighborhoods

of similar quality and utility– Should be located near residential areas where

employees of the tenants live

Could be a downtown office building– Should have adequate parking, be near hotels,

restaurants, and have good access from major highways

Office Definitions

Gross Building Area– Total square footage of the building, measuring from

outside wall to outside wall

Net Rentable Area– The actual useable area. The gross area less areas

not rented by tenant (restrooms, public corridors, janitor closets, etc.)

Absorption– the net amount of additional office space that is leased

in a year’s time. Can be positive or negative (if new product is built but not leased)

Office Considerations

Asbestos has been a major problem in attaining financing by commercial banks

Should consider the age and condition of the elevators

The age and efficiency of the HVAC, roof, and the utilities

Lease terms are typically 3-5 years Tenants include doctors, lawyers, insurance,

banks, other service sector employment

Retail Properties

As mentioned earlier, retail properties are more dependent on the whims of the customers (rather than appointment oriented)– Nothing like that appointment at McDonald’s!

Anchor tenants– National or regional chain store that is the primary

draw for customers to the property

In-Line tenants– Supporting players relative to the anchors

Domino Clause

Most retail leases will specify that if the anchor tenant leaves, the other supporting tenants have the ability to break their leases early (for a fee)– Also known as a “Go Dark Clause”

Sales per square foot– This is a key measure of performance for retail

tenants. Investors can request last few years of sales history to gauge success at location (and the probability that a tenant will renew their lease)

Types of Retail Properties

Neighborhood Center– Shopping center containing up to 150,000 sq.ft. of

leasable space– Typically will have an anchor (Food Lion), strong

supporting players (Dollar General), and local mom & pop tenants (local nail salon or local restaurant)

– There are many of these in most communities– Should determine if the property is experiencing a

positive trend line or a negative trend line

Types of Retail Properties

Unanchored Center– A retail strip center which is smaller than a

neighborhood center: does not have a primary tenant

– Think of some of near campus

Outparcel– Separate tract of land at front of shopping center– Typically includes a restaurant, bank, or movie

theatre

Types of Retail Properties

Regional Center– A large mall containing 400,000 square feet of

leasable space (and above)– Usually has one to three major department stores– These types of properties are typically too large

for the average real estate investor– Also require a lot of maintenance and property

management due to the size of the property

Various Shopping Centers

Primary

Type of Shopping Center Size (Sq. Ft.) Anchor Ratio Trade Area

Neighborhood Center 30,000-150,000 30-50% 3 miles

Fashion/Specialty 80,000-250,000 30-50% 5-15 miles

Community Center 100,000-350,000 40-60% 3-6 miles

Regional Center 400,000-800,000 50-70% 5-10 miles

Power Center 250,000-600,000 70-90% 5-10 miles

Super-Regional Center (Mall) 800,000 + 50-70% 5-25 miles

Changes in Shopping Center Returns

Key Factors:– Competition entering market– Outdated design and layout– Changes in trade area income levels– Changes in population density– Changes in highway construction/traffic patterns

Projecting Retail Demand

Primary Trading Area: Measure of potential revenue of tenants in property from geographic boundary where 60-80% of sales in a given area originate– Based on property size, goods/services offered,

population density, & transportation facilities More competition equals lower possible revenue

Good for choosing locations in a given market

Location of Retail Properties

Should be near residential neighborhoods Building should be facing the road vs. perpendicular

to the road Should be located at an intersection

– Stop light is a big plus Should be convenient to major highways

– For both consumers and product deliveries Going Home side of the road (groceries) Going to Work side of road (coffee, bakeries)

Common Area Maintenance (CAM)

Typically landlords require their retail tenants to pay for their own utilities, and tenants typically will pay for taxes, insurance, and maintenance of the property on a pro-rata basis.

The landlord pays for these expenses, and then is reimbursed by the tenant– All of this is spelled out in the leases.

Second Story Retail?

This is very hard to lease Customers do not want to climb stairs or take elevators

in most cases Sometimes what was supposed to be second story retail

space is converted into office space or possibly apartments

In some metro locations, two story retail space is successful– Fort Lee, NJ example– St. Catherine’s Street in Montreal

Retail Tenant Mix

Tenants vary from grocery store chains, drug stores, dollar stores, restaurants, hobby stores, etc.– Which drug stores will survive?

How would you find out about the financial strength of the tenants?

When would be a crucial time to find this out?– Remember QQD here….

Tenant Improvements & Leasing Commissions in DCF

Tenant Improvements:– Estimate probability of renewal vs. new lease and

the costs per square foot for each– Calculate weighted average of above x sq ft of

space– Include inflation/growth factor depending on when

in holding period expense is estimated to occur

Tenant Improvements & Leasing Commissions in DCF

Leasing Commissions:– Estimate probability of renewal vs. new lease and the costs

as % of EGI for space– Calculate weighted average of above x % of EGI of space x

length of lease– No inflation/growth factor as this is included in DCF

estimation of EGI for a given year

Should survey market averages for inputs to include cost of renewal and new lease and length of leases

End of Session: