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

Updated on July 15, 2020

Buying a retail shopping center has the potential to be a very profitable transaction.  If done correctly, it can deliver a stable stream of rental income and steady capital appreciation resulting in a substantial return for the owner upon exit.  However, buying a shopping center isn’t nearly as easy as picking up a few things at one of the stores within it.  It’s a big purchase that requires considerable thought, resources, operational expertise, and due diligence.

Defining Characteristics of a Shopping Center

In the world of commercial real estate, a retail shopping center is 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 store 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 drive the current and future value of the property.

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:

Characteristic Method of Evaluation
Neighborhood Safety Sub-Market Crime Statistics
Car Traffic Traffic Count – Should be > 50K cars daily
Foot Traffic If the neighborhood is walkable – pedestrian count
Parking ~10 spaces per 1,000 SF of retail floor area
Convenience Ingress/Egress, signaled intersection, proximity to highways
Neighborhood Demographics Do they match the tenant base?
Competition Do they have nearby competition?

Retail Center Type

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:

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

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.

Limited Purpose:  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.

Quality & Age

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 flip side, 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.

Tenant Base

It’s important to consider the existing tenant base within the context of the demographics of the surrounding location.  For example, a luxury shopping center 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 center and a series of supporting tenants whose products complement those of the anchor.  To ensure that they can pay the rent, careful analysis must be performed on their financial statements.

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 it’s 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 property with a low cap rate likely has strong tenants, a good location, and profitable operations, but it’s 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.

For investors sold on the idea of a shopping center investment and bullish on the prospect for high returns, there’s two ways to make a purchase, each with their benefits and weaknesses.

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 and operational expertise.  It’s not for everyone and likely out of reach for most individual investors.  Luckily, there’s a second option.

Indirect Purchase

Investors lacking the financial resources and operational expertise to purchase and manage a shopping center can gain exposure to them indirectly by partnering with a private equity real estate firm.  Doing so offers 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 assets that wouldn’t otherwise be available to them.

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 broker relationships to land deals that aren’t normally possible for an individual investor.

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, including shopping centers, 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’re an individual investor considering an investment in a retail shopping center, it’s essential to work with a team that can guide your investment decision and we’d like to be the team to do it.  To learn more about our investment philosophy and shopping center opportunities, please contact us at (800) 605-4966 or info@fnrpusa.com.

[1] Private Real Estate investments require that an investor be accredited.  Accreditation requirements are outlined in Rule 504 of Regulation D

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