New Contenders: Retail Condos Take on Traditional Net Lease Investments

Reston, VA-Net lease investors interested only in freestanding retail properties are ignoring a very lucrative investment opportunity--net lease retail condos. These properties offer many of the same benefits as traditional net lease investments. Moreover, they allow net lease investors (or net lease brokers) to put money into areas that traditionally exceeded most net lease investor budgets: dense urban areas with strong foot traffic.

“In general, retail condos are very well located and have very good demographics and demand drivers,” says Harmar Thompson, senior vice president of Lowe Enterprises Real Estate Group. The Los Angeles-based developer recently sold the retail portion of its CityVista project to Columbia, SC-based Edens & Avant.

Located in Washington, DC's Mount Vernon Triangle neighborhood, the mixed-use project includes 441 condominiums, 244 rental apartments and roughly 116,000 square feet of retail. The project is structured with a condo regime, Thompson says, which allows Lowe Enterprises to sell pieces of the project to monetize other components. A 55,000-square-foot Safeway anchors CityVista and was part of the retail condo that Edens & Avant acquired.

Like traditional net lease investments, net lease retail condos are leased to tenants that have committed to a long-term lease, usually longer than 10 years, and as long as 25 years with increasing rent over the lease term. The tenant is responsible for paying rent plus some or all of the operating expenses of the building such as taxes, insurance premiums, repairs and utilities.

Retaining Value
Most retail condos are located in central business districts, though retail condos can also be found in suburban locations. Cities such as New York, Chicago, Boston, San Francisco and Washington, DC have the largest concentrations of retail condos, but smaller cities like Seattle, Denver and Charlotte, NC also have retail condos.

Over the past five years, more than $20 billion worth of retail condos have changed hands in the United States--and that’s just in urban areas, according to Real Capital Analytics, a New York City-based research firm. Though the total includes only deals larger than $5 million, a significant portion of retail condos sales come in well below the $5-million mark, making retail condos accessible to a wide range of investors.

Real estate assets in urban areas tend to retain their value better than assets in suburban locations, making urban retail even more attractive to net lease investors. However, most net lease investors have been priced out of urban markets because the only available investments were entire buildings with price tags in the tens of millions, if not hundreds of millions.

The vast majority of retail condos are part of mixed-use buildings. They typically occupy the ground floor of vertical mixed-use projects with office, hotel or residential above the retail, and sometimes all three. They can also be found in town center projects in suburban areas. Retail condos range in size, from as small as 500 square feet to 50,000 square feet or more.

The difference between a typical mixed-use project and one that includes retail condos is the ownership structure. Developers choosing to go the retail condo route end up implementing a condo regime on their projects, which basically carves up the different uses in the project into as many pieces the developers desire. Retail condos can be sold to an investor or buyer who plans to occupy the space. The retailers occupying retail condos aren’t just mom-and-pop retailers either; large national retailers also sign leases in buildings that have been structured as retail condos.

“Retail condos offer bite-sized pieces for net lease investors,” Thompson points out, adding that investors are increasingly willing to pay a premium for retail condos because of their urban locations and built-in foot traffic from nearby office tenants or residents.

This willingness to pay a premium is a marked change from just a few years ago. “We find that people are much more accepting of condo interests than they used to be,” Thompson says. “In the past, investors paid less for condo interests because they were uncomfortable with the fact that they would never have full control of the entire property. But, enough developers have done retail condos that lenders and investors are comfortable with the product.”

That doesn’t mean net lease retail condos still don’t have their quirks. Janis Schiff, a partner in the Washington, DC office of Holland & Knight and head of the firm’s real estate group warns that investors must accept they own only a piece of the building and the entire project may have issues or expenses in addition to the retail condo. Also, investors have to deal with condo associations, an added complication that many net lease investors actively avoid, Schiff says.

Nonetheless, net lease retail condos offer plenty of benefits. “For net lease investors who don’t want to own a property in the middle of nowhere and prefer a sure thing in terms of traffic and density, retail condos are an option,” Schiff notes.

Monetizing Pieces
Retail condos are not only lucrative for investors, but for developers as well. In fact, more and more developers and joint ventures are structuring their projects to include retail condos. “Condo regimes are a way to harvest value in complicated mixed-use projects,” Thompson says, adding that Lowe Enterprises sold the CityVista retail condo before it was able to sell out its residential condos. “We had the option to monetize components to pay off the loan.”

In traditional retail developments, developers can subdivide their projects and sell off parcels to multiple retailers, and the proceeds from the land sales provide equity for the entire project. Historically, developers didn’t have the ability to monetize specific pieces of mixed-use projects because it was nearly impossible to sell off parcels of a mixed-use development, especially a vertical development. Developers were forced to follow an “all or nothing” strategy--either leasing everything or selling everything.

But condo regimes make it possible for developers to divide mixed-use projects in various ways. Schiff contends that condo regimes are one of the best ways to separate value and reduce risk because developers can own each component of their projects separately. “Condo regimes give developers more flexibility,” she concludes.

Beyond flexibility, it’s not uncommon for some developers to actually make more money by selling parts of their projects rather than selling the projects whole, Thompson notes. This is especially the case for mixed-use projects in urban areas with national tenants committed to long-term net leases.

“We see mixed-use properties as the future, so it makes sense for a net lease investor to bet big on those types of projects,” Thompson says.

Jonathan Hipp is president and chief executive officer of Reston, VA-based Calkain Cos. and a member of NET LEASE forum’s editorial advisory board. The company’s website can be found at calkain.com