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Weekly UpdatesOpportunities exist to increase the cash flow and value of many shopping centers by creating a pad--or out parcel--as a free-standing building in the parking lot. There are a few suburban office buildings and industrial developments with heavy street traffic that may also provide the opportunity to create a pad on the corner of their parking lot.
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Before creating or adding a pad to a site, the property owner must review and research several issues, including the financing strategies, the lease issues for the pad and any lease restrictions from other tenants, as well as the municipalities' parking requirements.
PAD INCENTIVES
The financial rewards of adding a pad to a shopping center or other site can be significant. For example, if the annual ground lease rent for the pad is $50,000 per year, the cash flow of the property would be increased $50,000 if the management fee is not a percentage of the property's income. If the management fee is a percentage of the collected income, it would be a thousand or two less than $50,000. The value of the property would increase approximately $666,667 using a 7.5 percent cap rate on $50,000 of increased net operating income.
$50,000 (Annual rent)/.075 (Cap rate) = $666,667
THE PRICE OF DEVELOPMENT
The cost to do the pad deal includes paying fees to consultants to have a portion of the parking lot separately parceled; bringing utilities to the pad site; and paying a leasing commission to the property manager making the deal. There also may be legal fees to negotiate the pad deal.
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In most cases, the tenant will bear the costs of developing and constructing its building although the property owner may have a construction manager inspect the building when it is completed. If the pad deal is a build-to-suit, either the property owner or the tenant will contract for the development and construction of the building.
Pad buildings are almost always single-tenant buildings built to a tenant's specification. In some cases, an owner will develop a splitter building, which is a free-standing building leased and occupied by more than one tenant. The building's design is similar to the shop buildings in the shopping center and the tenants in a splitter building are the same categories of tenants as those in the shop buildings and the free-standing pads.
The most common tenants in a pad building are restaurants, drive-through coffee/espresso shops and banks. These businesses are excellent customer draws to the shopping center.
THREE TYPES OF PAD DEALS
There are three types of pad deals. The most common pad deal is the ground lease. For this deal, the property owner creates a separate parcel--the pad--and leases it to a tenant who builds the building. The lease is typically for 10 to 20 years with two-to-six five-year options. This deal is usually preferred because the owner of the property incurs limited expenses to create the pad, and has generated a solid cash flow and increased the value of the property.
The second type of pad deal is the build-to-suit. The property owner develops a building to a tenant's specification on the pad, and leases the building and the pad to the tenant. The lease is usually for 10 to 20 years with multiple five-year options. The building is designed to the tenant's standard format. In this deal, the property owner has the expense of developing the building. If the tenant vacates, it may be difficult to lease the building without significant modifications to it. This approach is seldom used because of the cost and the risks of constructing a specialty building.
The third pad deal is the sale of the pad. The pad is sold to a user who builds its building on the parcel. This pad deal will generate significant one-time revenue.
LEVELING LEASE ISSUES
When the pad is leased, there are several issues to address, most notably insurance, taxes and maintenance, and how the tenant will be charged for each of these areas.
The tenant will need to secure the insurance on its building. If the tenant maintains its own insurance, it should not be charged for the insurance on the other buildings. It is fair to charge liability insurance for the parking lot and damage to the parking lot improvements in the common area maintenance charges.
In terms of taxes for the property, the tenant either pays the real estate taxes directly with evidence to the landlord (property manager), or the landlord will pay the real estate taxes and bill the tenant for reimbursement 10 days before the taxes are due.
Maintenance of the common areas presents challenges as well. The owner and tenant must agree upon who will maintain the landscaping around the building and who will pay for additional services used during extended hours. For example, if the tenant is a restaurant that remains open after the shopping center closes, this tenant will need longer use of lighting around its building: Billing for the extra usage should be determined accurately. In addition, the tenant will have its own trash receptacle and should not be billed for the cost of the receptacle for the rest of the shopping center, except for a receptacle dedicated to common area trash.
REVIEW THE RESTRICTIONS
Another issue requiring research involves restrictions in existing tenants' leases that will either prevent or place conditions on a pad building. The anchor tenants' leases are most likely to contain such restrictions. Anchor tenants want to make sure their sight lines from the street aren't blocked and their minimum parking requirements are maintained, either in their parking field in front of their store or throughout the property. The anchor tenant or tenants may limit the number of pads, the location of the pads and the size and heights of the pads. These tenants are usually not willing to renegotiate this restriction unless they receive something in return.
Though it is not likely the other shop tenants will have such restrictions in their leases, it is prudent to review their leases and review each tenant's site plan, which is an exhibit to the lease. Hopefully the site plan for each tenant states the landlord may change the parking areas and add buildings at its discretion.
PARKING CONCERNS & CONCESSIONS
Having researched and addressed the issues discussed above, there are still major challenges in creating a pad in relation to parking. The site must meet the municipality's parking requirements after the pad building is developed, so gathering information up front is essential. Municipalities have a parking index for the number of parking stalls required based on the total square footage of all the buildings on the site. A parking index states there will be X number of parking stalls for every one thousand square feet of gross leasable area. A 5.5 to 1 parking index means five and one half parking stalls for every 1000 square feet of building area.
Usually shopping centers and other types of properties are developed to the minimum parking requirements with few additional parking stalls. The property manager must find out the municipality's parking requirements, count the number of stalls to determine if there are sufficient parking stalls to support the pad building, all the while keeping in mind that the footprint of the pad building as well as its walkways and landscaping will take away existing parking stalls.
In addition, the square footage of the pad building must be supported with additional parking stalls based on the municipality's parking index for the size of the pad building. Some municipalities will require additional parking for a restaurant use.
If there are not a sufficient number of parking stalls to meet the municipality's parking requirements, the property manager has several options to increase the property's parking count. One option is to add compact stalls to the parking lot, but it is best to check with the municipality for the percentage of compact stalls allowed. Alternatively, more stalls may be added in some sections of the parking lot by re-striping the regular size parking stalls and creating the compact stalls. Some areas of the parking lot behind the shopping center's main building may have no parking stalls and these areas can often be striped for more spaces.
If these approaches do not generate sufficient additional parking stalls to support a pad building, a parking consultant may be hired to more efficiently redesign the parking area and create several more parking stalls. A final alternative is to determine if the shopping center is over parked. This means there are more parking stalls than the number of customers who need to park. Most multi-anchored strip shopping centers developed in the prior century have more parking stalls than needed. A municipality may have an outdated parking requirement such as a 6-to-1 parking index. In this case, it may be wise to petition the municipality for a variance that would lower the parking index for the shopping center.
Of special note in relation to parking issues, the pad lease will restrict the location, size and height of the building and there will be an exhibit to the lease showing the layout of the building with approval of the location of drive-through and stacking lanes. If the pad is sold, there needs to be a cross easement between the ownership of the pad and the shopping center for access and parking on each party's parking lot.
MAKE A DEAL
Time spent analyzing whether a pad can be created at a shopping center, or possibly at a suburban office building or industrial development, may result in a rewarding opportunity. The property's cash flow and value can be significantly increased, and the property manager can earn a substantial lease or sale commission.
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