One of the most important decisions we make in commercial real estate is deciding which properties not to buy. Sometimes the best deals are the ones you walk away from.
There is always another transaction available, and when capital is ready to be invested, there can be pressure to put it to work. But completing an acquisition simply to get a deal done is not an investment strategy. We establish our criteria before evaluating a property, and if the fundamentals don't support the investment, we're comfortable walking away.
That discipline has become particularly important in grocery-anchored retail, where the presence of a strong supermarket can sometimes overshadow weaknesses elsewhere in the property.
A recognizable grocery anchor, attractive demographics and a seemingly reasonable capitalization rate may generate initial interest. None of those factors, however, guarantees a successful investment.
The real work begins when we examine the tenants, their leases and the income the property can realistically produce over time.
Start With the Credit Behind the Rent
A shopping center's value ultimately depends on its ability to generate dependable rental income. That makes tenant creditworthiness one of the first things we evaluate.
The grocery anchor deserves particular attention. We want to understand the tenant's financial strength, its commitment to the location and the importance of that store within its broader operating network.
But our analysis doesn't stop with the supermarket.
A center may have a strong grocery anchor while several smaller tenants present meaningful credit or operating risks. Those tenants contribute to occupancy, cash flow and the overall shopping experience. Their ability to meet lease obligations matters.
We also consider how the property fits within the surrounding community. A well-positioned grocery store can generate consistent customer traffic, but the strength of the overall tenant mix determines how effectively that traffic translates into sustainable income across the center.
A property with a recognizable anchor and high occupancy can still be an unattractive acquisition if the underlying rent roll is weak.
The Lease Tells You What You're Really Buying
Tenant quality is only part of the equation. The terms of the leases can be just as important.
We spend considerable time examining lease maturities, renewal options and contractual rent escalations.
A shopping center may appear stable based on its current occupancy and net operating income. But what happens when several tenants reach the end of their lease terms within a relatively short period?
What happens when tenants hold renewal options that limit the owner's ability to adjust rental rates?
And what happens when a long-term lease provides little or no contractual rent growth?
These issues can materially affect the economics of an acquisition.
A tenant with five years remaining on a lease and no rent escalations presents a different income profile from a tenant whose lease provides scheduled increases. Both may be creditworthy, but the property's ability to grow income will differ.
Similarly, renewal options can provide stability while limiting flexibility. The important question is whether those provisions have been properly reflected in the acquisition price and underwriting assumptions.
We don't automatically reject a property because a lease lacks escalations or includes tenant-favorable options. We do, however, need to understand the economic consequences.
The price has to reflect what we're actually buying, not what we hope the leases might eventually become.
A Good Property Can Still Be a Bad Deal
The relationship between acquisition capitalization rates and borrowing costs has made pricing discipline more important.
Consider a grocery-anchored shopping center offered at a 7% cap rate.
That initial yield may look attractive, but it tells only part of the story. Financing costs, capital expenditures, leasing commissions and tenant improvements all influence the investment's actual performance.
If several leases are approaching maturity, or if contractual rents remain flat for years, the property's future cash flow may be less compelling than its initial yield suggests.
This is where assumptions can become dangerous.
It's relatively easy to improve projected returns by assuming stronger rent growth, lower vacancy or a more favorable exit capitalization rate. The harder task is determining whether the property's actual leases, tenants and competitive position support those assumptions.
We prefer to identify opportunities to increase net operating income through achievable leasing and operational improvements rather than depend on a future buyer paying a higher valuation multiple.
If the investment only works under optimistic assumptions, it probably doesn't work for us.
Local Knowledge Still Matters
Our focus on the Carolinas reflects the importance we place on understanding individual markets and retail corridors.
Population growth and economic development can create attractive investment opportunities, but those trends don't benefit every property equally.
We want to understand the grocery competition, surrounding neighborhoods, traffic patterns and the long-term viability of the tenant mix.
A grocery-anchored center serving an established residential community may offer a different risk profile from a property dependent on future development or projected population growth.
Local operating knowledge also helps us evaluate the practical cost of improving a property.
Replacing a tenant, negotiating a lease renewal or addressing deferred maintenance involves more than assumptions in a spreadsheet. These decisions require an understanding of local leasing demand, tenant relationships and the capital necessary to execute the business plan.
The closer our underwriting reflects those realities, the fewer surprises we should encounter after acquisition.
The Discipline to Say No
We evaluate acquisitions with specific criteria because we believe consistency matters over the life of an investment program.
Tenant creditworthiness, lease maturity schedules, renewal options, rent escalations and acquisition pricing are not secondary considerations. They are fundamental to determining whether a property fits our strategy.
There will be transactions that look attractive initially but become less compelling as we examine the details. Sometimes the issue is the tenant credit. Sometimes it's the lease structure. Other times, the property is perfectly acceptable, but the seller's pricing expectations don't leave sufficient room for the risks involved.
In those situations, we're prepared to pass.
That doesn't mean every acquisition needs to be perfect. Real estate rarely offers that luxury. It means we need to understand the risks, have a credible plan to address them and pay a price that appropriately reflects them.
Grocery-anchored retail continues to offer compelling opportunities, particularly in markets supported by established residential demand and necessity-oriented retail.
But the presence of a grocery anchor isn't enough.
Ultimately, our responsibility is not to acquire the greatest number of shopping centers. It's to acquire properties that meet our investment criteria and have the potential to perform over the long term.
Sometimes the best investment decision is the deal we don't make.
About the Author
Blanton Hamilton is a principal of Tribek Properties (https://www.tribek.com), a commercial real estate investment and operating firm focused on the Carolinas. Through Southstar Investment Management, he focuses on the acquisition and management of grocery-anchored retail properties.