With so much capital chasing deals, investors looking for higher yields, and smart money pulling away from the Wall Street casino, where do you go for better returns in real estate?

Value add investments, a strategy where the sponsor/operator forces appreciation by creating additional Net Operating Income (NOI), cash flow, and appreciation through enhancing the positioning of the property.  Compared to ground-up developments, value add investments usually have cash flow from the start and are less vulnerable to dramatic market shifts outside the sponsor/operator’s control.

Leasing Is A Fundamental Value Add Strategy For Retail Real Estate

There are several retail (NNN and Shopping Center) strategies to add value from leasing.  The easiest way to add value is to lease any vacant spaces,  which increases cash flow and, ultimately, NOI/ value.  However, not all tenants add equal value for Shopping Centers.  Some tenants might just be a placeholder to fill a vacant space, but in retail leasing, the other key is do they attract other quality retailers that will pay higher rents?  So, retail tenant selection becomes vital to adding value for the Shopping Center.

Retailers want shopping centers that can produce the highest sales for their company. And, the higher the sales a tenant does, the more they can pay in rent!  So when evaluating a property to acquire, Concordia Equity Partners looks at the area demographic history and trends, sales reports, existing tenant mix, market dynamics, design/layout of the property, current rent roll, historical financials, and other capital market conditions that could impact our value add strategy.

Here’s another leasing value add strategy, by simply looking at the rent roll. For example, we have a 5,000 SF vacancy next to a 10,000 SF space that is leased by a low-quality retailer at below-market rents. The low-quality tenant’s lease expires in 12 months, and we know there is a quality hardware store looking for 15,000 square feet in the market.  You could negotiate a Landlord favorable “as is” (no tenant improvements or tenant allowance) 10 year lease to occupy the entire 15,000 SF for $6.00 per square foot rent which would add $90,000 in income and $1,125,000 value at an 8% capitalization rate ($90,000 annual rent/.08 cap =$1,125,000).  That’s a lot of value creation and leases your vacant space.

The “Desirable Tenant” also brings ancillary benefits of other tenants wanting to be in the same project with them and will pay a higher rent to be there.

Let’s say we stretched a little and could attract a desirable tenant like Old Navy, however, we would need to give them a larger tenant improvement allowance of $50.00 per square foot or $750,000 (15,000 SF x $50 PSF) total for their construction.   Old Navy will do more sales volume and attract more people to the shopping center, which will raise renewal rents and the probability of existing tenants renewing.  Additionally, Old Navy will attract other desirable tenants that previously wouldn’t consider leasing from our property. One strategy to combat the high tenant improvement allowance we would amortize the tenant improvement allowance over the tenant’s lease term ($750,000/10 year lease = $75,000; $75,000/15,000 SF = $5.00 PSF/year *simplified for illustration purposes).  Now your rent is $11.00 per square foot ($165,000 per year) instead of $6.00 per square foot for the Hardware store. Old Navy will also be valued at a lower cap rate of 7%, so your new value creation is $2,357,143 ($165,000 annual rent/.07 cap rate = $2,357,143 in value). After looking at all the options, who wouldn’t take the value from the Old Navy lease? Hopefully, no one.  However, slumlords take the easy low hanging options all the time, which creates more Value Add opportunities for Concordia.

Convert Gross Leases to Net leases.

Another way to add value through leasing is converting “Gross” lease structures (Tenant favorable) to “Triple Net” leases (Landlord favorable).  When renewing existing leases, we always try to shift the risk of expense increases back to the tenant who is getting the benefit of the services associated with those expenses. Even if we cannot get them to a full NNN lease, we will at least shift them to a “Modified Gross” lease where the tenant pays the increases from an established base year.  Again, lazy Landlord’s will accept gross leases just to get a deal done, avoid confusion/hassles, and save a few $ on legal fees.  Which, in the long run, will cost investors thousands of dollars.  Let’s say gross leases discount $15,000 of potential NOI at an 8% cap rate.  $15,000 annual losses/.08% = $187,500 in lost value. It all adds up.

Reducing Expenses Wisely To Maintain Service Levels.

Reducing expenses is another way to add value; however, you will not get as much value as leasing.  Concordia always rebids service contracts, appeals real estate taxes, and reduces payroll where prudent. Defined benefit pension plans can be replaced with SEP/IRA’s. Strategically replacing outdated equipment and fixtures with energy-efficient lighting and HVAC (where the landlord is responsible for energy costs or replacement) can also increase your bottom line.  Reflective TPO white roofs and adding extra insulation during a reroof also dramatically decrease energy costs.  If you neglect the property, most Landlord’s will be required to spend more on capital expenditures. More money in capital expenditures (roof replacement, HVAC replacement, not negotiating vendor contracts) equals less cash flow to investors. Additionally, if you save more money for your tenants, you can push renewal rental rates, which impact your NOI = VALUE.

Selective Renovations Can Revitalize A Shopping Center.

Simply spending a lot of money on a new facade will not automatically translate into additional rents or an increase in value.  That is why Concordia judiciously weighs the cost to benefit from renovations and redevelopments. Less expensive and high impact upgrades to appearance can include paying to replace tenant signs, adding pylon signs with tenant identification, adding, replacing and improving landscaping, seal coating and new striping, replacing existing lights with LED lights which decreases electric bills and increases light in parking lots.

We find the biggest bang for the buck is renovated or increased landscaping, which softens hardscapes and creates an inviting atmosphere. Along with LED lights making the parking lot and common areas brighter, safer, and reduces expenses. Plus, some utility companies subsidize the cost of retrofit, and there are great tax credit programs.

It is much more expensive to perform facade renovations, and even demolition of existing buildings to reconfigure and build new for quality tenants.

Developing Outparcels is Turning Pavement In To Gold

An Out Parcel (sometimes called Pads, Outparcels or Out Lots) are the buildings closest to the street that come most commonly in the form of fast food (Quick Service Restaurants/QSR), banks, small strip centers, and drug stores but can be an amazing array of service and retail tenants that benefit from high visibility or the need for a drive-through (drive-thru).  With cars getting smaller and ride-sharing apps, parking requirements have been reduced over the past five years.  So converting that sea of asphalt in front of the shopping has made a liability a key asset in driving value and cash flow.  Even if there are existing out parcel buildings, you might be able to squeeze in an additional out parcel or two (maybe even an ATM or Billboard in the side/rear of the center). This is usually accomplished by getting the zoning approval, and subdividing the property so that the parcel pays its own taxes.  It also sets up the property for another value add strategy below if done properly. The out parcel can be developed through a number of methods. You can execute a Ground Lease with a tenant and have them be completely responsible for constructing and maintaining the building.  You can also complete a Build-To-Suit whereby you contract with a tenant to build their store to their plans and specifications, and then they take delivery of a fully completed building and start paying rent.

You can also build a single tenant or small strip center on “spec” (speculation and lease the space as it is completed).

Selling Off Outparcels is Buying Wholesale and Selling Retail

Another excellent way to add value is parcelization. Subdividing a larger property into smaller parcels or putting every out parcel building on its own tax parcel gives you the property owner the ability to sell off those parcels separately.  Concordia Equity Partners strategy is to arbitrage the lower price per square foot and higher cap rates between larger multi-tenant shopping centers. There is a larger investor pool looking for smaller stabilized Single-Tenant Triple-Net leased properties than there is for larger, higher-priced multi-tenant properties.  Some of the reasons for this are: lower price point is easier access to commercial real estate, and Single Tenant NNN have much fewer management hassles. With single-tenant triple-net leased deals, one of the major decisions is do you want your rent check mailed or sent via ACH directly to your bank account.