How to Invest in Shopping Centers Through a Private Equity Real Estate Firm

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Key Takeaways

  • Investing in a retail shopping center can deliver a stable stream of rental income and steady capital appreciation resulting in a substantial return for the owner over time.
  • Traditionally, a shopping center contains one or more “anchor” tenants who have a recognizable name, solid business, and the ability to drive traffic to the center on their own.
  • A real estate investment in a shopping center requires considerable thought, resources, operational expertise, and due diligence.
  • Private equity firms offer deep industry and operational expertise, which allows an individual real estate investor to outsource the task of identifying, selecting, acquiring, and managing a shopping center to the experts.

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How to Invest in Shopping Centers Through a Private Equity Real Estate Firm

Purchasing a retail shopping center has the potential to be very profitable for commercial real estate investors.  If done correctly, this asset class can deliver a stable stream of rental income and steady capital appreciation resulting in a substantial return for the owner over time.

An investment in a shopping center requires considerable thought, resources, operational expertise, and due diligence. This article will discuss the key attributes to consider when evaluating an investment in a shopping center, particularly through a private equity firm. By the end of the article, real estate investors will have the information to decide whether an investment in a shopping center through a private equity firm is right for them.

At First National Realty Partners, we are a private equity firm that specializes in the purchase and management of grocery store anchored retail centers.  If you are an accredited investor, interested in partnering with a private equity firm to allocate capital to a commercial real estate investment, click here.

Know the Defining Characteristics of a Shopping Center

The world of commercial real estate is characterized by many different property types, one of which is a retail shopping center. These properties are typically characterized by a single large building or series of smaller buildings that contain customer-facing businesses set up for the purpose of direct-to-consumer retail sales.

Traditionally, a shopping center contains one or more “anchor” tenants who have a recognizable name, solid business, and the ability to drive traffic to the center on their own.  The anchor tenants are supported by a mix of smaller tenants whose businesses offer products and services complementary to those of the anchor.  Together, they create a “center” of shopping convenience for the customer.

A classic example is a grocery-anchored shopping center supported by a series of complementary tenants like a coffee shop, dry cleaner, nail salon, office supply store, and smoothie shop.

Owners like shopping centers for their stable stream of income, valuable real estate, and operational efficiency because all of the tenants are in one location.  However, owning a shopping center isn’t without risks.  The success of tenant businesses, particularly the smaller ones, are subject to changing consumer tastes.  Failure to adapt can cause bankruptcy for the tenant which leads to vacancies and declining net income for the owner.  In addition, shopping center success is directly impacted by the ever changing landscape of surrounding neighborhoods, competition, and the high cost of tenant improvements.

To increase the odds of success, investors contemplating a shopping center purchase or investment should carefully evaluate a wide range of factors that might impact the value of retail properties over time.

Consider the Factors that Drive the Shopping Center’s Value: Location, Visibility, and Traffic

In commercial real estate, it’s often said that location is everything and it’s especially true for retail shopping centers.  To maximize the odds for success and to attract top tenants, it’s critical that the center has an excellent location with strong visibility from major roads and easy ingress/egress from the center itself.  To determine whether or not a location is a good one, several characteristics should be considered:

CharacteristicMethod of Evaluation
Neighborhood SafetySub-Market Crime Statistics
Car TrafficTraffic Count – Should be > 50K cars daily
Foot TrafficIf the neighborhood is walkable – pedestrian count
Parking~10 spaces per 1,000 SF of retail floor area
ConvenienceIngress/Egress, signaled intersection, proximity to highways
Neighborhood DemographicsDo they match the tenant base?
CompetitionDo they have nearby competition?

Know the 3 Types of Shopping Centers

Once familiar with the location of the property, it’s important to consider whether the “type” of shopping center is a logical fit within the context of the surrounding neighborhood.  The International Council of Shopping Centers (ICSC) defines three broad types of retail shopping centers:

1. General Purpose Shopping Centers

A general purpose shopping center seeks to be “one-stop shopping” by offering a wide variety of tenants and products.  Think shopping malls, community shopping centers, and strip malls.

2. Special Purpose Shopping Centers

A special purpose shopping center is built to serve a specific audience and the tenants may fall within a particular category.  Examples include power centers, lifestyle centers, outlets, and other themed shopping centers.

3. Limited Purpose Shopping Centers

A limited purpose center is a consolidation of stores built to serve a limited audience.  Think airport retail shops.

Again, the importance of the type is that it should be consistent with surrounding retail or a good fit for the surrounding neighborhood.  For example, a large outlet center may not be a good fit for a high end residential area.

Consider the Quality & Age of the Shopping Center

Maintenance and repair work is unavoidable, so it’s important to consider the current condition of the building before making an investment.  Older shopping centers may have a lower price tag, but prospective owners should be prepared to allocate capital to maintenance and plan for potential big ticket repair items like electrical, plumbing, HVAC and roofing.

On the other hand, buying an older property for a good price and investing in renovations to bring the physical condition up to current standards can allow an owner to increase rents, which raises the value of the property and the return for all who invested. This is known as a value-add strategy, and many institutional investors choose to focus on this as a way to generate strong returns for investors.

In fact, some of the best track records in the commercial real estate industry have come about through opportunistic purchases of properties where the management team could increase the property’s operating income by renovating the space and leasing it up to high-quality tenants.

Let’s take a closer look at the importance of tenants in private equity real estate investing.

Consider the Shopping Center’s Tenant Base

It’s important to consider the shopping center’s existing tenant base within the context of the demographics of the surrounding location.  For example, a luxury shopping mall with high end tenants may not be a good fit for an economically distressed area.

It’s also important to consider the financial strength, experience, and diversity of the tenant offering.  In an ideal situation, there’s an anchor tenant in place to drive traffic to the shopping center and a series of supporting tenants whose products complement those of the anchor.  To ensure that the tenants can pay the rent, careful analysis must be performed on their financial statements.

Know the Shopping Center’s Cap Rate & Risk Return Profile

Commercial real estate properties, retail included, trade on cash flow and the cap rate is an indication of the relationship between a property’s cash flow and its value.  The lower the cap rate, the higher the value.  The higher the cap rate, the lower the value.

The cap rate is also a good indicator of a property’s risk/return profile.  A shopping center with a low cap rate likely has high-quality tenants, a good location, and profitable operating metrics, but a low cap rate is also an indication that the upside may be limited because an investor will have to pay a lot more for relative safety.

On the other hand, properties with high cap rates may have a low entry price, but represent more risk in the form of vacancy, physical obsolescence, or an inferior location.  Potential investors should consider the risk/return profile to ensure suitability for their goals. Again, some real estate funds choose to focus on value-add properties that typically trade at high cap rates with the idea that this investment strategy can lead to very strong returns if executed properly.

Know the Common Types of Shopping Center Leases

There are several types of shopping center leases that are commonly used. These include:

Gross Lease

In a gross lease, the tenant pays a fixed monthly rent to the landlord, and the landlord is responsible for paying all operating expenses, including property taxes, insurance, and maintenance. To protect themselves from rising costs, property owners may negotiate an “expense stop” which puts a cap on the amount of expenses that they are required to pay.  If actual expenses exceed the cap, the tenant may be responsible for the overage.

Modified Gross Lease

A modified gross lease is similar to a gross lease, but the tenant is responsible for paying some of the operating expenses in addition to the base rent. These expenses are referred to as the “Common Area Maintenance” or “CAM” charges and they are typically in proportion to the percentage of space that the tenant leases.  For example, if a tenant leases 25% of the total space in a property, they may be responsible for 25% of the Common Area Maintenance charges.

A Modified Gross Lease is one of the most common lease types used for commercial properties.

Net Lease

In a net lease, the tenant pays a base rent plus a portion of the operating expenses. There are several types of net leases, including:

Single Net Lease: The tenant pays a base rent plus a portion of the property taxes.

Double Net Lease: The tenant pays a base rent plus the property taxes and insurance.

Triple Net Lease: The tenant pays a base rent plus the property taxes, insurance, and other operating expenses.  Triple Net leases are particularly popular with investors who want a more passive approach to property management because the tenant handles the bulk of the work.

Absolute Net Lease:  Finally, in the Absolute Net Lease, the tenant is responsible for a base rental amount plus all operating expenses and maintenance.

Percentage Lease

In a percentage lease, the tenant pays a base rent plus a percentage of their sales to the landlord. This type of lease is commonly used for retail stores and restaurants.

Choose How to Purchase a Shopping Center

For investors sold on the idea of a shopping center investment and bullish on the prospect for high returns, there are two ways to participate in investment opportunities, each with their benefits and weaknesses.

1. Direct Purchase

The first option is to purchase a shopping center directly through an LLC or small partnership.  Making a direct purchase provides the owner with direct operational control of the property, full participation in the potential profits, and complete oversight of the property identification and selection process.

But, the direct purchase of one shopping center also exposes the owner to portfolio concentration risk and requires significant financial resources or net-worth as well as operational expertise.  It’s not for everyone and likely out of reach for most individual investors.  Luckily, there’s a second option.

2. Indirect Purchase

Investors lacking the financial resources and operational expertise needed to purchase and manage a shopping center can still invest in these potentially lucrative properties by partnering with a private equity real estate firm. Other options to purchase commercial real estate indirectly include buying shares in real estate investment trusts (REITs) or real estate mutual funds.  Indirect purchases offer several benefits over the alternative:

Diversification

Private equity firms pool investor funds and purchase multiple properties to provide a level of portfolio diversification not available through a direct purchase.

Asset Quality

By pooling assets with other investors, an individual can gain exposure to institutional quality real estate assets that wouldn’t otherwise be available to them.

Management Expertise

As part of their value proposition, private equity firms offer deep industry and operational expertise, which allows an individual investor to outsource the task of identifying, selecting, acquiring, and managing a shopping center to the experts.  In addition, private equity firms have significant resources and can leverage vast networks of brokerage relationships to land deals that aren’t normally available to an individual investor.

Risks and Mitigation Factors to Consider

While the benefits are impressive – and substantial – a private equity investment isn’t without risk.

Partnering with a private equity firm to purchase a retail shopping center often requires a lengthy holding period, abdication of operational control, slightly smaller returns due to management fees, and a smaller share of the profit upon exit.  In addition, shopping center owners are subject to the risk associated with a fast changing retail environment and the competition posed by internet retailers.

To mitigate these risks for ourselves and our investors, First National Realty Partners employs a proven retail acquisition strategy with a rigid focus on value-add shopping center acquisitions whose tenants are either service oriented or experiential retail businesses.  For example, we prefer gyms, grocers, and movie theater tenants over shoe, clothing, and gift stores because they’ve proven to be resistant to the e-commerce driven change that has upended traditional product based retail concepts.

Interested In Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.

If you would like to learn more about our commercial real estate investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.

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