I recently saw an article about the huge hit that owners of strip malls have taken in the wake of the challenging economic circumstances some are currently facing.
The point of the article was to convey that vacancies in strip malls have spiked to levels not seen in over a decade. This is apparently related to the current consumer preference for large warehouse-style stores (such as Sam’s Club, Costco, etc) versus conventional drug stores and grocery stores, which are usually the anchor stores for strip malls.
Before I go farther, please allow me to state unequivocally: I am not an expert in commercial real estate. The opinion I express in this post may be entirely wrong, but I do have a strong level of confidence in the general approach I’m going to share with you.
In general, it’s my experience that news coverage of the negative results in a particular industry or industry segment suggests that buying opportunities are coming. I suspect this is true for strip shopping malls.
However, I do not know enough about this market to say that the time to buy has arrived. (I do believe the time to buy has arrived in residential real estate for most markets in the U.S., but I have little commercial property experience.) In fact, my theory is this:
Generally speaking, media coverage of negative financial circumstances in a particular industry tells me it’s time to begin researching that market for buying opportunities. If I was interested in strip shopping malls, now is the time I’d start to research the history of these types of properties and begin to formulate a strategy for entering the market.
Let me know what you think! Also – if you are more experienced in commercial real estate than I (if you have any experience, you have more than me!), please let us know what you see happening “on the streets”.
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I think apartments are a better bet then strip malls
There high prices look like they are going to bee around for quite a length of time
Jere – thanks for your comments! I know nearly nothing about commercial investments, so understand that this question is from the vantage point of a “newbie”. But my understanding is that the rental market has gotten a pretty good boost from the housing crunch, as more people are foreclosed and enter the rental market. Wouldn’t this lead to higher prices in the current market for apartment buildings? Thanks! — Bryan Ellis
Residential houses, condos, small multifamily (less than 5 units), and townhomes are valued by “comparable sales”, which is what similar buildings in the near vicinity have recently sold. Apartment buildings greater than 4 units are not valued by “comparable sales”. Instead, they are valued by Net Operating Income (NOI), Capitalization Rate (CAP Rate), and Cash On Cash Return (also called Return On Equity (ROE)). The NOI is gross income minus recurring expenses (other than debt service). The Cap Rate is the NOI divided by the property price. As rents go up (and hopefully expenses stay the same), the NOI increases and thus the valuation increases according to the CAP Rate. For example, if the NOI is $25,000 and the current market CAP Rate is 10%, then the property price (valuation) is $25K/10% = $250,000. The property price varies inversely to the CAP Rate. Higher CAP Rate means lower property price and vice versa. The ROE is the net cash flow (before income taxes or depreciation allowance) divided by the equity invested (down payment). The net cash flow is the NOI minus the debt service (mortgage payments). All cash flows (income, expenses, debt service, etc.) are expressed in annual amounts. If you pay all cash for an income property, then your ROE equals the CAP Rate (because there’s no debt on the property). The Debt Service Coverage Ratio (DSCR) is the NOI divided by the debt service, which is what most commercial lenders look at when evaluating a loan request for income property. Most savvy investors set their criteria for a minimum CAP Rate and a minimum ROE, and then negotiate for higher returns. Thus, they get better returns during good rental markets and they can lower rents when the rental market turns downward and still earn their required minimum returns. Smart investors look at the future trends, not just what’s happening today.
Strip malls, retail buildings, office buildings, warehouses, etc. are another kind of commercial property that is also valued by CAP Rate and Return On Equity (ROE). However, the occupant is a business, rather than a consumer resident. Therefore, commercial leases are very different from consumer residential leases. In particular, most commercial leases are long term “triple net” or “absolute net” that require the tenant to pay recurring expenses, taxes, insurance, maintenance. The “absolute net” lease is of particular interest to an owner of a “single occupant” commercial building, like a fast food franchise or big name retailer. The “absolute net” lease requires the tenant to pay everything that a “triple net” lease tenant pays, plus the tenant also pays capital costs, like roof replacements and the structure itself. The owner receives a “net check” from the tenant, and the owner has no costs whatsoever, other than debt service (if any). The cost for commercial space is much more expensive than the equivalent square footage of a residential house or apartment unit. The tenant must have a viable income stream from the business to pay the lease and pay the building expenses. If customers switch to other competition, then the tenant has a serious problem.
Funny I read this; there was an article in my daily paper yesterday about how our indoor malls are “working to stay afloat” by the headline. 2 of them are up for sale and have been for some time…another and I’m sure others have the majority of their tenants on a month-to-month/special lease deal.
Part of this I’m sure was the very rapid expansion of some companies and/or getting special deals done on leases to get them into a particular space…once the wall got hit, now you see all these store closings being announced (i.e. Starbucks for one).
Another smaller strip mall in my hometown has been vacant for years and nobody ever bit (or it probably was never marketed much either). Last year the town finally gave tax incentives for a couple of developers to work on it. They then finally get a store in there in Steve & Barry’s as a solid retail “anchor” a couple months ago, only now S&B just announced last week that they are looking to shutter many of their stores and could ultimately go until Chapter 11/liquidation if enough emergency capital isn’t raised…
My point exactly – when there’s “blood in the streets” is generally a good time to think about getting into a market. But let me reiterate – I’m no expert in commercial real estate. In fact, I don’t have even basic knowledge about that business. But I do know that in capitalism, when there’s serious fear, uncertainty and doubt in a market, that’s the time to keep your eyes open! — Bryan Ellis
Thanks for the article. If you believe in coincidences I was looking at a strip mall that has been mostly vacant for years. Many small stores have come and gone and it is only 25% occupied. A thought I had was turning it into an apartment complex, it definately has the parking area and utilities are on the property….just a thought but would be interested in anyone else’s thoughts on this as I have as little commercial training as you.
You better check the zoning first. It likely will require rezoning. Also, the conversion will likely be a huge axpense that might eat up any profit for quite some time.