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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   March 2013

What’s in Your Cart?

Ensure grocery properties meet industry benchmarks

What’s in Your Cart?

Over the past few years, retail  investment-property sales have picked up steadily, with many buyers getting off the fence to take advantage of lower prices and more readily available financing products. Despite this positive momentum, however, commercial mortgage brokers should be aware that lenders view different retail properties in different ways.

Lenders generally continue to be cautious and selective in their funding. They typically require larger equity contributions and have a strong preference for quality assets that have a stable rent roll and solvent tenants, as both of these factors increase the probability of long-term success.

To further understand how lenders are likely to perceive retail properties and assess their long-term viability, commercial mortgage brokers must understand the basic trends in consumer spending, which typically are dictated by the overall state of the economy.

The economic effect

The retail market is affected directly by the condition of the economy, and individual retailers’ revenue is determined by the availability — or lack thereof — of consumers’ discretionary income. In turn, the revenue that retailers generate affects the stability and overall value grade of the investment when it comes to purchasing and financing real estate.

In a strong market with low unemployment and high job growth, consumers typically have excess amounts of discretionary income that is likely to be spent on nonessentials or luxury goods. Most retailers benefit from an influx of consumer spending that contributes to higher profits, which in turn will spark a growth-and-expansion cycle for retailers.

In a slow market similar to the one we are in, many retailers have been hit. With higher unemployment and much more limited access to discretionary income, consumers are directing their spending toward the bare necessities. As a result, retailers of basic commodities have seen their sales on the rise at a significantly faster pace than the general trend.

Grocery is a commodity business that flourishes in a weak economy because consumers are likely to spend less money on dining out and focus instead on stocking the refrigerator. As a result, retail and food-service sales have posted strong increases since the peak of 2008. With this consumer shift, retail properties that cater to grocery stores have been gaining in value and performance stability.

The benchmarks

With adequate knowledge, commercial mortgage brokers can be in a position to help borrowers understand the benchmarks that lenders likely will be using when considering financing grocery stores and grocery-anchored retail properties. This knowledge doesn’t only guide borrowers to fulfill lenders’ requirements to get funding, but it also provides good insight into what ensures long-term stability for their investments. There are two major points to keep in mind:

Sales per square foot: This is a number that gauges the overall economic health of a store. The higher the sales that a grocer generates per square foot, the more likely it is that that user will continue to operate at that location for a long period of time without the risk of relocating or going dark. This perceived long-term stability has a correlation to the value of the property as an investment when that particular tenant is occupying space. This industry benchmark typically is $300 per square foot of gross annual sales. A store that achieves this benchmark generally will be considered to be performing well. In areas with a higher cost of living, stores will expect higher sales because of the increased cost of occupancy and typically much greater density of population. If a store has consistent sales of less than $300 per square foot, lenders may perceive that store to be at a higher risk level with a potential of vacating before the investors’ holding period. Borrowers also should take this benchmark into consideration to assess their risks when deciding on the investment feasibility.

Rent-to-sales ratio: This is an industry standard that lenders typically use to gauge an operator’s ability to pay rent by comparing the amount of rent that a store is paying to the gross annual sales of that particular store — or projected sales for a proposed store. The lower the ratio, the stronger the store, and vice versa. The industry benchmark typically ranges from 2 percent to 4 percent of gross annual sales. Grocery stores that have a ratio higher than 4 percent may have a tough time competing in the marketplace, and lenders are likely to see them as weak, high-risk investments. Lenders, therefore, may either require a larger equity contribution from the borrower or deny funding altogether. Stores with a much lower ratio, however, typically are seen as a prime investment because of their ability to generate strong cash flow that contributes to long-term stability.

• • •

The slow economy has been a boon for grocery operators who generally have seen increasing sales per square foot over the past five years. Commercial mortgage brokers, therefore, may have noticed the increased lender appetite for this product, particularly for the stores that are performing at or above industry benchmarks. There is also a stronger appetite from larger retail investors nationally who are focusing a good portion of their acquisitions on grocery-anchored properties or freestanding grocery stores. This trend is likely to continue until the market sees enough positive momentum and consumers’ comfort level on discretionary spending loosens.

With that in mind, commercial mortgage brokers should ensure that their borrowers’ investments meet industry benchmarks before they go shopping around for funding. They also have to take into consideration the specifics of each market, and whether it provides the same stability that grocery investments have seen nationwide. If all of these points are in line, then it is time to check out lending opportunities.


 


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