What Approaches Do You Apply to a Small Strip Mall?

[Terrel L. Shields]

Have a 9 unit shopping center with about 12000 SF. It sold in 2013 for $850,000 and appraised in 2018 for $1.4 mil...seemed optimistic. In a town of about 20,000 active lakeside market. I found one newer with nigh identical size selling at $1.2 million. But they gave me the appraisal and they used only the sales and cost approaches. IMNSHO, perhaps the income approach should be considered. Sure enough in the report someone apparent flagged that and the appraiser responded (cool to have the review embedded.) They went to say that the gross income was $75,000 but did not develop the income approach nor estimate a cap rate. Well, even with a conservative 20% expense ratio, would you be cool with a 4.8% cap rate? Seems awfully low to me. I suspect the income estimate should be a little low from the sales I have but still I would think the cap rate should have bumped 7-8% offhand which chases that value down closer to where it sold for in 2013.

 

[Ricky LaFleur]

*in for the comments.

Just out of curiosity...
Did they give reasoning why Income Approach wasn't developed? Maybe they thought rental data was insufficient? Existing subject leases matter. If reliable data could be obtained it would very applicable here.
Did they give any support as to how they arrived at 4.8% cap? Unless this is a brand new Class A building and there were some 20yr leases with AAA rated tenants with above market rates... those kind of leases could cause an impressive sale price to an investor = lower cap rate. I'm interested what others think about retail cap rates post covid.

 

[Terrel L. Shields]

Did they give any support as to how they arrived at 4.8% cap?

They didn't make any guess and did not explain why they didn't use the income approach. Just said that they didn't need to. I just estimated from the income 80% for NOI and that makes for a very low Cap rate. They did mention the income and the expenses after the lender (?) queried why the income approach was not used. They noted the ground maintenance was done by the owners and no mention of a management rate or contingency for repairs etc. The cap rate for the purchase is around 9% in 2013. I had appraised a smaller strip that is 2 doors down. I'm going to go back and check the comps then even though it was 2+ years ago. I was going to look at it TH or FR but they were getting away for the weekend (he is a professional bass fisherman) and wouldn't be back until next week. I just don't think a pure rental property should not be valued by the income approach even if you later decide it is weak. I'd rather rely upon a weak cap rate from Realtyrates or some such than none at all.

 

[nauthead]

Why else would someone buy a retail plaza but for the income? I can't imagine not including that approach.

 

[Red Flint]

Strip mall cap rate discussion. RIP Stephen J

Cap Rate Anatomy - Retail Strip Center

I am doing an appraisal of a newer retail strip center. Good quality, strong tenants. The rents are quite high. The cap rates from the sales have been quoted from a secondary source. I contacted the seller to confirm the method of calculating and haven't heard back. My question is-for these...

appraisersforum.com

 

[glenn walker]

And with Covid-19 tenants uses being restricted , how many are paying ? Or able to be open ? We have two strip centers with over 50% of occupants, in trouble or not able to reopen , over the last 25years we had 90% + occupancy and 90% paying- Whats our strip centers worth Today "V" last year ? W have to many tenants that are considered non-essential service tenants, small restaurants, bars, etc, just opened last week and Governor closed them all again today for another 3 to 4 weeks- Income approach ? Yes our buildings lost 50% in 4 months : ) LOL

 

[Mark K]

I don't know many investors that would accept a 4.8% return on, what today is, a very risky investment. Maybe double that (at least) when you consider that the mortality rate of a small business today is significantly higher than the C-19 mortality rate.

In the past I looked pretty seriously at investing in some small NNN buildings, Dollar Store type of free standing buildings, but even when times were good they were paying 6-6.5%. Times aren't good out there today. Interest rates are lower today but the risk is infinitely higher until this virus situation blows over. Small strip centers may be looking at 50% vacancy this time next year, IMO.

 

[Deleted member 152047]

Have a 9 unit shopping center with about 12000 SF. It sold in 2013 for $850,000 and appraised in 2018 for $1.4 mil...seemed optimistic. In a town of about 20,000 active lakeside market. I found one newer with nigh identical size selling at $1.2 million. But they gave me the appraisal and they used only the sales and cost approaches. IMNSHO, perhaps the income approach should be considered. Sure enough in the report someone apparent flagged that and the appraiser responded (cool to have the review embedded.) They went to say that the gross income was $75,000 but did not develop the income approach nor estimate a cap rate. Well, even with a conservative 20% expense ratio, would you be cool with a 4.8% cap rate? Seems awfully low to me. I suspect the income estimate should be a little low from the sales I have but still I would think the cap rate should have bumped 7-8% offhand which chases that value down closer to where it sold for in 2013.

Sales and income......20% opex ratio is ridiculous. At $6.25 PSF in PGI you would be lucky to report a NOI of $2.00 PSF. The fixed costs for operating such a center will be low, but RE Taxes are likely $1.00 PSF (at least), utilities $1.00-$2.00 PSF, insurance, R&M, management, etc. Management expense will likely be much higher than the normal percentage ranges. No one is managing a retail center for $3,750 per annum....most firms have a minimum say 5% or $10,000 (minimum).

 

[glenn walker]

I don't know many investors that would accept a 4.8% return on, what today is, a very risky investment. Maybe double that (at least) when you consider that the mortality rate of a small business today is significantly higher than the C-19 mortality rate.

In the past I looked pretty seriously at investing in some small NNN buildings, Dollar Store type of free standing buildings, but even when times were good they were paying 6-6.5%. Times aren't good out there today. Interest rates are lower today but the risk is infinitely higher until this virus situation blows over. Small strip centers may be looking at 50% vacancy this time next year, IMO.

Agree- What's difficult for the commercial appraiser right now is all his sales and income data are looking in the rear view mirror , and since we can't forecast the future I have a feeling that, as of now some of the appraisals coming through now will look crazy high next year. I now view most strip centers as non-essential properties because so many like ours catered to small -family run sit in eateries, sports bars, hair salons etc. And at least 50% in my area will not make it through this year. Whats deceptive for the commercial appraiser is a center can be 100% occupied but only operating at 50% capacity and owners are not going to tell the appraisers that tenants are not paying. I saw an-old guy like me with a camera walking by some of our stores a few weeks ago and he looked like an appraiser , so I asked him and he said yes. he was a MAI and doing a strip center down the road from ours, he said his was a little smaller but with some similar type tenants. He asked me about our rents and occupancy - I told him we were 90% occupied but 50% of tenants were either behind in rent or not paying at all, because they keep getting shut down by Governor. The MAI said yes similar to the one I am doing except, the property manager swears everyone is paying --I laughed and said of course-he is trying to sell it and hopes the new buyer doesn't figure it out. I then asked the MAI-how was he going to deal with the income approach ? He responded with I got to be honest in 30 years I have never dealt with anything like this and I know all my sales comparables from 6 to 12 months ago are all higher and they had good lease rates and occupancy, so he laughed and said I have no idea -He said good by and I said good luck : ) LOL

 

[Deleted member 152047]

Agree- What's difficult for the commercial appraiser right now is all his sales and income data are looking in the rear view mirror , and since we can't forecast the future I have a feeling that, as of now some of the appraisals coming through now will look crazy high next year. I now view most strip centers as non-essential properties because so many like ours catered to small -family run sit in eateries, sports bars, hair salons etc. And at least 50% in my area will not make it through this year. Whats deceptive for the commercial appraiser is a center can be 100% occupied but only operating at 50% capacity and owners are not going to tell the appraisers that tenants are not paying. I saw an-old guy like me with a camera walking by some of our stores a few weeks ago and he looked like an appraiser , so I asked him and he said yes. he was a MAI and doing a strip center down the road from ours, he said his was a little smaller but with some similar type tenants. He asked me about our rents and occupancy - I told him we were 90% occupied but 50% of tenants were either behind in rent or not paying at all, because they keep getting shut down by Governor. The MAI said yes similar to the one I am doing except, the property manager swears everyone is paying --I laughed and said of course-he is trying to sell it and hopes the new buyer doesn't figure it out. I then asked the MAI-how was he going to deal with the income approach ? He responded with I got to be honest in 30 years I have never dealt with anything like this and I know all my sales comparables from 6 to 12 months ago are all higher and they had good lease rates and occupancy, so he laughed and said I have no idea -He said good by and I said good luck : ) LOL

Argus is a beautiful thing, but most in our profession are afraid of it (as they are not qualified to use it and/or don't want to spend the $$). Sales are great, but to your point, they are stabilized indications of value.

Your Argus run would be your "as is" market value and you could derive an adjustment between the stabilized and "as is" market values. This adjustment would be applied to your sales to arrive at an "as is" indication FWIW. Regardless, I would spend 85% of my time in the income approach talking with participants and modeling that Argus.