The valuation of retail properties offers an analyst a myriad of choices. Anyone who has appraised a mall or a community shopping center can tell you of the numerous projections required for market rents, tenant fit out allowances, absorption of vacant space, downtime between leases, free rent periods, renewal probability, commission and marketing expenses, reimbursed expenses, and more. Appraisers model the behavior of buyers and sellers. So the question arises: do the buyers of retail outlets themselves employ only complex analyses to sort through the market of properties offered for sale? Or, as part of buyers' process of shopping the market, do simple methods also come into play?

Buyers initially review the location, access, and design features of a center. Competition is measured by the center's size, image, vacancies, tenant mix, and market rents. Preceding a review of market supply, demand and/or basic demographics such as median household income and population within a five and ten mile radius is understood.

In major retail properties, such as community shopping centers, anchors represent the key to understanding value. Anchors can make up a significant portion of the gross income and are the bellwether for rental income for the infill tenants. First and foremost, a buyer will review the economics and length of the anchor's lease. Second, buyers scrutinize the anchor's credit, market position, and competition within the submarket. After anchor leases are understood, a potential buyer is afforded the necessary insight into the remaining economics of a shopping center's cash flow.

Existing occupancies and the quality of the tenant mix allow an understanding of vacancy and bad debt factors. Expenses should be readily supported with market data that presents a tight range. Reserve for replacement allowances, specifically for roofs, parking lots, and HVAC systems, need to be carefully quantified. In direct capitalization, the treatment of reserves, tenant improvement costs, and leasing commissions can be either included or excluded from the net operating income. (Whether they are will impact estimated value; the client should be aware of these methodological variances.)

After expenses are deducted from the effective gross income, the net operating income is derived. A buyer then proceeds to estimate value by a capitalization factor. Capitalization rates depend on a host of criteria, which include a buyer's investment objective, the cost of money, potential income growth, and the overall market demand for comparable retail properties. The final determinant of a capitalization rate then becomes a synthesis of all the variables and assumptions that led up to the net operating income. The needle "goes back to zero."

Information of this kind forms the background for a buyer's evaluation. For any particular property, a simple method is available. Leases for retail properties are typically written on a "net" basis, with the tenants paying the cost of operating expenses and the building owner paying little. By the "net" nature of these leases, the work of stripping rent to a cash flow to the owner is largely completed. With rough adjustments, the cash flow may be capitalized for a snapshot of value.

For example, assume a 170,000 square foot community shopping center, in an average location, anchored by a 70,000 square foot supermarket. Rental income under net leases averages $9.40 per foot. Fifteen percent is lost because of vacancies, operating costs for the vacant space, bad debt, brokerage, and reserves. Net income is thus $8.00 per foot. Capitalized at 9.5%, the value is $84 per foot (and $14,300,000 for the property), which falls comfortably into the range of prices that community shopping centers in Massachusetts have recently commanded.

All properties are unique. For valuation, their uniqueness demands individualized attention. Moreso than for offices or industrial properties, retail outlets are heavily influenced by national trends. Principals in the retail market nationwide make use of increasingly complex analyses. Yet simple methods remain useful to buyers faced with an array of properties to shop among and a need to efficiently narrow the field.

Daniel Clifford, MAI, Principal, Clifford Associates
  • 24 Thorndike Street
    Cambridge, MA 02141

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Eric Reenstierna Associates LLC is a real estate appraisal firm taking on valuation and consultation assignments in Greater Boston, Massachusetts and New England. Eric Reenstierna, MAI, is the office's principal and is a commercial real estate appraiser.


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