Top things to consider when buying a Boston retail property
Providing you have the right experience and knowledge, investing in the Boston retail sector can be very rewarding.
Investors typically buy retail property in Boston for its income potential as commercial real estate (of which retail is a sub-set) is expected to achieve a higher return on investment (“RoI”) when compared to residential properties. There are several reasons for this which we will discuss later.
The two main types of owners of Boston retail property are
- investors who will buy a property and rent it out for the income stream, and
- owner occupiers who will buy a retail property so as they can run a business from the premises. The owner occupier type buyer is generally in the minority with most retail properties in Boston owned by investors. Most times business owners wish to be “asset light”.
But, in any event, what are some of the key things which should be considered when buying a Boston retail property? To start, though, let’s be clear about: just what is a retail property.
A retail property is…
… a street side unit or space within a purpose-built shopping centre from which a trade or business selling goods (ie clothes or cosmetics or a variety department store) or services (ie dry cleaners, postal or courier services or mortgage brokers) may be carried out.
A Boston retail property may be single or multi-storey, say from 30m2 or 300m2 and in the city or the suburbs. There may be restrictions imposed by the local planning authority on what a particular retail space may be used for.
Some top things to consider when buying a Boston retail property
Investing in the Boston retail property sector requires specialised knowledge and experience as such properties are highly locational dependent plus the nature of occupancy can vary widely.
It’s, therefore, smart to study the sector carefully and ask lots of questions. Ask professionals whom you know and who deal in the retail sector lots of questions: ask real estate broker(s), commercial loan advisers, legal advisers and so on.
Group similar questions together and find objective answers to them all before making a decision to invest in the Boston real estate sector.
Here are some of the key questions to consider, the answers to most of which will help determine the likely rental value of the property and, as a result its capital value::
Location and suitability of the property
- location: is usually the most important factor key for the majority of retail properties. Is the unit in a highly visible location, either passed by many pedestrians or can it be seen by passing traffic; can it be easily found and is there parking nearby or on site for customers?
Of course, some retail units where the occupier is selling services may not need a “high footfall location” as their client will have to find them even if they are not located in a “prime prime” location. The same can be said to an extent for national brand names such as McDonalds or Burger King whose customers will seek them out, lured by their reputation and marketing.
But, suffice to say, location is very important!
- permissible or restrictive uses: do local planning regulations provide a list of “permissible uses” for certain retail units (ie selling fashion items or other goods) but restrict the uses of certain retail designated units for food and beverage outlets (or restaurants) services (or non-retail) businesses such as lawyers or mortgage brokers?
size and layout: is the retail small or big enough to cater for a variety of trades; is the frontage wide or narrow and the internal space column free or dotted with structural pillars which make selling goods difficult?
demographics of the surrounding neighbourhood: unless the retail property is in the city centre, it’s worth to establish if the surrounding neighbourhood is affluent or up and coming? Conversely, is it a relatively poor neighbourhood where the residents have limited purchasing power?
How to compare the purchase price with the rental return (“Return on Investment”)
There are a number of terms which you need to get used to when considering buying a
Boston retail property and it’s easy for the inexperienced investor to sometimes be unsure.
The most important thing to know when buying a retail property is the return on investment (“RoI”). This is sometimes called “cap rate” or “investment yield”. However, try to make sure that your “Net RoI” exceeds any repayment you have to make to your loan provider.
Here is an example to demonstrate this: If you buy a single unit retail property:
$1,200,000 for 1 unit = $1,200,000
Annual rental = $ 72,000
Gross RoI = $ 72,000 divided by $1,200,000 = 6% (or the cap rate)
Now this part is important… many retail units are let on so-called “triple-net” leases which essentially mean that the tenant pays for all outgoing including repairs and maintenance and utilities. Therefore, the rent the investor actually receives is the Gross Rental or very close to it. There are exceptions and variations as, for example, the owner has to pay some taxes.
But here, let’s say, simplistically, that:
the only expenses for the owner amount to 5% of the Gross NoI; this takes the NoI down to $ 68,400 per annum or 5.7%.
As long as you have a loan with an interest rate of around 5% or less, then you will have a positive cashflow.
Of course, buying the retail units for all cash means the NoI is all yours!
Is there potential for an increase in capital value?
Most experienced investors will look at two key financial aspects of buying a retail property in Boston. First will be the rental income as mentioned above and, secondly, the potential for capital growth. These are usually interlinked.
Retail rentals should grow over the long-term as a tenant’s business improves, an area becomes more established and in view of the relatively limited supply of retail units. It’s not always possible to easily create new retail areas due to planning and other restrictions.
However, cap rates (that is the rate of RoI accepted by buyers) will decrease as more buyers want to buy retail properties. In such cases, prices will rise as long as rents remain stable.
Using the example from the section above:
if net cap rates drop to, say, 5%;
the NOI stays at $ 68,400 per annum;
then a potential buyer will pay $ 68,400 divided by 5% or $1,368,000 compared with the original purchase price of $1,200,000… a 14% uplift in value!
What sort of financing can I get?
Financing a retail property in Boston will more than likely be possible through a specialised commercial mortgage lender. They will probably handle commercial mortgages for a range of property types including retail units, offices and industrial space.
Generally, commercial mortgages or loans cost more than residential loans and the investors in retail may have to make a higher down payment and pay a higher interest rate. This is mainly as the success of a retail investment depends to an extent on the tenant leasing the space and running the business. However, cap rates are generally higher to reflect such risks.
Are there tax benefits?
Any expenses associated with renting out retail property in Boston are subject to federal tax. However, tax is only paid on the profits, not the gross income and legitimate expenses can be deducted.
Taxes can be further reduced by depreciation write downs and interest payments being offset.
There are also some limits and exemptions in respect of taxes payable on commercial property income.
Property management: do it yourself or sub-contract?
Most experienced retail property owners hire a property manager instead of self-managing.
Not only does this take away the problems of being a landlord, such as being on call for repairs or maintenance items 24/7 but the property manager will likely find it easier to identify and negotiate with new tenants etc.
