Real Estate:

In a World of Changing Retail, Some Things are Consistent
by Matthew L. Rufrano, Managing Director, DJM Realty

You can just see the corporate scene now! The chief executive officer is discussing methods to grow corporate revenue, and up pops a Power Point slide showing new potential locations for retail operations. While it is difficult enough to build, acquire or lease stores, it is just as difficult to operate a store and generate the necessary sales volume to achieve an appropriate profit. Given the competitive nature of retailing, and the need for public/private companies to demonstrate growth, it's not surprising that some stores are not successful and change quickly from operating stores into vacant excess space.

Retailers are just that -- retailers. While they keep real estate professionals on staff, their major business is retailing, not operating or disposing of real estate. When retail stores change labels from "operating business" to "excess real estate," the two dominant questions are how to convert that real estate into a profitable, or breakeven scenario, and how to implement a strategy to reduce losses.

How this endgame eventually plays out is a function of many variables -- some of which are fixed and others which are much more dynamic. Whether the store is owned in fee simple (both land and building) or leased from a landlord represents the first major hurdle. Owned real estate allows for a "clean" sale subject only to zoning issues and any deed restriction the seller may or may not incorporate within the deed. But even owned real estate must interact with market dynamics such as the space's size, configuration, existing parking, competitive stores and resulting market demand. In the final analysis, a user-buyer will only pay a price equivalent to a calculation based upon potential sales volume. And since each user-buyer may bring a different business concept to the real estate, it is not surprising to see a wide spread in offers to buy.

If the real estate in question is leased on a long-term basis, then the position (i.e., leasehold estate) may or may not have value. As with the fee simple estate there are many variables, but a unique factor dominating the analysis of a long-term lease is the comparison of contract (as stated within the lease) and market rent. While contract rent is easily computed, the market rent estimate is much more challenging since it must "match" with a typical user of the space (most probable) and not necessarily the highest rent bid. Confusing market rent with the highest rent bid (associated with a particular retailer) can lead to some very strange conclusions; therefore, the analyst needs to focus on market trends vs. a value in use to a particular retailer.

In conclusion, while retailers will be aggressive in their business plans in order to grow, not all "arrows" will hit the mark. Even if they do miss, the economic repercussions may not always be negative; in fact, they might even turn out to be surprisingly profitable.