Buying retail shopping centers for investment is a great way to invest. Shopping centers anchored by a grocery store is an even better deal. Why? Well, everyone has to eat at some point and, when they do, they go to the grocery store to buy milk, bread, eggs, whatever. That provides an incredibly consistent stream of prospects for other nearby tenants.
Buying a strip center or shopping center with five or more tenants is much better than buying one with only two tenants. If one leaves you have a big hole in the rent.
Buying a shopping center with five equal sized tenant and one tenant taking up 30% to 40% of the space is riskier than buying a center with 7 roughly equal-sized tenants. The only case where this makes sense is if the large tenant is a very strong anchor like a grocery store or a big national chain with a nice long corporate lease.
Anyway, let’s say that you want to buy a shopping center in the Houston area that has:
– some vacancy
– some deferred maintenance
– an old, outdated look
You want to analyze the deal to see what kind of return you should expect. Now, we know that “cap rate” is simply a “snapshot” of the potential return on the day you purchase the shopping center. So, what about figuring out the return for the remaining holding period? How do you take into account the cost of upgrades, the slowly improving occupancy, the improved rental income due to rental increases?
You need obviously to review all of those items and project an exit price as well, maybe 5 years down the road… this analysis will give you an “Internal Rate of Return” for the project. With interest rates as low as they are right now, it’s a great time to invest. I’ve heard of “back-to-back” loans of as low as 2.5%! So, if you can purchase a shopping center with a cap rate of around 8.5% with 50% cash and 50% financing at 2.5% you are making a spread of at least 6% on the borrowed money!
On projects with upside potential, even when using very conservative estimates, it’s not uncommon to see projected IRR returns of at least 18%.
Another thing, shopping centers are usually pretty big deals and require some serious money… so, maybe you want to partner up or get some investors to join you? How do you put the deal together? How do you project returns for your investors?
We have the solution… I’ve produced a spreadsheet that allows me to “plug in” the various inputs for the project as follows:
This one sheet, when properly filled in with conservative estimates (even covering rent expectations & occupancy during the term), provides a very detailed analysis for a project that could be used to: 1) obtain investor partners 2) provide accurate projections for a bank providing financing 3) give you an accurate idea of what you should expect from the investment.
The final piece of the software calculates the projected IRR:
As can be seen in the above projection, the principals in the deal are projecting a very attractive return. Passive investors are also projected to earn a very good 21% return. They might wonder why they are not getting a higher return (i.e. like the principals)… well, the principals invest a much smaller percentage usually into a project, their additional return comes from their “sweat equity” in finding the right deal, managing it and “making it happen”. In addition the principals are almost always on the hook personally to guarantee the financing. That could run into millions of dollars. So, they are taking on big risks.
So, there is not much wrong with being a passive investor… you don’t have to do any of the work and you can get a very reasonable reward.
If you are interested in investing in retail shopping centers or strip centers (as an individual or as part of a group), please get in touch. We can help you analyze the deal.
Lance Langenhoven, CCIM.
Remember, work with a professional!