A customer loads his truck after shopping at a Kroger grocery store in Houston, Texas. (Photo by … [+]
In today’s post-pandemic world, brick-and-mortar retail has surprisingly made an incredible comeback. At one point, as consumers stayed home and shopped online, the future of physical stores was called into question. Yet now many retailers are welcoming in customers who seek an experience or the chance to see and touch merchandise before making a purchase.
Recent data provides further insight into this intriguing trend. More than half of consumers (56.6%) report a preference to shop online, according to a survey by Raydiant, a media management platform. During the fourth quarter of 2022, however, the U.S. Department of Commerce reported that e-commerce purchases only accounted for 14.7% of total sales. Thus, even as customers lean into online transactions for convenience, they are still walking through doors and having in-person interactions for certain purchases.
For real estate investors, retail properties in some markets will be here to stay. Before jumping into the game, however, it’s vital to know the inner workings of the space. In this fourth article of the series, “Making Investment Decisions in Today’s Real Estate Market,” we’ll cover essential aspects of retail investments. (See the first, second, and third articles of the series.) I’ll lay out what to expect, as well as the importance of knowing when to step in—and why waiting could be worthwhile.
Here are five factors to keep in mind when making an investment in retail property:
1. Study the landscape.
This asset class encompasses everything from family-owned locales to home improvement big box stores, commercial strip malls, large shopping complexes, grocery stores, and more. Some are extremely specialized, such as a dentist office or nail salon. Others tend to be more general in terms of design and purpose.
2. Check the tenant’s track record.
If you acquire a retail space, your tenant could be in a service industry, such as a fitness center or laundromat. They might run a small mom-and-pop business and sell candles or artwork. They may be part of a national brand, like a pharmacy or fast-food chain.
Before accepting a tenant, you’ll want to know their background. Do they have other locations? How long have they been in business? What type of financial backing do they have? A retail leasing broker who understands typical lease structures can help you sort through these questions and vet tenants.
3. Be aware of the risks.
Compared to some other property types, including multifamily, retail holds the potential for higher returns. However, I’m always quick to warn of the inherent risks attached to these places. First, if you have a property that holds just one business, and that shop closes or moves away, you could lose your source of income. It might take months or longer to fill the space, and if the tenant was in a specific industry, you might have to rework the property to fit the next tenant (or bring in another business in the same niche).
Checking who guarantees the lease is also important. If you’re dealing with a national tenant, ask if you are getting a franchise or a corporate guarantee, as there will be different implications to each. A franchise guarantee could be viewed as higher risk, for instance. The credit rating will also affect the cap rate for the trade. If the credit is stronger, the return for investors will be lower.
4. Monitor market changes.
While retail has recovered better than many expected, there is still change in the air. This can impact prices and create uncertainties as we look ahead. In Soho in New York City, for instance, on the Broadway corridor, five years ago retail rents were in the $300 to $400 per square foot range. They kept increasing and eventually hit $1,000 per square foot. Then Covid struck, causing them to plummet, with some reaching a low of $150 per square foot. Today those rents are returning and we’re starting to see rents for $300 per square foot again. For investors getting in at the right time, there could be opportunities to ride waves of increases and reap the returns (and the other side is true too—get in at the wrong time and the values could decrease).
In addition to checking overarching market trends, study the submarket nuances. Retail rents can vary widely depending on the location of the block, the size of the store, and the frontage. Consult a retail leasing broker to get insight on these factors and their implications, as well as comparable sales.
5. Look for undiscovered opportunities.
As online retailers open physical locations, and brick-and-mortar chains expand, investors with the right team will have the chance to meet new demands. A larger retail property built for one tenant could be divided to accommodate several, especially if businesses in the area are looking for smaller spaces. With trends toward in-store events and showroom displays, there could be opportunities to repurpose existing properties and make them attractive to retailers with shifting needs.
A great investment strategy often involves establishing tenant relationships before you make an acquisition. You might buy vacant retail at a discount and then bring the tenant to the table. The approach will help you lock in better financing, not to mention the chance to add value to the investment from day one!
If you’re new to investing, another asset class (such as multifamily) could be a great start before venturing into the retail space. Once you’re ready to step in, look for a partner who has ample experience and can provide the insider’s knowledge to gain a competitive advantage. Study the local market before making a move—and when you do, keep tabs on the trends so you’re ready to pivot if needed.
