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Things to Consider with Retail Property Valuations

TORONTO - DECEMBER 2018

The criteria used for assessing property values changes and adapts as a new competitive landscape emerges. As property owners face new pressures to differentiate their business models from online experiences, their tenants are combining excitement, digital integration and a high levels of service to compete. Investors, appraisers and landlords should consider these factors on existing and potential retail properties.


A property may no longer be financially feasible to continue operating as a retail property. A growing number of landlords are realizing retail may not be their property's maximally productive use. Symbolic of this shift is the repurposing of the 676,000-square-foot Lord & Taylor flagship store in Manhattan, New York into WeWork’s new global headquarters, with plans to convert all but the lower three levels to office. The giant acquired the iconic property from Hudson’s Bay.


Investors historically sought retail properties with traditional anchors like Macy’s and Nordstrom because they drew a strong consumer base. There were 34 billion visits to U.S. stores in 2010, nearly twice as many as the 17.6 billion recorded in 2013. Some forward-looking landlords are hoping to attract customers, refresh their malls and, in some cases, quadruple their rental income, by replacing these struggling department stores with a number of smaller, experiential shops. As investor demand shifts toward malls with more experiential tenants, such as movie theatres and food and beverage, real estate appraisers or investors need to have a fresh mindset in how the preferred tenant mix impacts value


Some property types within the Retail Category, such as lifestyle centres, entertainment-centric malls and regional malls may continue to thrive, while big-box retail may transform into a combination of store and distribution or warehousing space.As the integration between online presence and retail stores evolve, so too will the retail physical spaces. These changes may have a material impact on rent and expense levels that drive the valuations.


Leases should be examined for co-tenancy and go-dark clauses, which can dramatically impact the rental income collected. A major tenant’s departure can have a devastating effect on surrounding retailers’ foot traffic and sales. Co-tenancy clauses protect remaining retailers by lowering their rents in this instance. But because the stores’ sales may decline as a result of the overall property occupancy fluctuations, the rent paid to landlords as a percentage of store sales can also diminish.


Depending on the overall health of the mall and its anticipated response to store closures, future cash flows may be significantly lower and difficult to estimate.


Newly developed retail properties may take longer to lease up vacant space as the uncertain competitive climate inspires greater caution. Historical property data and assumptions may no longer be valid forecasting tools. Downtime and re-leasing assumptions of vacated space will require reconsideration.


Landlords may need to allocate more money for tenant improvement allowances to incentivize new tenants. As ambience becomes increasingly necessary to lure shoppers, additional capital expenditures may be required to update common areas and building exteriors.


The capitalization and discount rates are key assumption drivers of value in the discounted cash flow analysis. As e-commerce continues to challenge retail properties, many retail assets will be in a state of being non-stabilized, and the estimation of the capitalization and discount rates will require much greater consideration. An appraiser or investor will need to evaluate the risk inherent in the cash flows projected, such as the net operating income growth over the analysis period, and properly reflect market and execution risk in the investment rates.