Why You Shouldn’t Ignore Strip Centers

NEW YORK CITY—Think every asset type in the net lease sector has been picked over? Then consider the strip center. While it might lease to multiple tenants, its smaller size makes it more of an alternative to single tenant offerings, but with better cap rates and returns. So says Joe Chichester, director of Faris Lee Investments, in this commentary for ICSC New York National Deal Making event. The views expressed below are his own.

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Joe Chichester, Director

In recent years, single tenant net leased investments have been wildly popular among real estate pros and novices alike. As yield-seekers recognized this segment as an attractive alternative to other investment options, the category experienced significant growth and along with it historic cap rate compression. At the same time, those with more experience or a more adventurous temperament have favored the potential reward that comes with the operational complexities of multi-tenant investments.

But what about strip centers? While there are those who seek out strip investments, this often overlooked segment is a viable investment category in its own right; and in the polarized world of single vs. multi, strip centers can offer a compelling alternative.

The fact that strip centers can get “lost” between STNL and multi-tenant options presents an opportunity. In today’s fully-priced real estate market, real estate fundamentals become ever more critical, and well-located and relevantly designed strip centers are often providing investment opportunities with cap rates ranging from .75 to 1.25 basis point higher than STNL. At the same time, strip centers provide significantly less operational complexity than larger multi-tenant centers. With typically two to five tenants, strip centers usually offer meaningful services to their local community while providing the investor/owner with diversification—they are not solely dependent on just one tenant. STNL is either 100% leased or 100% vacant, and it is often difficult to replace with a tenant of equal or greater value in 2nd generation assets. Whereas strip centers are still candidates for self-management, larger multi-tenant centers almost always require larger scale human and financial resources and greater management experience for optimal investment return.

For those who are invested in STNL assets who want to leverage into a higher yield for nominal additional risk, there is an opportunity to take advantage of the dislocation in pricing between STNL and strip centers. Yield can improve significantly, simply due to the arbitrage between these two asset classes. If debt is incorporated, pricing still provides for positive leverage, thereby adding additional improvement to the cash-on-cash return. Not all strip centers are the same, however, and real estate fundamentals are paramount…location, well-designed physical layout and need-based tenancies are key fundamentals to look for.

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