When it comes to commercial real estate “pad sites,” the interests of retail tenants and property owners are aligned.
Retail business owners looking for new locations sometimes find that the available space in a given market isn’t a good fit for their needs. The space may be too big, too small, not visible enough, or it may not have enough parking. Ideally, if they could, retail business owners would customize a space to their needs.
Property owners, who may be accountable to investors and shareholders, are always looking for ways to maximize an asset’s income and profits. In our case, one of the ways that we like to maximize income and profits from an asset is through the use or development of “pad sites.”
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What is a Commercial Pad Site?
A building lot adjacent to a mall or shopping center is called a pad site. In a typical commercial retail property, there are two types of space. The main space, sometimes referred to as the “inline” space, makes up the bulk of the leasable square footage of the property. Typically it is set back from the main road and has a large parking lot to accommodate visitors to the property. In addition, some properties contain “outparcels” or “pads” that are standalone sites upon which a customized space can be built and/or leased for a tenant. The picture below provides a good example of this. (NOTE: This is not a property in our portfolio; it is for illustrative purposes only.)
This aerial photo is fairly typical of a modern shopping center. The “inline space” (circled in blue) is set back from the main road and it houses the main or “anchor” tenants in the center, in this case Whole Foods and Nordstrom Rack. These tenants occupy the largest spaces and their rental payments may make up the bulk of the income for the property. But, there is some very valuable real estate with frontage on the main road. So, rather than use it as a parking lot, developers and owners have figured out that this space can be developed and leased to tenants whose line business is complementary to that of the anchor tenants.
So, the “pads” or “outparcels” are circled in red. They share parking lot space with the main tenants, but have frontage to the main road. Pad sites benefit from the automobile traffic that passes by the center every day, and from the foot traffic generated by the individuals coming to shop at the anchor tenants. For example, in this center, one of the developed outparcels is a branch location of a major bank. So, someone looking to run their errands for the day could go to the grocery store and the bank without leaving the same shopping center.
In the past, pad sites were viewed as “leftovers” or “fringe” parts of a larger commercial property. But, this is no longer the case. This extra land can be used to boost overall profitability while meeting the space demands of local retailers at the same time.
Why We Like Deals With Commercial Real Estate Pad Sites
We prefer a “value-add” approach to commercial real estate investment and one of the primary ways that we like to add value is through the sale or development of pad sites.
There are a number of reasons we like deals with the potential for commercial real estate pad sites:
There are three ways that pad sites can add to the profitability of our properties.
First, since we already own the land, we can develop the pads without adding any basis to our cost. Once developed, we can lease the space to increase the amount of income produced by the same property.
Second, we could sell the pad sites to be developed by someone else and use the proceeds to reduce our cost basis (and interest expense) in the property. By reducing the amount of debt service that must be paid, the property becomes more profitable.
3. Ground Lease
Finally, if it makes sense, we can work with a tenant or builder to execute a “ground lease” on the pad sites. Under the terms of a ground lease, someone pays us to lease the “ground” associated with the pad site and then invests their own funds to develop a building. In this scenario, we get the benefit of the income without the risk of developing the site.
National retailers like pad sites. For example, in the aerial photo above, the pad site tenants include a national bank and a national cosmetics store. Other common pad site tenants are gas stations, fast food restaurants, convenience stores, and coffee shops with drive-thru service. In many cases, these national retailers are “credit tenants,” which means that an independent rating agency has reviewed their financial condition and deemed them to be a low default risk. When it comes time to sell the property, those with national retailers tend to command the lowest cap rates / highest prices.
Minimize Project Risk
Normally, when developing a retail center or other development with retail space, one of the major challenges is the time it can take for construction. Depending on the property type and local zoning requirements, construction time can mean that there can be months or years without any income. When developing a pad site for a retail building, there is no such concern because the inline tenants are paying rent, which can partially offset the development cost and reduce the risk of developing them.
Commercial real estate is valued on a metric called Net Operating Income, which is calculated as the property’s income less expenses. Whether developing, selling, or leasing pad sites, the net result is the same, increased Net Operating Income, which leads to increased property values and solid returns for our investors.
Diversity of Tenant Base
More businesses equals a more diverse tenant bases, which can provide a more pleasurable and convenient shopping experience for consumers. For example, if a property has just a grocery store, there is no issue, but it means consumers may have to go to multiple places for their errands. But, if a larger shopping center with more leasable square feet has a coffee shop, grocery store, bank branch, boutique fitness studio, and drug store, that same consumer may be able to accomplish all of their errands by going to just one place.
3 Pad Site Considerations
Sale, development, or lease of pad sites are a way to increase the profitability of a property, but there are a number of factors that must be considered before proceeding with the project.
1. Traffic Count, Visibility, and Accessibility
How many people will see the building? Is there a large enough demand in the area to support the business? Is the ingress/egress to the site easy and well marked? Will the pad sites have adequate parking?
2. Anchor Stores
Even though the pad sites are separate from the inline space, the anchor stores can impact the traffic through the shopping center. We like to consider the proximity of the pad sites to the anchor stores and whether their businesses are complementary.
3. Local Regulations
Additional local factors need to be evaluated, such as the municipal regulations affecting the construction of the standalone building as well as the architectural designs, height, and size needed to meet regulations.
If the economic and market factors make sense, we will choose to proceed with the pad site project in an effort to boost the overall profitability of the property.
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.
We review all of our acquisitions for pad site sale/lease/development potential and see this as a path to delivering strong returns to our investment partners. If you would like to learn more about our investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.