Achieving success when investing in retail assets is challenging, especially when you are pursuing value-add opportunities. More often than not, investors are in a mad dash to fill vacancy, often forgetting to properly align new tenants correctly to ensure success in the given market.
Creating the right tenant roster is like creating a go to recipe. The different characteristics of your tenants have to blend evenly in order to generate the correct result. So before you go through the process of preparing a vacant space for leasing, ask these three questions.
Does This Tenant Fit Within the Market Demographics?
At all times your rent roll needs to be in tune with the needs of your market. Accomplishing this requires heavy due diligence when researching items including population, average household income, ethnicity ratios, average consumer spending trends, etc. Although this data may seem like needlessly useless collections of quarterly figures, it can actually be used to determine whether a certain tenant will thrive in a particular market.
As an example, if a market has a median household income below the current national average of $59,039, it would not be a good idea to bring in a high-end retail tenant. Why? High-end retail requires a large portion of individuals with a higher percentage of expendable income. If the majority are below the national average, expendable income is most likely lacking in the market.
By taking the time to know your demographics, you will be able to pinpoint a tenant that not only pays an attractive monthly rent, but one that will thrive and continue to renew its lease.
Does The Presence of The New Tenant Negatively Affect One of Your Current Tenants?
Tenant exclusivity is so important that many tenants will require the terms of exclusivity be “baked” into the lease. This is meant to properly outline the types of tenants your current tenants will allow the landlord to populate a neighboring space with.
The exclusivity clauses are a way to ensure that the business of one tenant is not impacted negatively by another. As an example, if you were to fill a retail center with four pizza parlors, there would be obvious competition between the four tenants as they each sell a similar product. Eventually this will cause one tenant’s business to decline which could eventually lead to vacancy.
Although exclusivity clauses are important in establishing security for your current tenants, it is important to remember that the exclusivity clause should not bind the landlord from brining in non-direct competitors.
As with the example of the pizza parlor, having four retailers selling the same product at the same location would impact the tenants negatively. However, if the tenant roster were made up of a pizza parlor, coffee shop, sandwich shop, and ice cream parlor the four tenants would not be in direct competition with each other.
Creating the correct balance of exclusivity for both the tenant and the landlord is often achieved by dictating that new tenants cannot derive a certain percentage of their core business through the sale of a similar product which makes up the current tenants core business.
Will This New Tenant Bring In Additional Foot Traffic?
The most successful retail centers generate the image that they are a destinations for distinctive experiences which different stores, restaurants, and entertainment centers offer. This balance of different attractions creates consistent foot traffic throughout the day and work as a benefit to the entire tenant roster.
The best way to create a natural flow of foot traffic is to choose tenants with varied peak hours of operation that support other businesses in the center as well.
As an example, if you were to bring on a gym as one of your anchor tenants, the gym would have different sets of peak hours. There would be the early morning rush, the afternoon rush, and the evening rush. With these three different sets of peak hours, the gym tenant would create a steady flow of consumers which will work as a benefit for the co-tenant which rely on the foot traffic to drive sales.
On the opposite side of the spectrum, a bar would normally experience peak hours only during mid to late evening which may do very little to expand foot traffic for other tenants with hours of operation outside of these peak hours.
By asking yourself these questions, you are evaluating whether a potential tenant will add value, not just for the rent roll but for the market overall.
These three aspects, or ingredients to the retail recipe, are the primary focus of the Value-Add approach for investing in commercial real estate. By selecting quality tenants with long term leases you will be able to build equity in a commercial asset that can be used to achieve your personal financial goals.