What kinds of tenants are leasing retail space today? What are the top 5 things you should keep in mind when negotiating retail leases? Drew Kristol from Marcus & Millichap Olson Kristol Group shares his insights
Tell us a little bit about you.
I grew up in Westchester just outside New York City, but have been living in South Florida in Miami Beach for over 20 years. I've been in real estate my entire life. My family started a real estate company, when I finished college, I went straight into office leasing brokerage in Manhattan, after graduating from Emory University in Atlanta. I represented tenants and negotiated office leases, which was very difficult, and I was probably too young to be doing it. It was a good opportunity for someone looking to learn about the real estate world. I decided to move to South Florida in the late 90s. I went to law school at the University of Miami, got a law degree, only to decide not to become a lawyer and go back into real estate brokerage in 2005. I've been working at Marcus and Millichap, one of the largest commercial real estate brokerage companies in the country for 17 years, focusing on multi tenant shopping centers. Since 2005, my partner Kirk Olson and I formed a team, selling near 400 properties at around 1.5 billion worth of value. We represent the institutional division of our company for the state of Florida and sell anything from $2 million strip centers to $50 million grocery anchored centers. It's been a wild ride, we've seen some ups and downs and things are changing even today.
What is the state of retail right now, and what kinds of tenants are leasing a space?
In Florida retail we're experiencing what we call a post COVID bounce. Florida came back very quickly after COVID, we have a government that is very pro business and has done as much as they can to try to encourage people to get outside and shop. There has been a lot of business occurring in Florida, whereas some other states have been locked down and not encouraging the amount of outdoor experiential shopping. Marcus and Millichap had its all time greatest year in 2021, with $90 billion worth of sales. Our previous high was $45 billion, which is unbelievable and we're actually ahead of the sales this year compared with the previous year. Most of my colleagues are having career years the last year and this year. I think the main reason is that there has been a lot of real pent up demand in the retail market, and we are seeing returns that are a lot better than other product types. What do we mean by product type? Multifamily, industrial, office, retail land, those are really the major product types.
Multifamily has gone off the charts, especially in Florida where a cap rate, or the return has been crunched down to three or 4%. Return on a cash investment is so low that people are looking for any other type of yield. It has driven a lot of investors out of both multifamily and industrial across the country and to retail. If someone can get anywhere from a 5.5 to 7% return on investment before leverage, they are ecstatic. They are looking at retail as an investment that maybe they wouldn't have made before. Whereas the retail market was already hot in Florida, because of the density and the amount of people that are constantly moving into Florida, we've always had what we call a net positive migration. When COVID hit, it really increased the amount of migration to Florida, so our density numbers have gotten even more compounded. What happens when you have too many people and not enough retail? Rent escalates. There's not as much vacancy. It's a very healthy retail market, Florida has notoriously been under retailed, that's why there's there's so much interest in Florida retail because more and more people keep moving here. There's more demand to shop, to drive around, density and they're building apartments. The other major reason why there's been so much activity is that rates have peaked. For example, 8 months ago people were going to commercial banks and getting recourse or personal guarantee loans as low as 3%, and in some cases interest only loans. That allowed people to really invest and even pay in the low to mid 5% range cap rate and still have positive leverage, which means they can borrow at an interest rate that was still lower than the cap rate. Even down in the fives for a cap rate they could borrow at 3%. What we've seen is that has changed in a big way, interest rates are back up to the low to mid fives, and it has pushed values down as people cannot buy a low cap rate deal as easily.
We're still seeing tons of activity, we were just marketing a shopping center in Plantation, which is a very nice affluent location in Broward County. It's a grocery anchor deal with a grocer called Aldi, a big national grocer, with great credit. That shopping center, if it was a year ago would have traded at around a 5.25-5.5% return on a cash investment. We did a call for offers last week and generated 12 offers. The best buyer, which was a Latin American group, is buying the deal at a shade over a 6% return. So you can get a sense for the shift. The demand is there, and there's a shift in value right now.
Can you share what the difference is in terms of millions, or hundreds of thousands?
I would say the difference in a 50 basis points is probably the difference between 17 or 18 million and 20 million. It's significant, as a real estate owner, as a seller, these are the conversations we have with our clients, Do you hold out? Or if you really missed the boat, and we know rates are going to continue to go up, are you prepared to hold for another five to seven years? Aside from a few blips, including COVID, we've been on an upward trajectory in values and compression of cap rates since 2010. It's been a really long ride, mainly bolstered by interest rates being really low, but it's all going the other way and had to eventually.
Who is leasing space nowadays?
Some interesting new trends that we're seeing is the grocers are still doing very well. COVID sped up the internet race to take over brick and mortar retail. About five or seven percent of retail sales were on the internet, and there were projections that they were going to eat up the amount of people that would actually go to stores, affecting brick and mortar retail sales. When COVID hit my mom and dad, who are both about 80 and 85 years old, all of a sudden had to learn how to get groceries online, out of necessity. They learnt how to use Amazon Fresh and order food, they started buying things online that they never knew before. Across the country it has created sectors where older people who may have never learned were forced to learn. There are more service related tenants backfilling spaces than there are tenants that are now getting eaten up by the internet. Medical is a big one, there's a lot more leasing. For example we have Humana, and also Baptist. They are big hospital chains that are opening up local urgent care and offices in shopping centers. Medical is pretty popular, and a lot of a lot of urgent care is happening right now and taking up the space that used to be taken by shoe stores and clothing, for example. People are ordering online, and they can return it for free.
Beyond that, we're seeing a lot more restaurants that are doing very well right now. Coming out of COVID people are really dying to shop, eat, and get out of the house after a year and a half of being stuck at home. There are a lot more restaurants that we would call experiential, larger box tenants where they're trying to eat up some other big boxes that are not there anymore. Trampoline parks are starting to pop up in a lot of areas. There's a national company called Goldfish, these are children's aquatic centers where children go and learn swimming indoors. It's a very high credit tenant, they will eat up about 15,000 square feet. They're doing very well, because the kids are swimming indoors, even in bad weather. These type of things drive a lot of parents to the shopping center. When they're waiting for their kid to get out, what are they doing? They're shopping with all the other tenants in the center. There are grocers that are expanding, no matter how many grocers there are, there's always more expanding. I have multiple clients that are developing Amazon Fresh, they are popping up all over Florida, there will be many more that are going to compete directly with Publix supermarkets, which is the big kahuna in Florida, and in the southeast, along with other middle grade shopping centers, not as much the Whole Foods market. Those are some of the tenants that have been doing a lot of leasing lately.
I find it fascinating that a state that is so friendly to business actually has a lot of people moving in. And that benefits everybody around, it's a beautiful ecosystem.
It's a great place to live. It used to be that the quality of life was a lot cheaper, and in a lot of areas, it has become really expensive to live here. Unfortunately, you used to be able to rent a two bedroom apartment for $2,000, and it's now $4,500. That change happened very quickly post COVID when there was a rush for people to move. The thing about Florida is that when you move here, you usually don't ever leave because the weather will suck you in. It's just a beautiful place to be, it's outdoors, you can play golf all day, it's just it's a nice, fun place to live.
Can you give us the five most important things that retail investors should keep in mind when negotiating leases?
I sell for a lot of sophisticated institutional clients, but the bulk of my business is working with private investors. If they're going to sell one day, what are some of the things they want to avoid? Some people can lose some value of the property if they miss something here or there. A few things that I would note would be:
1. Try to get annual rental increases that at least match inflation. Inflation is off the charts and I don't know if it's going to continue to go this way, but I would say try to negotiate at least 2.5-3% minimum annual increases, but the more the better. A lot of people are going to look at "What is my NOI growth, my net my profit growth over time?". The only way to match inflation is to have increases. And if they don't, when you market the property, people are going to do their analysis, and probably going to be a little concerned that the growth is flat, and they will look at some other investments where it may grow more, and they may pass over your deal, or offer you a lower price to get a better return to cover for that.
2. Some people miss this one, because they may not understand the dynamics of the different types of leases that are out there. You know what the major leases are, there's a gross lease where tenants are just paying base rent, and then the landlord is essentially eating all other costs and expenses. Then there's a NNN lease, which is where the the tenant will pay a base rent, and also pay their pro rata share of all the expenses in the property. Expenses are going up, we're going through a mini insurance crisis right now in South Florida, where insurance used to cost, for full coverage, about $1 per square foot for the building. We're looking at quotes in some cases between three and $5 a foot in certain areas. Why? Because we are in Florida and insurance companies are taking a lot of hits on the storms, and a lot of them are backing out of the state. When expenses increase, if you don't have clauses for your tenant to cover the increase in insurance, or the increase in real estate taxes upon a reassessment, when you buy it, it will eventually get reassessed. It's a dollar for dollar loss to you, if it's a gross lease, the expenses go up, and no one's covering that. So it's better to have a net lease structure where you can at least have a shot at passing through the increased expenses to the tenant, because all it's going to do is take it right out of your bottom line.
3. Having a tenant base that is as service oriented as possible. You don't want to have too many tenants in your tenant roster that someone's going to inspect that rent roll and say "GameStop is not long for this world, kids are downloading video games, how is that business going to last if kids keep continuing to go online and download their video games?" You don't want too many tenants like that, that are not long term for this retail world. You want to have a good mix of restaurants if you have the parking, because you need parking to add restaurants. You need to be aware, especially when you're buying a shopping center, what the parking ratio is in relation to the zoning in that shopping center, so you can make sure you don't buy it and then realize, "hmm, there was only one restaurant in a 20,000 foot center, I thought that was an upside that I could put more restaurants". If you don't inspect it, it may be because the parking ratio is so low that the government won't allow more restaurants, and then you're stuck and you cannot put more restaurants in there. You always want to make a good analysis as to how much parking there is. Parking, accessibility and visibility are key. Service oriented tenants like barbers, medical, salon, daycare, things that people have to go to that they cannot get online are things that are what investors are looking for when they're inspecting a rent roll. They can be confident that those tenants aren't going to go by the wayside and not retrieve the rent or they will blowout because they're not making their sales figures.
4. This is important, a thematic tenant roster. When I say thematic tenant roster, I mean that you want to try to not put the wrong type of tenants together. If you have children's clothing, a daycare, or a church, then you don't want to put a marijuana dispensary in the center even if you're allowed to. They may pay good money, but they may drive off other tenants. If you have a bar, or a liquor store, and you have that theme going, then sticking a marijuana dispensary may not be a bad idea, it may flow. That's why a thematic tenant roster can really help. There's a real demand for these things, marijuana dispensaries in Florida make a lot of money, and it looks like they're here to stay. Be aware of who you're trying to pair together, you don't want too many of the same thing. Also, you don't want too many of the same tenants. It's kind of obvious, but some people get desperate, and they do things that maybe they don't want to do.
5. You should always be in constant contact with the rental market. I've dealt with a lot of owners who stayed in the box, meaning they don't really like to talk to brokers. They're not magnanimous with their information, therefore, they don't get much information. What ends up happening is they live in this world that they're not aware of what the market is around them. And most brokers, if they're good, are very giving in information. That's how we're evaluated. If I call you and you own a 30,000 foot center and I'm trying to build a relationship with you, the first thing I'm going to do is say "I want you to understand that I want to be a resource to you, you may transact now, or you may transact in 20 years, I'm not going anywhere. You're in my market, how can I be a resource?". There's no way that any owner shouldn't want to know what all their neighbors are paying in rent, or what developments are happening locally, what new laws could affect their property, what new zoning codes are coming in, that could add density or be a detriment. It's important for investors to have open ears, it may be annoying to get cold calls from people, but some of these brokers can have a lot of value to add. I always tell my clients that they should talk to everybody, because I don't know everything. It's good to get as much information as possible, they would be making a mistake not opening themselves up, in order to keep an understanding of what the market is. If it spikes, and you have a couple of leases coming up, you really should know that you could be leaving money on the table, if you're not aware of where the market just went.
Is there anything else that you think should be important for our audience to know?
The market right now is getting very interesting. There’s a lot of demand, because there’s still a lot of capital out there. As the stock market continues to fall, it’s going to affect some tenants because if it’s not a corporate tenant, you’re talking about a family, and probably this is their business, their livelihood. When times get rough, some people keep their money in the stock market, and when they lose two thirds, or a third, or half of the value that’s liquid to them, that they could have sold for whatever reason. This is when tenants start to come back and ask for money, they ask for rent reductions because they’re having a problem. And as the stock market gets more volatile, that’s when people and buyers sense that they’re going to need a bigger return, because that 7.5 cap may turn into a 6.5 cap very quickly if they lose a tenant or two, depending on the size of the shopping center. You’re going to see an incremental drop in value as interest rates go up, as the stock market becomes a lot more volatile. People may take their money out of the stock market, or out of crypto at this point and move it into brick and mortar because the best part of owning real estate is not just that you can get cash flow, but it’s actually a real thing that you are owning land. You have this asset, and you will continue to own it, and it appreciates, the tax benefits of being able to depreciate the property are very big, and you don’t get that with stocks. A lot of people will continue to move their money into real estate.
Why did the market get so heated? I think in a big way a lot of people have learned, partly from shows like yours, that commercial real estate investments are much more commonplace than they ever were before. You have more people investing in single tenant properties and in smaller multi tenant shopping centers and they now consider that as an investment option. Because of that, you have more competition and more demand. We live in an area here in South Florida where there’s constant demand, and it’s coming from not just America, or Florida, but also from South America, Europe, everywhere. And from all the people that are moving down here and moving their money here. We see it all the time, you go to a market in northern Florida, you get a better return, because there’s less demand, you go to Ocala, or Jacksonville, we’re selling deals at 7.25-7.5 caps. The same property in Miami-Dade County is probably a 5.75 cap, and the rents are twice as high.