I Got More for My Money With Shopping Center Setups
When I first struck out on my own in the real estate game, I really had no intention of “getting involved” with shopping centers. The way I saw it, my bread would be buttered with standalone properties all the way.Young as I was – and with the mistakes I certainly made – I wasn’t stupid for thinking that way. Just a little short-sighted, I suppose. You see, the ‘80s and ‘90s were the heyday of corporate chain expansion. And my very first client, Advance Auto Parts (AAP), oftentimes preferred single-store setups. Blockbuster, another corporation I built for, was fine taking up space wherever enough people were. And the same went for Papa John’s (PZZA).On my end of the bargain, I only had to worry about one client at a time. It was easier to consult with one management team about one set of specifications, then go to work. And work, I did. During my heyday, I was getting about one new stand-alone shop up and running per month. It was good money, though, and I loved what I did. So I just kept signing deals and making them happen.My shopping center epiphany happened while researching a new site for Advance Auto, this time in Cullman, Alabama. Typically, my searches were simple enough – I’d look for the local Walmart (WMT) and purchase the nearest suitable plot of land.But Cullman was problematic. Cullman had apparently already seen an influx of developers with my same strategy. So there was nothing that fit my price range and land size requirement, which was about an acre.Frustrated, I expanded my search – only to find the perfect place. At least it looked perfect to me, even though it was double the acreage I was looking for and, therefore, undoubtedly more expensive.Going with my gut anyway, I sought out the owner, who, sure enough, quoted me a price that was way too steep for me to justify. Unless, I realized after some thinking, I didn’t just build a standalone store; I built an entire shopping center instead.I’d have to make some more phone calls to more management teams, that way it was true. Yet the more I thought about it, the more I realized how well it could work. The returns would more than make up for the original investment.
A 200 Basis-Point Difference Over Standalone Structures
Let me try to explain exactly how and why that Cullman opportunity worked out so well. Typically, when I signed a single-store development deal, I would build it with a 10% capitalization rate, then sell it for 8.5%.Cap rates, for those of you who don’t know, are calculated by dividing a property’s net operating income (NOI) – actual or expected – by its market value. The higher the cap rate, the greater the reward – and the risk, more often than not. The lower it is, the smaller the risk and reward potential.Though, in my case, with deals already etched with stable and growing companies, I was pretty much in the clear for any heightened risks. Which is precisely as I always planned.My usual 10% to 8.5% cap rate story, for the record, makes for a 150 basis-point profit. Which is a tidy sum. But if I switched from the single-store method to a shopping center focus? I could purchase a property and build on it for an expected 12% cap rate – then, still sell it at 8.5%. Which means my standard 150 basis-point profit would skyrocket to 350 – a number I was very happy to handle.The difference came from building a single parking lot for three stores instead of one – which, yes, would have to be bigger – yet the final cost would still work in my favor. Because I’d be hiring the same company for the same materials in the same spot, I’d get an ultimate discount compared to stringing out jobs between sites and dates.The same would apply to the land, which I wouldn’t actually need as much of, and the actual construction costs, since there would be shared walls and plumbing between them. In the end, that 200 basis point difference meant I could cut the number of buildings I contracted from 12 per year – to two.
Know Your Shopping Centers Inside and Out
So that’s the appeal of developing a shopping center. But I also know firsthand what it’s like to own them and rent them out. Because once I started building them, I liked them so much that I had to keep some for myself. There’s so much to appreciate about the setup.One of the biggest is this: If a free-standing tenant doesn’t renew a contract, that’s it. You’re out of money on that whole property – and you might not find it easy to find a new tenant, depending on what the original building was used for.I’ve explained this before, but some businesses require very specific construction specs that do not lend well to other industries.However, if a single tenant – especially a smaller one – vacates a shopping center, there are still other paychecks coming in. To varying degrees, this is true across all three of this subsector’s classifications:
Of course, no matter which one you choose to invest in – either through REITs or otherwise – you do need to be aware of who your anchor tenant is. And where the whole kit and caboodle is placed.The rules that applied back when I was running shopping centers are the same ones that apply today – even if the exact players have changed (Blockbuster, for instance, isn’t in the game anymore).I would typically find the dominant grocery store in that particular market. So if you’re investing in the Southeast, you’ll want a Publix. If you’re in Pennsylvania, Giant dominates. The West Coast is Safeway all the way. And so on. Other chains like Walmart or Home Depot can work just as well.The most money-making shopping centers are also located in high-traffic corridors or densely populated areas. And while people might drive further for a big-box store like the two just mentioned, you’d better make sure your grocery-store-anchored property is five minutes away from multiple neighborhoods.That’s something a former Kroger (KR) insider told me, and it’s completely true. It’s called the five-minute rule – an acknowledgment that ice cream starts to melt that quickly once it’s off the freezer shelf. So most people, regardless of whether they’re getting a sweet treat or not, will trend toward a grocery store that’s a five-minute drive when available.Keep all this in mind as you consider the shopping center REITs below. Look at their client list. Study where they operate out of. See how good they are about letting go of properties that even hint at underperforming.Then, if they’re trading on the cheap as so many REITs still are, see if one or more will fit into your portfolio. It wouldn’t surprise me if that’s exactly the case.
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