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Retail Outlets
The valuation of retail properties offers an
analyst a myriad of choices. Anyone who has appraised a mall or a community
shopping center can tell you of the numerous projections required for market
rents, tenant fit out allowances, absorption of vacant space, downtime
between leases, free rent periods, renewal probability, commission and
marketing expenses, reimbursed expenses, and more. Appraisers model the
behavior of buyers and sellers. So the question arises: do the buyers of
retail outlets themselves employ only complex analyses to sort through
the market of properties offered for sale? Or, as part of buyers' process
of shopping the market, do simple methods also come into play?
Buyers initially review the location, access, and design features of
a center. Competition is measured by the center's size, image, vacancies,
tenant mix, and market rents. Preceding a review of market supply, demand
and/or basic demographics such as median household income and population
within a five and ten mile radius is understood.
In major retail properties, such as community shopping centers, anchors
represent the key to understanding value. Anchors can make up a significant
portion of the gross income and are the bellwether for rental income for
the infill tenants. First and foremost, a buyer will review the economics
and length of the anchor's lease. Second, buyers scrutinize the anchor's
credit, market position, and competition within the submarket. After anchor
leases are understood, a potential buyer is afforded the necessary insight
into the remaining economics of a shopping center's cash flow.
Existing occupancies and the quality of the tenant mix allow an understanding
of vacancy and bad debt factors. Expenses should be readily supported with
market data that presents a tight range. Reserve for replacement allowances,
specifically for roofs, parking lots, and HVAC systems, need to be carefully
quantified. In direct capitalization, the treatment of reserves, tenant
improvement costs, and leasing commissions can be either included or excluded
from the net operating income. (Whether they are will impact estimated
value; the client should be aware of these methodological variances.)
After expenses are deducted from the effective gross income, the net
operating income is derived. A buyer then proceeds to estimate value by
a capitalization factor. Capitalization rates depend on a host of criteria,
which include a buyer's investment objective, the cost of money, potential
income growth, and the overall market demand for comparable retail properties.
The final determinant of a capitalization rate then becomes a synthesis
of all the variables and assumptions that led up to the net operating income.
The needle "goes back to zero."
Information of this kind forms the background for a buyer's evaluation.
For any particular property, a simple method is available. Leases for retail
properties are typically written on a "net" basis, with the tenants
paying the cost of operating expenses and the building owner paying little.
By the "net" nature of these leases, the work of stripping rent
to a cash flow to the owner is largely completed. With rough adjustments,
the cash flow may be capitalized for a snapshot of value.
For example, assume a 170,000 square foot community shopping center,
in an average location, anchored by a 70,000 square foot supermarket. Rental
income under net leases averages $9.40 per foot. Fifteen percent is lost
because of vacancies, operating costs for the vacant space, bad debt, brokerage,
and reserves. Net income is thus $8.00 per foot. Capitalized at 9.5%, the
value is $84 per foot (and $14,300,000 for the property), which falls comfortably
into the range of prices that community shopping centers in Massachusetts
have recently commanded.
All properties are unique. For valuation, their uniqueness demands individualized
attention. Moreso than for offices or industrial properties, retail outlets
are heavily influenced by national trends. Principals in the retail market
nationwide make use of increasingly complex analyses. Yet simple methods
remain useful to buyers faced with an array of properties to shop among
and a need to efficiently narrow the field.
Daniel Clifford, MAI, Principal, Clifford Associates
The Reenstierna Associates Report is published as a service to the clients
of Eric Reenstierna Associates and other real estate professionals. The
views expressed are those of the articles' authors and do not necessarily
reflect those of other members of the organization. Copyright 1996. All
rights reserved.
Eric Reenstierna Associates
24 Thorndike Street
Cambridge, Massachusetts 02141
(617) 577-0096
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