The internet has permanently transformed the landscape of the retail industry, and investing in retail commercial real estate assets will never be the same. But despite the headlines you might be reading, it’s not all doom and gloom. In fact, capitalization rates for all retail properties in the U.S. dropped from 8% in 2010 to 6.5% in Q1 2017 — lower than rates during the 2006–2008 boom.
While technology will continue to influence consumers’ attitudes and expectations of how they experience retail, one opportunity that will persist for investors seeking steady ROI is the neighborhood shopping center.
Neighborhood shopping centers often include a combination of national credit tenants (NCT) — retail brands that operate on a national level — and local credit tenants (LCT). There is a perception that NCT are more dependable than LCT and yet it’s not hard to find examples such as Blockbuster, Best Buy and Radio Shack that are struggling due to advances in technology and e-commerce.
With the recent closures of several NCT across the country, many investors are looking for shopping center assets with the right tenant mix of both name-brand and local operators.
UNDERSTANDING THE ROLES OF NCT AND LCT IN A SHOPPING CENTER
Neighborhood shopping centers find that strong LCT can prove to be as dependable as NCT due to their customer loyalty, unique services and neighborhood convenience. Often, LCT can offset drops in retail center occupancy when mixed with NCT. This is because an NCT’s decision to close certain locations is typically dictated by analytics derived from the highest-performing locations across hundreds of national stores.
By comparison, LCT typically own their businesses and their livelihoods depend on their success and the relationships they build with customers in the communities they serve. A shopping center with a healthy number of local tenants with steady customer bases can be less dependent on national tenants to drive business.
One interesting example of the appeal of LCT is Warren Buffett’s recent purchase of a 9.8% stake in Store Capital Corp., a single-tenant REIT that primarily leases to mom-and-pop stores. This REIT tends to invest in retailers deemed “internet resistant” or businesses that offer a service, experience or goods that are not found or easily recreated on the internet. When you think of “experience-based business” you might think of entertainment-focused concepts like Pinstack Bowl or TopGolf, but this category can also include nail salons, hair salons, health and wellness businesses, restaurants, dry cleaners, fitness centers and medical offices.
STRIKING THE OPTIMAL BALANCE
Every shopping center has a unique story, and the ability to craft and present each story is the best way to evaluate tenants, assess their impact on the surrounding community and ultimately decide on the value of each asset.
For the income-oriented investor, well-located neighborhood retail shopping centers that have approximately 25,000–150,000 square feet of LCT can be an effective hedge against the risks of NCT closures and can offer attractive yields with comparable income durability to other retail investments like power centers and malls.
While there is no guarantee of longevity with any tenant, incorporating the right mix of national tenants and established local businesses with strong track records can give an investor a feeling of confidence when making retail acquisitions.
As a Vice President of Retail Services in Dallas-Fort Worth, Brian Cyphers works with commercial real estate investors throughout the state of Texas.