8 METRICS TO HELP YOU CHOOSE THE RIGHT RETAIL INVESTMENT FOR YOUR PORTFOLIO
Many investors are squarely focused on the "Big Six" markets -- the New York metro area; the Washington, D.C.-Baltimore corridor; Boston; San Francisco; Chicago; and Los Angeles. But we also see a great deal of opportunity and value in many other strong markets around the country, in addition to the Big Six. Kimco invests primarily in 31 MSAs around the U.S.
One of those alternative MSAs is Denver, which I wrote about in our first Market Profile post. (We're working on a post about Orlando next, so be on the lookout for that installment.) Retail investments in these MSAs can offer excellent returns because they typically have lower pricing than those in the Big Six, and investors face less competition from foreign and many institutional investors.
However, that's just one reason why we've invested in these areas. When we seek properties to acquire, we also weigh the asset according to several metrics to determine whether it will yield a worthwhile return for our investors and Kimco, and fit well within our portfolio. Here are eight of those factors, which can help any investor chose the right retail investment to add to his or her portfolio:
1. Property demographics. Look at the demographics within a three-to-five-mile radius of the property. This includes metrics such as population, population density, household income, and spending power. Larger populations and higher incomes are strong indicators of greater purchasing power, which is what retailers are seeking. When considering an investment, some elements of these statistics should be on par with or slightly higher than your portfolio averages in order to strengthen the overall value of your portfolio.
2. Unemployment rates. Know the local and surrounding unemployment rates for the property's area. This is an obvious indicator of consumer spending power and disposable income. Look for properties in areas with unemployment rates lower than the national unemployment rate.
3. Current retailer performance. Analyze and evaluate each retailer's success at the property: What are their sales per square foot? What is the retailer's health ratio? The health ratio is the relationship between a retailer's sales and total occupancy costs (TOC), including rent. This will vary by industry, but you can bet that if an above average percentage of a retailer's revenue goes towards paying rent, they might have problems in the future.
4. Future retailer performance. Consider each retailer's predicted performance in the next 10-15 years. Is the retailer's business under attack by the Internet? For example, if you are buying a property with a book store, try to understand the long-term viability of its retail strategy and set your expectations accordingly. You might need to assume it will reduce its store size and rent based on its new business model.
5. Retailers' in-place rents. This also helps you predict your ROI. Compare a retailer's in-place rent to what you predict the average market rent will be if you got a particular space back in the future. For instance, say a retailer's rent is $10 per square foot. However, it plans to downsize, and its lease expires in three years. We might predict that rent per square foot for this space will roll down to $7. We build this into our financial model when we predict our ROI. If we were blind to the issue and assumed rent would grow with inflation, we might predict rent to be $11 in three years. We'd miss our projections and get a much lower return than expected. This would naturally signal a property to avoid. On the flip side, we focus on buying properties with below market rents. For example, we own a site on Staten Island where Kmart had a gross rent of $315,000 per annum -- well below market. We are leasing the space to Target at a net rent of $2 million per annum, resulting in a tremendous increase in our ROI.
6. Mortgage on the property. Does the property have a mortgage on it? If so, consider how difficult it will be to assume the debt by determining if it's a high loan for the property's value. For instance, say the property was bought in 2007 for $100 million and financed with an $80 million loan. Since prices have dropped, the property is worth $80 million today, and the mortgage is just under $80 million due to amortization. So the property is highly leveraged. In these situations, some lenders require you pay down some of the principle balance, set up reserves, pay assumption fees, put up a guarantee, etc. Determine if you're willing to take on this property under these conditions. Consider if you can pay down the mortgage or re-tenant the property to increase its value. If the property doesn't have a mortgage, you have a more straight-forward decision -- buy it without any debt or finance it.
7. Up-and-coming industries. Look for new industries, organizations, and technologies cropping up in the area that are generating jobs. For example, Houston is becoming a technology hub, leading the nation last year with a 149 percent increase in technology job growth. Charlotte has bolstered its energy industry, adding 6,000 energy jobs since 2007. Other new and growing industries will attract jobs and spur relocations, bringing more shoppers to the area.
8. Deferred capital improvements. It is very common to overlook the capital investment required to maintain a high-quality shopping center. This can be a costly mistake, and can damage your long-term investment performance. Typically, the most costly items are roof repairs or replacements, and parking lot repairs. Capital costs can run into the hundreds of thousands of dollars, and might not be recoverable from tenants. Be sure to have an engineer give you a thorough property condition assessment and carefully read the leases to see if the landlord might recover some of the capital costs.
We encourage you to evaluate your next potential acquisition against these criteria to determine if a property is well-positioned to add value to your portfolio and generate excellent returns. Tell me what I've missed -- are there any other factors you make sure to consider when acquiring a new property? Let us know in the comments.
- CATEGORY: General
- DATE: Wednesday, February 22, 2012