Retail real estate’s Haves and Have-Nots
Over the past two years, investors have become increasingly active in buying retail real estate. Investors use many criteria to evaluate properties. Historically that started with, “Is the brand national? Is the lease corporately guaranteed? What’s their credit rating?” Now, the focus has shifted toward, “How is this retailer performing relative to its peers?”
Performance can be measured by average unit volume, profitability and share price. However, momentum and brand exuberance are hard to quantify but do move the needle when it comes to demand from real estate investors.
Let’s look at Raising Cane’s, a privately held, rapidly expanding brand that’s found tremendous success. While they don’t carry an investment grade tenant rating, the real estate they occupy is highly sought after by investors and, when sold, these properties command some of the lowest cap rates in the QSR space.
Landlords clamor to attract a company like Raising Cane’s to benefit from the traffic their stores generate. And if investors intend to sell that property, the tenancy of Raising Cane’s commands top pricing and typically takes the shortest time to sell.
Starbucks, on the other hand, is publicly traded and features an investment grade credit rating. A property leased to Starbucks will sell for a cap rate that is on average 100 basis points higher than Raising Cane’s, and it will take twice as long to transact. Liquidity and pricing premium are key attributes for landlords reviewing potential tenants.
Expansion today is a story of the “Haves” and the “Have Nots.”
Pro-growth environments
Single-tenant, net-leased properties are often referred to as “bonds backed by real estate,” a mantra linked to the passivity and hands-off ownership structure of these leases. Similar to how home prices vary based on the quality of the local school system, commercial real estate investors pay attention to the business climate of those that “have” extra intangibles have another lever to pull when vying for top real estate in an ever-tight market.
The initial purchase of a single-tenant property like a Raising Cane’s or Starbucks generally comes with the stability of a long-term lease in place, but investors have an eye for the future.
The question “If my tenant were to leave, how easy would it be to find a new tenant?” gets asked frequently. The zoning may allow a variety of uses, the building may be perfect for a host of tenants and feature a hard-to-come-by, drive-through window. But if the city or state is enacting excessive business regulations or promoting an unsustainable minimum wage, it might be tough for a landlord to attract new tenants.
Starbucks’ recent store closures, for instance, revealed a heavy concentration in California and other heavy-regulation/high-cost markets. Growth states such as Florida and Texas, meanwhile, saw limited closures. Certainly, there are a host of reasons a tenant may choose to cease operations in a given location, but it’s hard not to consider the business climate when looking for a long-term real estate investment.
The disparity of demand by real estate investors for top brands in top markets isn’t meant to say other brands will struggle to expand or that you won’t see new stores in less desired markets. It’s simply reality that those that “have” extra intangibles have another lever to pull when vying for top real estate in an ever-tight market.
The good news for those real estate investors that own property occupied by struggling retailers is that increased costs, limited vacancy, and strong occupier demand mean a building might be worth more empty than it is occupied under a dated lease with a failing brand.
