7 key retail property valuation considerations
As retail evolves and adapts to a new competitive landscape, so do the criteria used for assessing property values. Retailers face new pressure to refine, differentiate and Amazon-proof their business models, often by combining excitement, digital integration and a high level of service.
- Highest and best use
In some cases, a property may no longer be financially feasible to continue operating as a retail property. A growing number of landlords are realizing retail may not be their property's maximally productive use, according to RSM real estate valuation and advisory director Kenny Kim.
Symbolic of this shift is the repurposing of the 676,000-square-foot Lord & Taylor flagship store in Manhattan, New York into WeWork’s new global headquarters, with plans to convert all but the lower three levels to office. The co-working giant acquired the iconic property from Hudson’s Bay for $850,000.
- Tenant mix
Investors historically sought retail properties with traditional anchors like Macy’s and Nordstrom because they drew a strong consumer base, Kim said. There were 34 billion visits to U.S. stores in 2010, nearly twice as many as the 17.6 billion recorded in 2013.
Some forward-looking landlords are hoping to attract customers, refresh their malls and, in some cases, quadruple their rental income, by replacing these struggling department stores with a number of smaller, experiential shops.
“As investor demand shifts toward malls with more experiential tenants, such as movie theaters and food and beverage, real estate appraisers or investors need to have a fresh mindset in how the preferred tenant mix impacts value,” Kim said.
- Retail category
According to Kim, some property types, such as lifestyle centers, entertainment-centric malls and Class-A regional malls may continue to thrive, while big-box retail may transform into a combination of store and distribution or warehousing space.
“As the integration between online presence and retail stores evolve, so too will the retail physical spaces,” Kim said. “These changes may have a material impact on rent and expense levels that drive the valuations.”
- Co-tenancy and go-dark clauses
Kim said leases should be examined for co-tenancy and go-dark clauses, which can dramatically impact the rental income collected.
A major tenant’s departure can have a devastating effect on surrounding retailers’ foot traffic and sales. Co-tenancy clauses protect remaining retailers by lowering their rents in this instance. But because the stores’ sales may decline as a result of the overall property occupancy fluctuations, the rent paid to landlords as a percentage of store sales can also diminish, Kim said.
Depending on the overall health of the mall and its anticipated response to store closures, future cash flows may be significantly lower and difficult to estimate.
- Lease-up and downtime
Newly developed retail properties may take longer to lease up vacant space as the uncertain competitive climate inspires greater caution, according to Kim. Historical property data and assumptions may no longer be valid forecasting tools.
“Downtime and re-leasing assumptions of vacated space will require reconsideration,” Kim said.
- Tenant improvement allowances and capital expenditures
Landlords may need to allocate more money for tenant improvement allowances to incentivize new tenants.
As ambience becomes increasingly necessary to lure shoppers, additional capital expenditures may be required to update common areas and building exteriors, Kim said.
- Investment rates
The capitalization and discount rates are key assumption drivers of value in the discounted cash flow analysis.
“As e-commerce continues to challenge retail properties, many retail assets will be in a state of being nonstabilized, and the estimation of the capitalization and discount rates will require much greater consideration,” Kim said. “An appraiser or investor will need to evaluate the risk inherent in the cash flows projected, such as the net operating income growth over the analysis period, and properly reflect market and execution risk in the investment rates.”
This article, authored by Alec Berkman, was originally published Nov. 13, 2017 in Bisnow.
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