Multi-family and industrial product types may be the hottest in many markets, but Jeff Conover and Shaun Riley, managing directors of Irvine, Calif.-based Faris Lee Investments, believe retail has the most great opportunities for investors.
“It comes down to two things,” says Conover. “Higher yields and higher returns.”
Triple net leases also mean that expenses are passed on to the tenant. Speaking of tenants, Riley notes that tenant listings are stronger than ever these days. The pandemic has slaughtered the herd a bit, so to speak, but those players who have been able to persevere through retail’s toughest time have honed their operations.
What now fills the malls are the tenants who have come to play.
“Tenants who are in centers today are better long-term tenants,” Riley says. “They’ve done a good job of adapting to this new retail environment, and they’re urging investors to view properties more favorably now, because they can see tenants are stronger, listings are stronger and rent listings are stronger.”
Shop for benefits
These stronger tenants benefit retail owners and investors as a flight to quality is happening right now, Riley notes.
“A lot of tenants go up the food chain,” he says. “Maybe they wanted to be in a center for a long time but couldn’t manage the rent or couldn’t get in due to lack of space. Many take advantage of vacancies, which owners should not be afraid of.
“Vacation” has always been a bad word in commercial real estate…until now, argues Riley. This is because these empty spaces can accommodate the largest group of tenants looking to enter or expand in a market. He cites Dollar Store, among others, as a prime example of this.
“Dollar stores are grabbing vacancies in malls where they can come in and combine a few spaces together,” Riley says. “Chipotle, Panera, and even some of T-Mobile’s and AT&T’s biggest franchisees are expanding into sites they’ve wanted for a long time. Now those leases are being signed.
Vacancies also give investors the opportunity to increase cash flow as the property is stabilized. This is one of the benefits that a private investor who recently moved to Orange County, California was able to realize when he purchased La Paz Mall in Laguna Niguel, California for $14 million. dollars in March. The center was anchored by Walgreens but had a few vacant suites at the time of the sale.
Wild Fork Foods, a relatively new meat and seafood market that opened its first locations in South Florida, signed a long-term lease at the center and was under contract when the escrow ended.
The property generated several offers and closed at a high of 4.88%, less than 6% of the seller’s forecast. Faris Lee represented both the buyer and the seller, a private firm based in Newport Beach, Calif., in the transaction.
Stabilization can also occur, Riley also points out, if increases in the consumer price index (CPI) are factored into leases. With inflation being what it is today, these CPI increases can be hugely beneficial to homeowners, especially if they don’t have a cap.
“For store tenants that aren’t corporate names, these rent increases tend to be annual rent increases,” Riley adds. “If you don’t have a cap on where those KPIs go, the landlord is able to pass on cost of living increases to tenants. In this way, commercial real estate is an ideal hedge against inflation.
Invest with enthusiasm
CPI clauses can provide room for growth – an attractive feature for many investors who haven’t seen much trail in other types of products.
“When you look at core retail cap rates versus core industry, retail will be 75 basis points higher than industry,” Conover says. “There is a retail premium spread.”
Conover further notes that retail demand remains high. There are investors out of the industrial and multi-family markets, office investors who currently don’t see an opportunity in this sector, and hobbyist retail investors who have cash at hand. These investor pools are, of course, mixed with traditional commercial real estate investors.
“There has been an abundance of new investment post-pandemic,” says Conover. “In 2020, the money was on hold. Everyone was frozen. All of that pent-up demand has worked in 2021. Everyone walks away and the tokens are played. Investors are the full range of institutional, private, family office, REITs. There’s just a lack of investment and an abundance of capital chasing them right now.
Competition can be fierce, but Conover believes there’s a place for every type of investor in this market, including hobbyist retail investors.
“The mall with two to five tenants is probably where I would place a new investor,” he says. “It has a higher return potential, while the risk factor is not as high as in a larger center. In addition, you can manage two to five tenants very well. I would place a new investor in a tax free state like Florida, Texas, Arizona or Utah.
Riley agrees. He notes that while location can be important to all business investments, it has been and always will be the main pillar of retail.
“It’s the purest form of real estate based on location, location, location,” he says. “Have you found the right place? This is still the biggest question investors need to answer and feel comfortable with, despite all the changes in commercial real estate.
— By Nellie Day. This article is published as part of Shopping Center Business’ Retail Insight series. Click here to subscribe to the Retail Insight newsletter, a four-part newsletter series, followed by video interviews delivered to your inbox in May/June.