Demand is from two sources: consumers and retailers. Demand for retail real estate is distinct from that for other investment property because it has two components: primary tenant demand (stores) and secondary shopper demand (customers). A host of demographic and economic influences (job growth; household composition; household income; disposable income) drives shopper demand. For Greater Boston, growth as projected by NPA Data Services is expected to be a moderate .4% to .7% per year for population, households, and income over the next five years.
Primary tenant demand is led by anchor tenants. The long term viability of anchors is what underpins value. The new, dominant force in the retail marketplace is the "big box" user the wholesale club, like BJ's, and the "category killer," like Home Depot. These have created a battleground among retailers, where new centers are built even as older centers seek tenants. In competition with the big boxes, older style anchor stores often benefit from a strong, established location and low rent. With their anchors at low rents, however, community center owners are pressured to negotiate ever higher rents from smaller tenants which becomes problematic as the universe of the smaller tenants declines.
Key lease language is crucial to risk. Operating covenants that require continuous operation affect a center's viability. Long term leases require scrutiny for appropriate default and "escape clause" language. A "dark" anchor can devastate an otherwise healthy center. In view of the recent history of overly aggressive projections, it can be said that this risk is not easily assessed.
To properly evaluate risk requires evaluation of the anchor tenant. Dominant anchors will attract an array of credit worthy satellite stores. The durability of the income stream is reflected in the "location linkages" transportation arteries and patterns of growth in population and employment.
One anecdote aptly sums up the result of projections gone awry. In 1987, before the market crash, a consortium of pension funds invested $2.7 billion in Cadillac Fairview, a major retail developer based in Canada. The anticipated rental growth rate was projected to range from 6% to 7% per year, with an annual internal rate of return of 14%. Instead, income from rents ceased in 1990, at $225 million. Vultures later purchased what was left of the assets for $350 million. History of this kind teaches that investment in real estate can be as volatile as in any other vehicle. The skilled retail property analyst factors a wide range of information before delivering a final estimate of value.
Daniel Clifford, MAI, Principal, Clifford Associates
The Reenstierna Associates Report is published as a service to the clients of Eric Reenstierna Associates and other real estate professionals. The views expressed are those of the articles' authors and do not necessarily reflect those of other members of the organization. Copyright 1996. All rights reserved.
Eric Reenstierna Associates