Key Takeaways:
- Service-oriented retail centers, with tenants like gyms and doctors, are attracting interest in CRE investment due to their resistance to e-commerce and potential for stable income.
- These centers benefit from factors like destination appeal, national tenants, long-term leases, and NNN leases.
- Investors must carefully consider location, tenant longevity, and holding period to mitigate risks associated with service-oriented retail investments.
The internet has significantly impacted commercial real estate (CRE), particularly retail properties. E-commerce giants have shuttered countless brick-and-mortar stores, forcing retail property owners to adapt. One of the most promising CRE investment strategies is to shift focus towards tenants offering services rather than products.
Those strategies are seeing payoffs according to Fortune:
“The vast majority of tenant demand formation is flowing into freestanding properties and neighborhood centers, but all segments recorded growth in 2023.”
What are Service-Oriented Retail Centers?
The International Council of Shopping Centers (ICSC) categorizes them by size and offerings, including malls, neighborhood centers, and power centers. Any of these centers can be service-oriented, but the key is a high concentration of service-based tenants versus product-based ones. Examples include grocery stores, medical offices, gyms, and restaurants.
Why CRE Investment in Service-Oriented Retail Centers?
Unlike physical products, services like haircuts or doctor visits can’t be easily replicated online. This inherent resistance to e-commerce disruption makes service-oriented retail centers attractive for CRE investment. They tend to have higher occupancy rates, lower tenant turnover, and offer several other advantages:
- Destination Appeal: Service-oriented centers can become destinations, attracting customers who visit multiple tenants in one trip. This creates a positive feedback loop, drawing even more high-quality tenants to the property.
- “Guilt by Association” Mispricing: The struggles of traditional department store malls have unfairly tarnished service-oriented retail by association. This can present a value play for investors seeking undervalued assets with strong fundamentals.
- Stability of National Tenants: Service-oriented retail centers anchored by creditworthy national chains can be particularly attractive. These centers often command higher valuations and lower cap rates, making them especially appealing to institutional investors.
- Long Term Leases & NNN Leases: Retail leases are often longer than office or multifamily leases, reducing disruption from frequent tenant turnover. Additionally, service-oriented retailers often have Triple Net Leases (NNN), where they cover most property expenses. NNN leases simplify management and can make service-oriented centers more marketable.
- Portfolio Management Efficiency: Managing service-oriented retail centers can be efficient, especially when buying multiple centers in the same market. This creates economies of scale and simplifies portfolio management.
Risks to Consider
While service-oriented retail offers promise for CRE investment, there are risks:
- Location: Location is paramount for retail investments. Success hinges on the long-term health of the surrounding neighborhood. Invest in communities with demonstrated support for service-oriented retail.
- Trends & Fads: Retail is susceptible to fads. Focus on properties with tenants with a proven track record, like grocery stores, rather than trendy concepts with uncertain lifespans.
- Holding Period: Retail investments often require a long holding period, typically 10 years or more. Macroeconomic shifts can negatively impact an investment over such a timeframe. Expertise in navigating economic cycles is crucial.
By understanding these factors, investors can capitalize on the growing opportunity in service-oriented retail centers within the CRE landscape.