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Benchmarking commercial real estate, regional mall developers

Rental yield is one of the most important criteria for determining the success of a regional mall developer’s portfolio. A strong portfolio is one which continuously generates high rental income with consistent demand for space in a locality or region. Moreover, other factors such as occupancy rate, market value of the portfolio, types of tenants, lease expiration profile, tenant cost of occupancy (rent per sq. ft. in relation to tenant sales per sq. ft.), demand-supply forces and the general state of the local real estate industry play an important role in determining the profitability and success of a developer.

Televisory compared three mall developers from the US, Simon Properties (Simon) (228 properties with 189 mm sq. ft. of space), General Growth Properties (GGP) (133 properties with 129 mm sq. ft. of space) and Macerich Co. (Macerich) (59 properties with 55 mm sq. ft. of space) on several operational and financial metrics, including net and gross rental yield, occupancy rate, tenant profile, development pipeline, revenue per sq. ft. and expenses per sq. ft.

The gross rental yield is a function of gross rental income and the market value of the property, while net rental yield is a function of rental income, net of core expenses and market value of a property. Both gross and net rental yield have consistently increased for all the three companies, but were at different levels, with Simon at 20.8%, GGP at 11.9% and Macerich at 13.2%. The location of properties played a vital role in deciding the level of rental income for the firms since all three operated within the same country.

Generating high rental income is a combination of multiple factors and is enumerated below:

  • Popularity and location of properties can be measured by the footfalls which in turn get converted into tenant sales. For instance, tenant sales per sq. ft. for Simon grew at a CAGR of 3.7%, while that of Macerich grew at a CAGR of 6.7%. In line with this, revenue per sq. ft. grew at a CAGR of 11.3% for Simon and 23.4% (almost a double like increase in the percentage of tenant sales per sq. ft.) for Macerich. The revenue per sq. ft. of GGP declined as the company sold a few of its major properties in 2015. GGP’s rental rates were below Macerich and Simon as it had lower tenant sales per sq. ft.

  • Rental revisions and reimbursements are dependent on lease renewals and tenant retention rate. The amount of rental revision is also dependent on tenant cost of occupancy which is calculated as rent per sq. ft. to tenant sales per sq. ft. Tenants are generally willing to pay 12-14% of their sales towards rent. Hence, as tenant sales increases, rental revisions can be high, thus, this impact revenue and profits positively. The three companies analysed have consistently had a tenant cost of occupancy between 12-14%. However, Simon had a lower tenant cost of occupancy, this may give Simon the ability to revise base rental rates upward in the future.

  • Higher vacancy rates indicate loss of rental income and increased expense per sq. ft. as the company would incur fixed costs, which is compulsory to maintain the property, whether occupied or unoccupied. The increase in the occupancy rate of Macerich was also one of the reasons for the consistent increase in its revenue. Further, number and type of tenants play an important role in ensuring vacancy rates are not too high for the developer. For instance, anchor tenants tend to contribute to the majority of revenue and the stability of these tenants is of major importance to the developer. Additionally, the developer can diversify tenants based upon different industries, so a fall in an industry will not impact the occupancy rates. 

  • Revenue structure–developers generate revenue by charging a base minimum rent which is the basic amount a tenant need to pay. A developer may include overage rent, wherein a tenant is required to pay a percentage of their sales if the sales cross the threshold that has been mutually agreed. Furthermore, developers also include reimbursements for utilities and maintenance in their rental agreements. This generally reduces the costs borne by the developer.

Although the gross rental yield is important, the net rental yield considers the core expenses and reflects the operating efficiency of the developer. The difference in gross and net rental yield was the highest for Simon at 5.3% followed by Macerich at 4.2% and was the lowest for GGP at 0.6% in 2015. This indicates that operating expense per sq. ft. of Simon and Macerich were much higher than that of GGP. A very low difference in the gross and net rental yield for GGP was due to the reduction in the core property operating expenses as a result of the sale of fewer properties in 2015. Macerich saw a high operating expense per sq. ft. because of investments in small power shopping centres that failed to enable leverage on economies of scale such as that of Simon. 

Along with the above-stated, the future expansion plans and development pipeline plays a significant role in order to ensure consistent improvement in the prospective performance.

In conclusion, one cannot understand the performance of a developer just by looking at the rental yield. One would need to delve deeper and analyse several factors as explained above to understand the true performance and success formula of a regional mall developer.

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