Outparcels are outliers no longer. Once a fringe niche in the retail leasing and investment world, these pad sites on the outskirts of shopping centers are getting snapped up at a record pace, as restaurants and retailers frantically seek in-your-face space on mall ring roads and busy streets.
The industry is responding to the demand by finding ways to create new outparcels or by repurposing old ones, say developers and leasing agents. “Pads are commanding big rents now, and tenants are paying it to get street exposure, show their individuality and have captive parking,” said Randy Blankstein, president of The Boulder Group, a Northbrook, Ill.–based real estate investment services firm. “Shopping center owners, whether new construction or existing, are recognizing the value in these outparcels.” Pad locations typically benefit from traffic-drawing anchors, superior access, ideal sight lines and reusability, Blankstein says.
Centers of all stripes seem to be going pad-mad. Among them is California’s Outlets at San Clemente, slated to open near Interstate 5 this fall, with 13 outparcels. “We’re going after high-end restaurants and uses that are unique and different that will create an experience,” said Jim Clarkson, a partner at Newport Beach, Calif.–based Strategic Retail Advisors, which is leasing the spaces. The success of the mall will inevitably help the pads, “and the pads, with the right mix, will in turn help the mall,” he said. “If you have upscale tenants on outlining pads, the entire center gets a high-end feel.”
The strategy of shifting new lease space from an in-line configuration to a shopping center’s perimeter is especially prevalent in Dallas–Fort Worth, one of the top markets for shopping center construction. Southgate Marketplace, a planned 500,000-square-foot power center in Fort Worth, will be flanked by 11 roadside outparcels complementing another 11 stand-alone junior-anchor and anchor spaces ranging from 27,000 to 98,000 square feet.
In Lewisville, near Dallas, Weitzman Group/Cencor Realty Group’s 300,000-square-foot, grocery-anchored Castle Hills center features a 123,000-square-foot Kroger, surrounded by about a dozen outparcels facing three different streets. The pads will accommodate the food, service, medical and fitness tenants that would customarily have been located in-line, creating that highly desired impulse traffic for them, says Herb Weitzman, the firm’s executive chairman. “This center is a good example of how retail development is changing,” he said. “The smaller tenants are in the out-front pad buildings, and the big boxes are in the back.”
Some shopping centers are replacing attached space with small multi-tenant pad buildings, according to Nick Egelanian, president of Annapolis, Md.–based SiteWorks Retail Real Estate Services. Among the users angling for such spaces are fast-casual restaurants, drugstores, phone stores, vitamin shops, men’s clothing stores, game sellers and mattress retailers, plus popular specialty grocers such as Trader Joe’s, brokers say. Trader Joe’s, which started out with mostly in-line stores, is now occupying pads, including a 9,500-square-foot unit it is building on a vacant out-lot on Westheimer Road, in Houston.
Branch banks, on the other hand, seem to be scaling back pad development as they reassess site-selection models nationwide, says Justin Greider, vice president of retail brokerage for JLL’s Florida operations. Last year Think Mutual Bank sold an undeveloped pad it had bought on the periphery of T.J.Maxx Plaza, in Rochester, Minn., to Natural Grocers by Vitamin Cottage. The Colorado-based organics supermarket is putting the finishing touches on a 14,000-square-foot store, its first in Minnesota. “Retailers came out of the recession much more selective in where they locate,” said Greider, a former director of leasing at Crossman & Co., where he marketed pads for the Publix-owned shopping center portfolio. Of the neighborhood and regional shopping center projects that have failed since the recession, many were tied to too much in-line space, he says.
REITS are also capitalizing on their own prime locations in select markets to add or repurpose pads, including Kimco, which in early July was marketing outparcels in 29 states. Kimco’s pad strategy has become a key value-creation initiative both in its redevelopment and acquisition programs, says David Jamieson, Kimco’s executive vice president of asset management and operations. “From a development perspective, it enables us to reposition retail buildings that have been underutilized with a more vibrant and current tenant mix — such as Chipotle, Mod Pizza and urgent-care centers,” he said. “This optimizes the pad’s value while providing a value-add service to the shopping center and its customers.” On the acquisition side, Kimco likes the embedded-growth opportunities in pads, Jamieson says. “It allows us to maximize our return by allowing us to self-develop at our discretion while considering the highest and best use for the parcel.”
Simon is developing a newly created 14,000-square-foot, freestanding retail pad building in Houston next to its now-under-renovation Galleria, the center’s only freestanding retail structure. It will connect to the Galleria by means of a covered walkway. Some pads are even cropping up in Europe, Egelanian says, though “downtown first” agendas in the U.K. and on the Continent often restrict the types of outlying shopping center development conducive to outparcel development getting built, he says. Big-box stores with excess parking-lot space as well as secondary-market and ‘B’ shopping centers are getting into the act, subdividing fringe land to add value. “A lot of those pad sites that were sitting dormant or were intended for extra parking are really helping drive growth in the quick-service trade for chains such as Noodles & Company and Zoe’s Kitchen,” Greider said.
With retail development relatively stagnant over the past five years, competition for prime pads has grown keen, says William Rose, president and national director of Marcus & Millichap’s National Retail and Net Leased Properties groups. “They’re also quite attractive because they require less planning and permitting.” Retailers reluctant to tie up capital in store construction are attracted to sale-leaseback deals for pads where they can control operating expenses with preset terms, Rose says (see story).
Pads are fetching good prices from investors. Last year in a Marcus & Millichap–facilitated trade, four pad buildings in suburban Atlanta measuring between 2,600 and 4,100 square feet — part of Doraville Plaza center — sold for some $5 million in total. Occupying them are Chick-fil-A, Krispy Kreme, McDonald’s and Wells Fargo. This year a freestanding, 10,500-square-foot Walgreens drugstore in a retail district in the New York City borough of Queens went for nearly $15.7 million, or $1,494 per square foot, according to Marcus & Millichap. While outparcel real estate really did not start coming into its own as an asset class until early last decade, “the product type isn’t new by any means,” said Rose. “Just think back to the very first McDonald’s.”
Supermarkets and warehouse clubs have been putting up gas stations on their pad sites for years. Home Depot announced in 2009 that it would parcel off portions of its lots at hundreds of locations, saying at the time that city -planners who once erred on the side of demanding too much parking are now requiring less. Lowe’s Home Improvement has also done numerous such carve-outs. While tenant covenants can still make it hard for shopping center owners to develop pad sites, big-box retailers such as Walmart and Target do not have that problem; they typically control surrounding property and select pad users to maximize their real estate and complement their mixes, according to Greider.
Some lifestyle centers got a jump on the pad trend too. The Arlington (Texas) Highlands, completed nearly a decade ago, penciled in 10 high-visibility pad sites along Interstate 20 in the early planning stage, all of which were built and remain fully occupied.
Not all new and renovated centers need pad sites to succeed, according to Weitzman Group spokesman Ian Pierce. “Pad sites in the front of a center are an evolution, not necessarily a replacement for the way community centers are being built,” Pierce said. But many newly built shopping centers are designed with just 14,000 to 20,000 square feet attached to anchors these days — far from the old 1980s construction ratio of one square foot of attached space for every square foot of anchor space.
Outparcels are likely to remain in vogue for a long time to come, says Egelanian. “Pad sites are increasingly defining the edges of centers,” he said. “Aside from offering convenience and high visibility, they often define the tone and character of what you will find inside the specialty centers.” Clarkson agrees. “They’re easier to understand and get your hands around, and they’re safe, because they’re part of a larger project,” he said. “They’re also easier to retenant because of high demand, and they usually command a lower cap rate because they’re so attractive to buyers. The right tenants on the fringe of a project can really change the dynamics of a center.”
SIDEBAR: Suddenly, there's a line
Investors in triple-net retail properties have long favored the relative simplicity of stand-alone buildings over the complexities of multitenant shopping centers. But given rising demand from national tenants to occupy single-tenant outparcels, coinciding with the lack of new in-line shopping center space, retail investors are queuing up to buy well-occupied pad sites.
Sure, those reliable investments in CVS, Rite Aid and Walgreen buildings remain hot tickets, but all sorts of stand-alone structures — convenience stores, automobile-service retailers, national restaurant chains and more — are also selling robustly, say officials of several busy net-lease firms.
Baby boomers who are preparing for retirement but may be skittish about the stock market comprise a big segment of the pad-investment market, according to William Rose, president and national director of Marcus & Millichap’s National Retail and Net Leased Properties groups. “They’re saying, in effect: “I don’t want to buy realty income stock; I want to own my own Wendy’s.’” Of the estimated 400 million square feet of retail construction in the pipeline (the largest number since 2006), much of what will actually get built will be net-lease-oriented, Rose predicts.
Meanwhile, net-lease specialty firms are reporting brisk transaction volumes, including Marcus & Millichap, which has seen its net-lease transaction volume jump by 21 percent from last cycle’s peak. National Retail Properties, a REIT specializing in diverse freestanding retail and restaurant buildings across 47 states, is 98.8 percent leased cross-portfolio, according to Chairman and CEO Craig Macnab. That is up 0.6 percent from a year ago for National Retail Properties, whose heaviest tenant concentration is convenience stores (17.7 percent), followed by restaurants (15.9 percent) and auto-service stores (7.2 percent). National Retail Properties typically deals directly with tenants in sale-leasebacks or in development funding for new buildings.
With safe and stable returns, such retail buildings have evolved into a highly popular asset class, says Randy Blankstein, president of national net-lease advisory firm The Boulder Group. “Values of net-lease assets, including outparcels, have increased to all-time highs,” he said. The recovery has also given 1031 exchange sellers a chance to finally exit pad-site properties they bought at the top of the last cycle, and at surprisingly high sale prices, Blankstein says.
Triple-net investors continue to prefer retail-building investment over office and industrial, thanks to their familiarity with the tenants, typically long initial lease terms, passive triple-net lease structures and lower price points, according to Boulder Group’s 2015 Net Lease Market Report. Private capital, including exchanges, now dominates the net-lease market, accounting for 60 percent of it last year, up from 42 percent in 2013, according to the firm. Such assets continue to command the lowest cap rates in the sector as well, and investment-grade restaurant buildings costing less than $5 million with corporate guarantees are emerging as favorites too, Blankstein says.
Tulsa, Okla.–based Stan Johnson Co. has enjoyed 35 to 40 percent annual compound growth over the past five years, thanks to net-lease transactions, company officials said in an interview at RECon 2015. “Net lease is not a niche in the market anymore,” said Harold Briggs, the firm’s executive managing director. “It’s one of the major food groups.”
Expansion-mode stand-alone convenience chains like 7-Eleven, Sheetz and Wawa have gained popularity as net-lease commodities in recent years, according to Briggs: “It’s estimated to be a $50 billion to $60 billion annual industry, but we think that’s conservative.” Stan Johnson COO Jeffrey W. Cox said: “Net-lease investors are seeking a risk-adjusted return, and net lease is delivering in that space.”
