Why should you invest in retail?

Broadly speaking, we acquire "shopping centers," which are a subset of the retail sector. Our expertise is in acquiring enclosed shopping malls, open-air power centers, and neighborhood shopping centers in HomeTowns across the United States.

Enclosed Shopping Malls:

• Two or more anchor tenants
• Centrally located
• 300k - 1MM+ square feet

Open-Air Power Centers:

• Multiple Anchors
• Anchor tenants (e.g., Best Buy, Hobby Lobby, T.J. Maxx, Ross Dress for Less, etc.) comprise 75%+ of the rentable square footage in our portfolio. 
• 150k - 500k square feet

Neighborhood Shopping Centers:

• One to three anchor tenants
• When possible,  a grocery store
• 50k - 150k SF

While there are certainly shopping malls that have become functionally obsolete over the years, and the land they are located on could be redeveloped for higher and better use, there are many more that have plenty of life left in them. As is often the case with real estate, location matters. 

Many malls were acquired by their current owners before Amazon disrupted the retail sector. They were purchased at prices that were much too high using bank debt. Those owners are now facing foreclosure as the values have plummeted, and the income generated from the property can no longer cover the loan payments.

This presents an opportunity to acquire these properties at prices close to the value of the underlying land.  Essentially, there are opportunities to buy the land and get the building for free. These opportunities come with pre-existing net cash flow from the rents being collected from the existing tenants. This can represent anywhere from 15 to 20% of the purchase price annually. In other words, you can potentially acquire a property, hold it for five to eight years, and recoup your entire purchase price when you sell, assuming you can maintain the current tenants at their current rents.

The opportunity is heightened further by the fact that very little new retail space is being developed due to increased construction costs and higher-than-average interest rates. This has led to near-historic lows in vacancy. Currently, your average shopping mall has a vacancy rate of below five percent. It's a simple matter of supply-and-demand. 

The barrier to entry for owning and operating shopping malls is relatively high. It requires expertise that most real estate investors don't have, such as property management, leasing, and construction management. While competition exists, it's not nearly as competitive as the multifamily or industrial sectors are.

RockStep has owned and operated shopping centers since 1997. Founder and President Andy Weiner has spent his entire adult life working in the retail sector. 

The primary way to increase a shopping center's value is to increase its net operating income. This is accomplished by increasing rental income and decreasing expenses.

The other strategy for increasing the overall return on a property is to sell off parts of the property to individual buyers. Sometimes the sum of the parts is greater than the whole.

As it pertains to increasing the net operating income, here are a handful of tactics that one may employ:

• Increase existing tenant rents to the current market rate rents.
• Replace an existing tenant with one or more tenants who are willing and able to pay higher rents.
• Fill vacant space with new tenants.
• Attract tenants that increase foot traffic to the property. 
• Repurpose some of the less desirable space with non-retail tenants.
• Work with the local municipality to institute an increased sales tax on goods sold at the property.

There are many other strategies and tactics that can add value to a property. The key to most of them is having the ability to be creative and the experience necessary to execute them. 

There are a handful of key risks that need to be taken into account when owning and operating shopping centers. It's easier to frame risk from the perspective of what could happen if an inexperienced investor attempted to operate a shopping center.

• They use too much leverage, such as a small down payment, and have inflexible loan terms.
• They don't account for the fact that they may have  issues with permitting, zoning, and tenant consent, which involves getting permission from one or more anchor tenants to make changes to the property.
• They don't account for the fact that property taxes and property insurance can increase significantly.
• They don't have any relationships with their major national tenants.
• They lack community buy-in. Or even worse, they have an adversarial relationship with the local community. This makes it extremely challenging to execute their business plan on seemingly simple things, like installing signage to increase visibility.
• They don't have proper cash reserves to fund tenant and property improvements, which makes it challenging to attract high-quality tenants.
• They assume the existing tenants will renew their lease when the time comes or that they are in a strong enough financial position to not default on their lease.
• They end up overpaying for the property because they didn't completely understand all of dynamics that go into operating a mall. 

To effectively mitigate risks, you need to understand them first. Once you know them, you're in a better position to mitigate them.

At RockStep, we make sure that we conduct an appropriate amount of due diligence ahead of time to ensure that we buy the property at a proper price. We then raise enough equity so that we only have to borrow around 50% of the purchase price, which gives us a margin of safety should property values fall. We develop relationships with community leaders who invest their equity capital alongside us in the project, creating alignment between us and the community. 

In the commercial real estate world, we refer to the major markets as "primary" markets This would include markets like New York, Miami, Houston, San Francisco, and Los Angeles. When we say "HomeTowns," we are referring to "secondary" and "tertiary" markets. 

The reason we like "HomeTowns" is that we are able to purchase properties at a much lower price while attracting many of the same high-quality tenants found in larger markets. And very often these tenants are willing to pay rents that are very similar to the rents in larger markets.