From Nostalgia to Net Profits: Navigating the Risks and Rewards of Shopping Center Investments

Remember those days of wandering through bustling shopping malls, grabbing a pretzel, and window-shopping with friends? For many of us, malls aren't just retail hubs—they're time capsules of memories. 

But for some investors, malls aren’t just nostalgia. They represent an opportunity for passive income and long-term wealth-building opportunities. 

However, investments are like shoes: they fit everyone differently, and mall investment might not suit every investor’s needs or preferences. The potential of this kind of investment comes with risks that need careful consideration. Still, the potential upside is massive, so this type of retail investment can prove very lucrative.

This article will highlight the top five risks of investing in shopping malls and strategies you can implement to navigate these challenges effectively. 

Why Invest in Malls Now?

Today, shopping centers present an underrated opportunity, surprisingly, because of the rise of online retailers like Amazon. When the lockdowns started during the COVID-19 pandemic, people were forced to turn to e-commerce options instead of shopping at physical retail locations. Many retail giants were forced to close due to this sudden rapid decline in physical shopping. 

For example, many household-name stores, like Pier 1 and SteinMart, declared bankruptcy during the pandemic, and countless more small businesses were forced to close their doors. 

However, the stores that emerged from the pandemic intact were strong and flexible, having strategically adjusted to the new retail landscape during the lockdowns. And while shopping habits have changed, people still enjoy in-person shopping just as much as online shopping. Data shows that a significant portion (up to 46%) of consumers still prefer to shop and interact with sellers in person. This is for a number of reasons, from no-fee returns for in-person shopping to the fundamental need to touch and hold what we are looking to buy.

With the shopping center sector flourishing despite popular opinion, it is time for investors to learn about how to navigate this rich but tricky industry.

Top 5 Risks of Mall Investing 

That famous quote from Uncle Ben applies to shopping center investing: “With great power comes great responsibility.” We can make this more accurate in this scenario: “With great opportunities come great potential downfalls.” Understanding each danger can help you, as the investor, know when you accidentally put yourself into one of these scenarios or if a firm you work with is. 

1. The Danger of Over-investing 

One of the biggest pitfalls in mall investment is taking on too much debt. If the interest rate on your loan exceeds the property's capitalization rate (cap rate), you're setting yourself up for financial trouble. In other words, you are creating a scenario where you will lose money faster than you can earn it. 

How to avoid this: 

• Ensure your cap rate is higher than your interest rate
• Aim for a lower debt ratio, around 50-60% instead of 70-80%
• Remember that while leverage can boost returns, it also amplifies risk

If a property has inflexible, unfavorable loan terms, sponsors may be forced to refinance at unideal times, potentially leading to even more stringent loan conditions. Maintaining a lower debt ratio while potentially limiting short-term profits can significantly reduce risk and give investors and sponsors more wiggle room to work within. 

Like most things, leverage is beneficial in moderation. While leverage can amplify returns, excessive leverage is a precarious strategy that often leads to foreclosure rather than wealth creation.

2. Lack of Community Support 

Shopping malls can be anchors for the community, and investors must keep this in mind. Underestimating the importance of local support can derail your investment before it even starts. Community backing is crucial for navigating local politics, zoning issues, and permit processes. Investing in a mall without community buy-in will leave you feeling like someone who tried to throw a party, and no one showed up. 

Before investing, consider: 

• Building relationships with local leaders
• Engaging with the community
• Understanding the local political landscape

People are the lifeblood of their communities, and the best way to connect with local communities is to be genuine and present in everyday life. Show respect to the communities you are investing in by getting to know their history, culture, and values. By being aware of these three components, you can ensure you are working with the community instead of fighting against it.  

3. Unexpect Costs: Taxes and Insurance 

Remember the old saying? “If something seems too good to be true, it usually is”? This principle rings true when investing in shopping malls. Acquiring a mall at a low price might seem like a win, but beware of hidden costs. Property taxes and insurance are based on factors beyond your purchase price and can significantly impact your bottom line.

Additionally, sponsors often overlook that a property’s purchase price does not necessarily reflect its taxable value. Property taxes are assessed based on the value determined by the county, and insurance premiums are calculated based on perceived risks rather than the acquisition cost.

Engage in the following to prevent expensive surprises:

1. Conservative Underwriting: Always assume the worst-case scenario when projecting property taxes and insurance costs. 
2. Community Engagement: Strong local connections provide valuable insights into the economic environment, helping to anticipate and manage tax and insurance costs effectively.
3. Rigorous Due Diligence: Comprehensive research before acquisition is essential to minimize the likelihood of unexpected expenses related to taxes and insurance.

4. Tenant Relationships: The Lifeblood of Your Mall 

A successful mall relies heavily on its tenants, especially well-known national brands that drive foot traffic. Without strong relationships with both national and local tenants, you may struggle to maintain occupancy and revenue. 

National tenants prefer to partner with entities they trust, and they are typically less receptive to offers from unfamiliar or untested parties. 

It isn’t all about the big-name brands, through. Maintaining a positive reputation among local tenants is just as important and depends on staying involved in the local community. 

Ultimately, a poor reputation can quickly lead to vacancies, turning a thriving mall into a struggling one.

5. Insufficient Cash Reserves

Many new investors need to pay more attention to the amount of cash needed to operate and improve a mall. Unexpected expenses can quickly deplete your resources, forcing you to sell at a loss.

Often, insufficient reserves result from a lack of understanding regarding the capital improvements necessary to execute the business plan. Unanticipated repairs, remodeling costs, or unexpected fees to leasing agents can quickly escalate, leaving the project underfunded.

Thorough due diligence is imperative to avoid this scenario. Sponsors must accurately assess the cash required to complete the project, including a buffer for unforeseen expenses. Failure to do so may result in the need for a capital call, a situation most sponsors strive to avoid.

Actions to take to protect your investment:

• Allocate ample cash reserves
• Accurately assess capital improvement needs
• Plan for unforeseen expenses and repairs

Utilizing Smart Retail Investing Strategies to Build Wealth 

Now that you know the factors that can derail a mall investment and ways to avoid these mistakes, it is time to apply your knowledge. 

Ensuring you partner with a reputable real estate sponsor with a proven track record, strong local connections, and established relationships with key tenants is a critical first step in reducing risk.

Investing in shopping malls isn't for everyone. It requires careful planning, risk management, and a deep understanding of retail trends and property management. 

However, for those who navigate these challenges successfully, mall investments can offer substantial returns and long-term value.