Shadow Anchored Retail Deal
Is Value-Add a Necessary Component? A Case Study
Happy Sunday! This week’s case study is a shadow-anchored retail center, a one-off private placement syndication. The asset is similar to this public REIT’s portfolio:
In this case study, we’ll discuss why it’s important to evaluate these three things:
Location and market demographics.
Tenant quality and lease terms.
Financial assumptions.
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Deal or No Deal?
Please remember, the deal is presented as a case study, and all relevant information has been changed to protect the identity of the sponsor. This is not investment advice.
Brief recap of the deal:
The property is being acquired as a stabilized retail center. The sponsor plans to hold the asset for 5 years. You may have noted the deal doesn’t have is a value-add component: 15 year weighted average lease term (WALT), no out-parcels that can be sold.
What makes the deal attractive is the very favorable assumable loan: fixed rate, fully amortizing, matures in 5 years. Need a refresher on terms? Read this post:
Pro Forma Review
Let’s walk through the three important considerations when evaluating retail deals and see how they apply to our case study.
1. Location and Market Demographics
Location: retail properties in high-traffic areas, close to major roads, or within established shopping districts are almost always more desirable. “Drive” around the property in Google Maps. Think of ease of access and visibility from major roads.
New supply: retail properties are not generally over-supplied, but this is very location-specific. Do your research on new product coming to market. During your virtual drive, pay attention to vacant storefronts.
Demographics: consider the area's population growth and average income. A strong customer base with sufficient purchasing power is critical for tenant success.
For resources on looking up demographic trends, read this:
Deal of the week: checks most boxes, median household income in the area is in the $80k range, no new supply coming to market. The property is located on a busy road with easy access.
2. Tenant Quality and Lease Terms
A list of all tenants with relevant information (square footage, start and termination of the lease, step ups, etc) should be included in the offering memorandum.
Tenant creditworthiness: are any tenants credit-rated? National brands are considered more stable, but they tend to negotiate much more favorable lease terms and co-tenancy clauses.
Lease terms: evaluate the length of lease agreements, rent escalations, and renewal options. Longer lease terms with strong tenants reduce turnover risk. The downside? Lease terminations provide an opportunity to bring lease rates to market (if current leases are below market rates).
Occupancy rate and anchor tenant: pay attention to expiring leases for larger tenants. Our deal of the week is shadow-anchored (located near a grocery anchor store, but the anchor store is not a tenant of this property). This adds some complexity: if that grocer were to leave, nearby businesses may experience a drop in traffic.
Deal of the week: two tenants are publicly traded companies, no info about any co-tenancy clauses is provided. The deck lists each tenants’ lease expiration date, but provides no detail on rent increases or renewal options.
3. Financial Assumptions
Cash flow projections: ALWAYS check to see the source of cash flow. We often see large working capital reserves which fund distributions during the first year or two of operations.
Debt structure: in addition to reviewing loan terms, etc, stress-test to see if any one tenant can make a significant dent in debt coverage (for example, what does debt coverage look like if a single tenant that represents 35% of the total rent vacated).
Cap rate assumptions: this is the single most impactful assumption in many NNN deals. Stress-test such deals for cap rates up to 200 bps higher than underwritten.
Deal of the week: cash flow is covered by operations, debt is attractive, and cap rate assumption on sale is fairly conservative. Given the high cash flow, I don’t expect this deal to be very sensitive to exit cap rate (but I’d always run a sensitivity analysis before investing).
We hope you learned something from this case study. Please share with your fellow investors if you found this helpful! The full database of our case studies can be found on the front page.