What are retail condos?

Retail condos are commercial properties where you can buy a unit in a multi-unit shopping center. Like the residential condominiums, it does not have its own lot because all the units in the center share a lot with common parking and common area. The property is normally governed by a “Covenants, Conditions and Restrictions” (CC&R) document that outlines all the rules and restrictions you must abide by. You will have to pay a monthly HOA fee based on the square footage of your unit for mall maintenance.

What you should know before investing

Retail condominiums are often offered for sale in densely populated metropolitan areas where there is a high barrier to entry to shopping centers, for example, California or Florida. The developers target small business owners who aspire to own their own unit and small investors who can only afford one or two units. This is a brilliant marketing strategy to get the best price for a vacant mall. Developers often start to market the project months, if not years, before construction even begins. They too

  1. Require that the initial deposit, up to 50% of the purchase price, be paid directly to the developers and not to the neutral third party, i.e. escrow companies. This way they can use the money for development. It also minimizes your borrowing costs on construction loans that often carry a fairly high interest rate. For developers, this is a smart thing. However, as a buyer there is a risk that you may not be able to get your money back if things go wrong, for example the developers are unable to complete construction. So make sure you deal with trusted developers with a good track record.
  2. Do not offer to pay real estate brokers commissions to represent buyers. This is mainly due to the fact that the demand is high while the supplies are limited. It also minimizes expenses and maximizes profit for developers (there is nothing wrong with this practice from a business point of view). As a buyer, you don’t have an experienced broker to guide you through a complex commercial real estate transaction. Since many residential real estate disclosures and buyer protection laws do not apply to commercial real estate, you may want to pay someone knowledgeable to help you with the transaction. Otherwise, you may end up signing a contract that unequally protects the developers and not you. Better safe than sorry.
  3. Offer a lower price as an incentive for early-stage buyers when there is nothing to see but a conceptual or architectural drawing of the property. Prices go up as more and more units are sold. The difference between the first phase and the final phase when the construction is completed could reach 50%. This is a common pricing practice in residential development. Near the end of construction, demand may increase as buyers begin to see a good mall. This motivates greedy and unscrupulous developers to find reasons to cancel contracts with early buyers so they can sell to new buyers at higher prices. There have been lawsuits against a developer in San Jose for selling the same unit to several different buyers. So if you’re dealing with a developer with no proven track record, you might want to subtly remind him that he’s got big guns, figuratively speaking. This is accomplished by having an experienced commercial real estate broker represent you and make sure he doesn’t unknowingly breach his contract. You may also want to have a lawyer review all contracts to make sure there are no loopholes. That way any greedy salesperson will think twice before coming up with fun ideas.

The advantage is that commercial condos are often in a very good location where there is a serious shortage of commercial space. They are also close to anchor tenants such as Walmart or Target to benefit from high traffic counts. Vacancy for commercial retail properties in the San Francisco Bay Area is about 3%, among the lowest, if not the lowest, in the nation. However, there are some drawbacks that you should take into account before investing:

  1. It is very difficult to obtain financing for the purchase if you are an investor. Commercial lenders do not lend money to investors to purchase vacant commercial property. You will most likely need to buy everything in cash. Therefore, you do not have the benefits of maximizing leverage associated with real estate investing. If you plan to use the unit for your own business, it is possible to get a Small Business Administration (SBA) loan with a 10-20% down payment.
  2. With the tenant improvement credit to the tenant and the lease fee, the final cost is close to $700/sf (if you buy near the end of construction). To get a fair 6% return on your investment, you’ll need to lease it at $3.50 per square foot plus estimated triple net costs (NNN) of about $0.40 per square foot. This is the fair market rent for commercial property in the Bay Area. However, it is more towards the higher end. Therefore, it may take a while to lease it, since there are not many businesses that can be profitable paying such high rents. The tenant churn rate can be high, as your tenant’s business may not be strong enough to sustain such high expenses.
  3. To maximize profits, developers tend to provide a minimum number of parking spaces, for example, 4 spaces per 1,000 square feet. If other units around your unit have businesses that require a lot of parking spaces like restaurants, you may have trouble renting your unit. You or our tenants could also lose business because customers can’t find parking spaces.
  4. In a typical shopping center, the tenant can require the landlord to grant him the exclusive right to operate a certain type of business. However, in a commercial condominium project, you do not have this exclusive right since there is no single owner for the entire center. This is one of the main reasons you’ll see few brand-name tenants—Subway sandwiches, for example—in a condominium mall. So if you or your tenant have a good business, say a hair salon, others may open another hair salon next door to compete and put you or your tenant out of business. So you can see 2 real estate offices, 2 coffee shops, and 3 cell phone stores in a 20-unit retail condominium complex. In another example, let’s say you want to open an upscale boutique that sells high-end, name-brand goods, there’s nothing at CC&R that prevents the store on the left from selling cheap toys and the store on the right from being a butcher. So the lack of exclusivity and consistency may be the biggest drawbacks for retail condos.