BiggerPockets

Retail Condo’s: Are they the solution to all the shopping center vacancies?

Tuesday, April 27

While touring a shopping center with an investor the other day, we started talking about the mass amount of vacancies and what the future holds for the retail real estate sector.   Both of us agreed that though the signs pointed towards the economy getting better, we still had a long way to go until things get back to “normal”.  After sharing a few war stories, we eventually started discussing the rising trend of converting retail centers to condo’s and selling the units to tenants.   Much to my surprise, he was familiar with the concept and had successfully converted, and sold out, seven centers using this method over the last couple of years.  I expressed our success with this strategy as well and asked why he thought more lenders and developers aren’t using this method given all the troubles they are having with retail projects.  He summed up his answer with a short story about how he tried unsuccessfully to get a loan, from a lender that had funded several of his other retail projects, to develop a retail condo development many years ago.  He met with the lender and discussed his strategy and the lender said they needed to think about it and get back to him.  When the lender called to decline the project, the developer asked them why.  Their response was “We don’t know why, we just haven’t seen many retail condo projects and there must be a reason”.  It was basically the fear of the unknown.  The lender didn’t understand the concept and fell victim to the “group think” mentality.

After a few years of declining lease rates, increasing vacancies and the nose dive that the retail investment sector has taken, lenders and developers are starting to realize the benefits of selling condo units versus setting on properties with high vacancy rates or having to give away the farm to get a tenant to sign a lease.  In a recent Retail Traffic article, the developer saw a huge increase in the interest of their project from quality tenants once they switched from a for-lease to a for-sale strategy.  It shouldn’t be a surprise given all the benefits that tenants receive from owning versus leasing a unit including:

• Low interest rate SBA financing for owner/users
• Cost of owning a unit is usually cheaper than leasing the space
• The payment stays the same (no annual rent escalations)
• Appreciation of their real estate asset
• No landlord meddling in their business
• Tenants get to use 39.5 year depreciation against their taxes
• They can can lease or sell their unit of the business goes belly-up

Both lenders and developers are also starting to see the case for converting retail developments into for-sale condo units.  In some cases, lenders are even putting pressure on developers to convert their projects hoping to stave off foreclosure and having another failed retail project in their OREO portfolio.  Some lenders are starting to convert their bank-owned retail projects into condo’s and sell units instead of selling the entire asset at a fire sale price.  Lenders even have an added bonus of potentially supplying the financing to the tenants giving them additional profits from the assets. Some benefits shared by the lenders and/or developers include:

• Higher overall sales price compared to selling as an investment to a single buyer
• Reduction in debt
• Better cash-flow on existing leased units
• Generally easier to sell than to lease units
• Attracts higher quality business owners

While retail condo’s aren’t for all tenants, local and regional business owners tend to prefer the benefits of ownership while the national tenants would still rather lease space.  This could possibly change over time as more and more tenants, developers and lenders see the value in selling condo units.

This is a re-post from our blog at www.acrescre.com