We are reviewing where is retail going, how should a retail investor think and approach their investments in today’s world, what are tenants looking for in a retail center nowadays, and what are major items that national tenants and landlords want to see in their lease.
We’re interviewing Jason Ricks, a professional real estate investor focusing on acquisitions, leasing, construction and development. He has a background in retail leasing and asset management working on premier properties worth hundreds of millions across the country. He also oversaw a 2.2 million square foot value add retail portfolio throughout Texas and Oklahoma, and most recently he was featured in the number one Amazon best selling book “Desire, Discipline and Determination”.
Where do you think retail is going based on your experience?
I’m sure a lot of folks that have come on your podcast talked about the retail evolution, the apocalypse, and that retail is dying. And when you look at the history of retail, it has always evolved based on consumer demands and convenience. From a macro view, we are seeing a slowing in the development pipeline, slightly higher cap rates compared to other sectors, and I’d argue we’re a little overbuilt in the United States when it comes to retail. However, there is a tremendous amount of product that is obsolete, a lot of C lass C malls and Class C shopping centers across the US need to be repurposed and rezoned. We’re starting to see this happening now, I go back to this idea that Sears completely disrupted retail back when they came out with their catalog, and then, the next flavor of the month was “It’s more convenient to go to the mall.” And then in the 90’s power centers just ballooned, you had these huge giant anchors, and they were fulfillment stores. Now you have online shopping, and we’re seeing all of these things shift out.
Retail has always been fast evolving and re-shaping around consumer demands and convenience. With all that being said, we’re still seeing NOI growth of around 2% across the board. Rental rates in all major metros are increasing, and a lot of this has been driven by consumer purchasing power within the US. We’re seeing increases in consumer retail spending, as I mentioned earlier, consumer sentiment index is at a 1oo, which is really on the high side, and we’re seeing year over year growth on retail trade of around 3.5% which are really healthy marks.
I wrote a blog post just posted a few weeks ago, talking about Amazon, online sales and all the headlines that are impacting retail investor sentiment. And I take it straight from the horses mouth, I go straight to Jeff Bezos’s annual shareholder letter. Online sales only accounts for around 12% of total retail spending, brick and mortar makes up about 88%. Most people think brick and mortar is dying when in fact it is growing, it grew by 2% last year, it’s not growing as fast as online sales are, but if you dig into Jeff’s letter, 58% of sales on Amazon are driven by third party sellers. These are not huge businesses, these are small and medium sized companies. And when I break this down even further, my friends at ICSE (which stands for the International Council of Shopping Centers), did a huge report on this about the relationship between brick and mortar and online and, their findings were that brick mortar locations help grow online sales and brand awareness. I think retailers are figuring this out now, and they’re adapting appropriately, it’s really an exciting time. I’m working with a ton of retailers that were born online that understand the importance of brick and mortar. So I would say to watch out for a lot of the headlines, and really dig into the numbers, they tell a different story.
That reminds me of this makeup brand that started online called Glossier. I came across one of their actual brick and mortar stores that they opened, and it was packed. I agree with you, there is a shift, but it will still be there.
I think a lot of these retailers are figuring out the business, it’s totally different than online. All the records clearly indicate that if you’re going to open a store, it’s actually going to increase your online traffic. And at the end of the day, I think sales are sales for these retailers and they’re just finding creative ways to reach their customers.
How should a retail investor think and approach their investments in today’s world?
I think that regardless of the asset, you have to take a longterm vision on real estate based on strong fundamentals. We can’t control what the Fed is going to do tomorrow, we can’t control what cap rates are, and where they’re going to trend, so I don’t want to spend a lot of time worrying about those things. Commercial real estate is so cyclical, and it’s always in either one of four phases. At the end of the day you want to find well located assets with really strong demographics, one, three and five mile radius, understand how many households, what’s the average household income, what’s the population, how’s it growing, how’s the job market? Just going back to the basics. And then we want to look for attractive opportunities. When you’re in a rising cap rate market, you have to find ways to grow your NOI. The only way to do that is to really dig into the market dynamics and understand where the value is.
There’s an art to underwriting shopping centers, it’s not the broker’s job because they will say that you can just lease up this vacancy in three to six months, and this is the market rate they’re going to pay. It’s not that, there are so many more nuances to getting leases done, you have to find ways to lease and attract the right tenants. My preference is doing this through re-merchandising, renovating, or redeveloping centers in growth markets. I’ll take it a step further and give you an example of a deal that we’re looking at right now in Sparks, Nevada, which has experienced a tremendous amount of growth, and has a very healthy employment figure at this point. We’re looking at a shopping center that’s around an 8% cap rate. We’ve great national anchor tenants, a grocery store, and on the outskirts of the property we have a lot of fast food restaurants. If I buy the entire shopping center at an 8% cap, and I can liquidate and sell these pad sites on a 6-6.5% cap to REIT’s that need to find these properties, that’s an immediate arbitrage. And on top of that, we have a broad base of tenant relationships and broker relationships that are already working with an anchor tenant to take 50,000 square feet while we’re trying to buy the shopping centers. So on day one, we could go in with a creative strategy to return equity to our LP’s right away, and also find ways to have long term cash flow by securing that anchor tenant in the space. These are the creative approaches that we’re looking at across the board.
As you work with a lot of tenants, what are they looking for in a retail center nowadays?
Generally speaking, it has always been about market share, finding sales, and finding the desirable tenant mix. Retailers are getting so sophisticated when it comes to understanding what the market analytics, trends, and where they need to be in the marketplace. Demographics play a huge role in this: understanding traffic counts, traffic patterns, visibility, the amount of parking that they will need, and they want to partner with well-respected landlords that are going to take care of the asset. As an example, a friend of mine works for Publix, he’s the head of their site election and can look at any market and say “Based on this three, five, and 10 mile radius, based on traffic patterns and household incomes, I know how much we’re going to generate in sales”. How accurate is that? Within 5%. It is unbelievable, they can look at that market and really come in with a clear set of eyes and say “Based on that we can only pay X in rent, and we will need this type of tenant improvement allowance”. It’s really becoming more sophisticated, as you know, data is everything, and it certainly seems to be that way in the whole industry.
What are some of the most important things that national tenants want to see in their lease when they’re negotiating it?
How long do you want your show to be? We have so many war stories about working with big national tenants, I’ll try to keep it brief and not go off on a tangent. At the end of the day, they want to have control of the lease and have flexibility in their favor. Besides the basic things like base rent and tenant improvement dollars, a lot of times we sit there and we’ll fight on exclusive use provisions. I’ll describe what that is: let’s say that you own a sandwich shop, in that sandwich shop you sell bags of chips and ice cream. You’re a big national, I own this huge shopping center and you say “You know what Jason, I don’t want you to lease it to anyone else that sells sandwiches, chips or ice cream”. And I’ve five other other tenants that are already doing that now. Let’s say you have a very fast, quick service restaurant, and I have a really fine dining restaurant on another pad site that has sandwiches and ice cream. These are two competing uses for two different competing consumers. We spend a lot of time negotiating and making sure that the landlord is going to have some flexibility there as well.
On top of that, one of the beauties of shopping center investing is that you have a NNN lease, which means that the tenants pay for their portion of the taxes, insurance and common area maintenance for the shopping center. A lot of the big guys don’t want to pay for certain things and they want my ability to pass through those expenses to be capped on a yearly basis, which I understand, but at the same time we have to be able to maintain the property in a certain condition to be able to attract other tenants as well. It’s also to their benefit that they should pay. These are a lot of the fun things that we do, going back to the sandwich shop example, you may come to me and go, “I want to do a five year deal with you Jason, but I want to have two renewal options for an additional five year and I want those to be capped at a certain rate”. I definitely don’t want to cap those because I think there’s probably the potential for greater upside if those were at fair market value. However, these tenants want to have certainty, they want to be able to bake it into their models as well, and be secured in that space for 15 years, or in some cases like I did a deal with CVS, they wanted a 75 year lease with me with five-year options.
Also, if you’re working with a large grocery anchored shopping center, they’re not going to want you to build in front of their space, which I understand, my old landlords would love to build in front of everyone’s space and just have a ton of pad sites. The tenants have “no build areas”, they don’t want any of their visibility to be impacted from multiple different vantage points, which makes total sense. Another one is these co-tenancy clauses. For example, if we do a deal with Ross Dress for Less, they want to make sure that the landlord’s keeping the center fairly well occupied, they may come to me and say “If this center goes below 60, 70% occupancy, I’m going to get a haircut on the rent”. So you have to work with a lot of those interesting scenarios with these nationals.
On the other hand, would it be fair to say that the landlords want the opposite of all of this, or are there any other items that the landlords would want to see in their lease during negotiation?
You’re absolutely right, it’s very similar. From my experience, it’s so important that you understand who signs the lease, what’s the entity, and how are you securitizing this lease? This could be a corporate guarantee, this could be a franchisee, or this could be an individual. I’m going to have to treat a corporate guarantee very different from a franchisee, or a local tenant. And the reason for that is you have to understand how to read a balance sheet and the P&L, understand where their liquidity is, what their longterm debt looks like, what’s the likelihood of these tenants being able to pay their rent over the life of the lease? Let’s say you have only a little bit of cash in the bank, and you’re taking on an SBA loan, and then you want me to give you $100,000 in tenant improvement allowance, that’s really tricky for me to do just because you don’t have a ton of money.
Those are the fun things, and you have to make sure you understand the nuances of entity law, and work with an attorney that gets it, and make sure that they have skin in the game, if they don’t, it is so easy for these guys to get in and get out. I can’t tell you how many times we’ve learned this the hard way where we’ll sign a sign a lease with the local franchisee and it’s a shadow entity, he closes the shop down, we try to pursue legal recourse, and there’s nothing to get. You really have to be careful and understand these nuances.
Is there anything else that you think our audience should know or be aware of?Amazon has called me 3 or 4 times within the last few months. I’ve been working with them over the last year, and they’re trying to open up 3,000 Amazon Go stores by 2021. They just opened up their fifth hundred Whole Foods location in Atlanta, and they’re also calling me for bookstores. There’s this perception that retail is dead and I can tell you that it is not, it is doing extremely well in certain markets with a certain product type. So you have to be careful as an LP investor, but find the right sponsor that gets it, find what’s right for you if you’re going to invest in the space.
Blog post: http://www.concordiarealty.com/resources/crc020-online-sales-vs-brick-and-mortar-retail/