At First National Realty Partners, we understand the seismic shifts in retail shopping behavior that have occurred over the past decade, driven by the relentless rise of e-commerce. It's only natural that questions arise about the profitability of owning a shopping center. In this article, we provide valuable insights into what it takes to make shopping centers not just profitable, but exceptionally so.
How Do Shopping Centers/Malls Make Money?
Like any commercial property, shopping centers generate revenue from two primary sources: lease income and sales proceeds. Here's a closer look at how these revenue streams work in tandem to create a profitable venture.
Lease Income
A shopping center typically hosts multiple retail tenants, each bound by a lease agreement to pay a specified rent monthly. These leases may also require tenants to contribute to operating expenses. The sum of lease income and ancillary fees constitutes Gross Income. The difference between Gross Income and operating expenses is known as Net Operating Income (NOI), the foundation of a retail property's profitability.
Sales Proceeds
While lease income provides a steady cash flow, the lion's share of profits often stems from selling the property itself. The sales price of a retail space hinges on various factors such as tenant quality, lease durations, market demographics, and property characteristics. Well-managed properties in strong markets can yield substantial profits upon sale.
Factors that Determine Profitability
The profitability of a shopping center hinges on several crucial factors:
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Commercial Property Class: Shopping centers are classified from A to D, with A being the newest and D the oldest. Surprisingly, Class A properties, while less risky, are often less profitable. Class C and D properties offer higher profit potential but carry increased risk.
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Value of Location: A prime location with high traffic attracts quality tenants willing to pay higher rent. Location plays a pivotal role in determining profitability.
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Quality of Tenants: High-quality, reliable tenants contribute to higher property sale prices. Anchor tenants, occupying significant space, play a particularly critical role.
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Lease Terms: Properties with long-term leases offer steady cash flow and reduced risk. Longer lease terms equate to a more profitable investment.
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Lease Rates & Expenses: High lease rates and controlled expenses result in a higher NOI, which is essential for a highly profitable investment.
Average Annual Return on Shopping Center Investment
The annual return on shopping center investments typically ranges from 5% to 20% or more. Class A properties and low-risk investments tend to be at the lower end of the spectrum, while value-add properties with more potential income variability can yield returns at the higher end. Investors should align their investment choices with their risk tolerance.
Are Shopping Centers a Good Investment?
Rather than categorically defining shopping centers as good or bad investments, it's essential to consider individual strategies. Here's an overview of the pros and cons of retail shopping center investments:
Pros
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Income: Shopping centers can provide a consistent income stream for investors, with distributions from income exceeding expenses.
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Depreciation & Tax Benefits: Operating expenses are tax-deductible, reducing overall tax liability. Capital gains taxes can be deferred using a 1031 Exchange.
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Reduced Risk: Properties with essential tenants, like grocery stores, tend to be resilient during economic downturns, reducing risk.
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Simplicity: Managing shopping centers is relatively straightforward due to a limited number of tenants, compared to multifamily properties.
Cons
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Maintenance: Older shopping centers may require costly maintenance and upgrades.
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Market Risk: Rental rates and property values can fluctuate, influenced by economic conditions.
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Credit Risk: The ability of tenants to pay rent is a significant concern, requiring thorough due diligence.
Investors should carefully weigh these pros and cons to determine if a shopping center aligns with their investment strategy.
Retail Trends in 2022 and Beyond
Shopping center investments are long-term commitments, necessitating an understanding of retail trends. Five key trends to watch include:
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Omnichannel Sales: Successful retailers must utilize multiple sales channels, including physical stores, e-commerce, and social media.
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Omnichannel Delivery: Post-pandemic, retailers must offer diverse delivery options, such as in-person pickup and home delivery.
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Social Commerce: Selling products through social media is becoming seamless and integrated.
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Augmented Reality: Retailers are using augmented reality to enhance the shopping experience.
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Focus on Safety: Enhanced safety measures, like sanitization stations and online order pickup, are here to stay.
Retailers adopting these trends can foster customer loyalty and strengthen brands, bolstering shopping center investment performance.
Summary & Conclusions
Owning a shopping center can indeed be profitable, but the degree of profitability depends on factors like property price, management efficiency, and property characteristics. Annual returns typically range from 5% to 20% based on risk factors.
At First National Realty Partners, we specialize in identifying and managing grocery store-anchored retail shopping centers. If you're an Accredited Real Estate Investor looking for investment opportunities that offer strong returns while benefiting the communities they serve, we invite you to contact us at (800) 605-4966 or info@fnrpusa.com to learn more about our offerings.
In the evolving landscape of retail, investing wisely in shopping centers can be a lucrative endeavor for those aligned with the right strategy and risk tolerance.
