As shopping center developers and owners know full well, operating a consistently successful center depends on their ability to attract and maintain highly recognizable, credit-worthy anchor tenants.
Unfortunately, by neglecting to separate anchor tenants' property lines from the rest of the shopping center, many developers fail to maximize their profits. The method takes some pre-planning, but it is very profitable in the end.
Process of separation By the time a developer has acquired a site and determined the type of anchor tenants and where they might be located, he should already have signed leases for them. Those leases should allow him to develop a separate lot line, or separate property, from the rest of the shopping center, with the required amount of parking allotted.
By taking this approach, the developer or owner could later, if necessary, split off and sell the anchors separately from the rest of the shopping center. This can be done with pad sites as well.
It is a basic fact that anchor tenants sold on a triple-net basis yield a much higher profit than an entire shopping center. That's because the centers themselves require a tremendous amount of management. Before the shopping center is constructed, the lease should be negotiated on a triple-net basis, which also would help the presale, or sale, of the anchor tenant itself.
Better yet, developers should construct the lease whereby the tenant is responsible for the direct payment of real estate taxes, insurance and common area maintenance of the tenant's portion of the center, with strong language to support the type of cleaning and maintenance necessary to preserve the shopping center's integrity.
Anchor tenants generally realize the importance of having good common area maintenance programs, so this is usually not a problem. This aspect of separating the anchor tenant is very important because the typical investor or purchaser pays top dollar for these types of properties, which require no landlord responsibilities or management.
The developer may be required to lower the rent slightly to entice the anchor to sign such a lease, but the profits will more than offset the cost of negotiating a lease to be a full triple-net. It is also important to make sure there is continuous operation included in the lease so that the space is never dark or unoccupied. This is absolutely essential because the image of the center and that of the anchor tenant are so closely aligned. An unoccupied building hurts the sales of other tenants in the center. Additionally, business interruption insurance should be required in the lease so that in the event of a casualty the landlord would still receive his rental payments.
Formula's proven track record This same formula applies to properties even as small as 10,000 sq. ft., which can be sold separately from the shopping center. We all have noticed a tremendous amount of 1031 Exchange buyers as well as many buyers who concentrate only on triple-net-leased properties with no management.
Nearly all anchor tenants earn a credit rating by the credit rating agencies, such as Standard & Poors. Ratings are important to the developer because the financing, the ability to resell the property, and the success of the shopping center all depend on the credit-worthiness of the anchor.
With a high-investment-grade credit tenant or anchor (S&P ratings of BBB+ or better), and possibly a 20-year lease term with increases every five years or so, it is possible that the selling capitalization rate could be as low as 7.5% to 8%, whereas the developer's cost could be in the range of a 9.5% to 10.5% cap rate. The lower the cap rate, the higher the purchase price. (Example: Annual rent is $750,000 divided by 8% equals a selling price of $9.3 million. At a 10.5% cap rate, divide $750,000 by 10.5% for a total of $7.1 million and a profit of $2.2 million on a sale.)
The sale of the anchor tenant portion of the center demands the highest price when all tenants are in place and the center is fully operable with a good track record. However, some smaller developers may need to sell the anchor site prior to construction to reduce the amount of equity required of them to build the center. This holds true for shopping centers of all sizes.
Play it smart Developers should be aware that the presale, as well as sales prior to the permanent loan, can often negate a large amount of equity required and ultimately prove to be quite profitable. A smart business move would be to engage a purchaser for these triple-net anchors prior to construction and then obtain a construction loan.
With this commitment in hand, it is routinely easier to get permanent financing and construction financing for the shopping center. It is not unusual for an entire shopping center with management to sell for approximately 150 to 200 basis points over the going cap rate for a triple-net property.
If the developer wanted to sell both the shopping center and the anchor properties, he would first sell on a presale, if possible, the anchor portion and possibly earn an 8% return. Once the shopping center is 90% to 95% leased or close to full, he could probably sell the shopping center portion for a return in today's market of close to 9%, depending on the amount of square footage contained in each parcel.
His overall sales price for either the shopping center or the triple-net property could be as low as an 8.5% cap rate. While this might not apply to all situations, separate lot lines, lease forms and common area agreements are usually quite advantageous for developers, as is placing responsibility on the tenant of a triple-net lease property. Historically, this tactic has been, and should continue to be, highly profitable for the developer.
Typically, the best time to sell leased properties is when the center is completed or when it is fully occupied. However, a discount is really sometimes warranted on a presale, which requires less equity for the developer.
Why a presale? Presale is a good way to go if the developer wants to minimize his equity requirements or take advantage of low interest rates, which have hovered near historically low levels for the past three years. There are strong indicators that interest rates will not drop much farther; in fact, they are expected to begin rising in the near term. It is a good idea to keep a close eye on Treasury rates. Periods when they are in decline are the most advantageous times to sell your property.
When do I sell? Trying to time a sale is like trying to time the stock market. It is almost impossible to guess the perfect moment. Instead, developers should watch interest rate trends while concentrating on potential pre-sales of anchor tenants with a plan that will separate ownership and/or split lot lines of these properties from the rest of the shopping center.
With such a plan in place, developers maximize their profits and they also generate the capital to develop other properties.
Even for the developer who would like to hold the property, the same formula applies because it is much easier to obtain permanent financing for a single-anchor tenant property than for the entire shopping center. Developers can get a higher loan-to-value by financing the property separately from the triple-net anchor and the rest of the shopping center.
Splitting off anchors in separate leases with separate lot lines helps on a presale; it also enables developers and owners to receive a higher loan amount which, in turn, increases the cash-on-cash return for any equity that the developer may infuse into the project.
