The Case for Investing in Service-Oriented Retail Real Estate

Updated on August 11, 2020

Like other industries, the rise of the internet has had a substantial impact on nearly all aspects of the Commercial Real Estate (CRE) business. Driven by the proliferation of internet-based retailers, like Amazon, offering low prices and the convenience of home delivery, the impact has been particularly profound for retail real estate properties and their tenants whose businesses have been shuttered by the thousands.

In response to the changes, retail assets have been punished by the market with higher cap rates and retail landlords have been forced to rethink their tenant strategy to minimize vacancy and provide an offering commensurate with current trends. What is the answer for real estate investors? For this asset class, we believe it is retailers that sell services, not products.

Retail Centers – Defined

A Service-Based Retail Center is a neighborhood or community retail shopping center or strip mall, often anchored by a grocery store or drugstore, whose tenants are service-based businesses like medical offices, fitness boutiques, barbers, and quick-service restaurants. In the internet age, service-oriented retail businesses have proven to be remarkably resistant to e-commerce driven change and the retail centers that contain them tend to maintain higher occupancy rates and lower turnover than their product based peers.

The Case for Service-Oriented Retail Investments

Despite the general retail headwinds, we believe that well placed, and thoughtfully curated, service-based retail centers present an attractive investment opportunity based on the premise that a medical checkup, personal training session, or haircut can’t be “experienced” online. They require that a person be physically present and we think that the businesses that offer these services will continue to thrive for the tenants as well as investors and property owners as we find ourselves in an increasingly digital world. We know that foot traffic will fill the square feet in our investments if we fill it with service-oriented retail tenants.

This investment thesis is further supported by the following:

  1. “Guilt by Association:” While it’s undeniable that e-commerce has exacted a significant toll on local retail businesses, the impact hasn’t been felt equally. Shopping malls with department store anchors have had a hard time in recent years. We believe that destination or service-oriented retail assets have been deemed “guilty by association” with the broader retail space category and that their higher cap rates represent a value play for long term investors.
  2. Stability of National Tenants: We think that Credit Tenant anchored retail centers with complementary service-oriented retailers are particularly attractive. When it’s time to sell the commercial property, we think they’ll command higher valuations, lower cap rates, and will be attractive to institutional investors. 
  3. Long Term Leases: Because retail leases often carry longer terms than their office or multifamily counterparts, retail shopping centers are less prone to the disruptions caused by vacancy and tenant turnover. For retail centers with financially sound tenants, the leases create long term, stable streams of income. 
  4. NNN Leases: A triple net lease (NNN) means that the tenant is responsible for the rent and the operating expenses associated with the property. They’re common with many service-oriented retailers and we think that their limited maintenance requirements generate portfolio efficiencies. In addition, service-oriented centers with NNN leases tend to be more marketable than those without.
  5. Management Efficiency: In our decades of commercial real estate experience, we’ve found that there’s an efficiency in managing retail shopping centers that make scaling a portfolio easier. Purchasing multiple centers can provide economies of scale, creating a profitable opportunity to build a portfolio of service-based retail centers.

Combined, these factors drive our retail acquisition strategy, which is to pursue value-add shopping centers whose tenants are either service-oriented or experiential retail businesses.

Risk Considerations

Although we believe that the service-oriented retail opportunity is substantial, it’s not without risk. Consumers have notoriously fickle tastes that can dramatically change the retail landscape in a short period of time. In addition, there are other risks that must be carefully considered including:

  •  Location: For retail investments, location is perhaps the most critical aspect of the purchase. However, locations can change and the long term success of a  retail property is directly affected by the characteristics of the surrounding neighborhood, which can change significantly over time. It’s important to invest in communities with a track record of stability.
  • Trends and Fads: More than other industries, the retail business is particularly susceptible to short-lived trends and fads. As such, it’s important to purchase properties with tenants who have a track record of longevity and stability.
  • Holding Period: For a profitable exit, a retail investment requires a lengthy holding period, often 10 years of more. But, a lot can change in 10 years and the success of the investment can be negatively impacted by broader macroeconomic trends over the holding period.

To mitigate these risks, we rely on our decades of expertise in finding, selecting, and managing retail assets through all phases of the economic cycle.

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 service-oriented retail 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. Whether you’re just getting started or searching for ways to diversify your portfolio, we’re here to help. If you’d like to learn more about our retail investment opportunities, contact us at (800) 605-4966 or send us an email at info@fnrpusa.com for more information.

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