Use these tools to determine the feasibility of a project and its ultimate go/no-go decision.
The retail industry is tougher than ever, especially with the pervasive influence of e-commerce. Having the skills and tools to make informed decisions is critical. One such tool is the retail property feasibility analysis featuring the CCIM Strategic Analysis Model. The model considers the goals and objectives of the investor/developer, alternative investments available, and the investment criteria that lead to the final decision.
A retail feasibility analysis determines whether a proposed or existing use at a particular site will meet the objectives of the developer or investor and the prospective tenants. Based on the CCIM Strategic Analysis Model, the comprehensive feasibility analysis includes analyses of the market and competition; location and site; political and legal components; and financial components. This holistic approach helps determine the feasibility of a project and its ultimate go/no-go decision or a go-decision with specific modifications.
Market and Competitive Analysis
The market competitive factors are the supply and demand considerations that affect the retail market in which the property competes. The information about supply and demand is related in a retail gap analysis to judge the economic viability of the proposed asset's trade area.
Retail Demand Analysis. Retail demand segmentation focuses on grouping customers by their demographic, economic, and/or psychographic attributes. Three of the most important attributes are the consumer's disposable income; population and household numbers; and consumer expenditure percentages for certain retail products and services categories such as food at home, food away from home, apparel, and furniture.
Location and Site Analysis
Linkages are the spatial relationships between the user on the subject property site, a retail establishment, and other land users necessary for the successful operation of the subject property. A retail store is linked primarily to customers who reside adjacent to or near the retail store; these customers are called the residential base. In addition, the retail establishment can serve the needs of customers who work near the property but do not reside nearby. These customers are a part of the daytime population in the subject property's trade area.
Employees and distribution centers are two other linkages necessary for retail operation. In the past, employees were considered ever-present resources, readily available at all points in the geographic area. But, depending on location, prospective employees may not have the required skills. Additionally, distribution centers used to be viewed as relatively insignificant because transportation costs for the products were considered a minor item. However, today's rising cost of gasoline and increased travel times due to traffic congestion increase the retail store's procurement costs.
Political and Legal Analysis
Real estate business decisions are integrated into the political and legal analysis, which can give rise to gaps between supply and demand and also can eradicate gaps. When a gap is identified in the market and competitive analysis process, the analysis might indicate support for the proposed development or acquisition. However, political and legal considerations and/or site limitations may increase the risk of achieving a successful development. Political considerations and societal issues are so pervasive that no feasibility can be evaluated and no decisions be made outside the context of them.
Legal Issues. Zoning jurisdictions provide necessary comprehensive plans for current and future permitted land use. Zoning then determines the use of a particular site. There also may be opportunities to pursue changes or get zoning variances.
Building codes determine the type of building, allowable signage, and parking lot requirements for the site. Licensing requirements can restrict the type of use for a site, such as requiring special license for the sale of alcohol.
The results of the first three areas of the strategic analysis ultimately lead to the financial analysis, which determines the financial feasibility. Financial feasibility answers the question, “Is the return and/or profit sufficient to attract the capital needed to develop the project?” Further financial analysis compares the alternatives of selling the project upon completion or holding it as a long-term investment.
The two benchmarks used to measure financial feasibility are cost markup feasibility and rent constant feasibility. If the investment/development is a go-decision, the analyst then can use net present value to compare the alternatives of selling the project upon completion or holding the property as a long-term investment.
Front- and back-door approaches are applied to both the cost markup feasibility and rent constant feasibility benchmarks. The front-door approach determines the minimum rents needed to achieve the investor/developer's benchmark threshold at a given project cost. The back-door approach determines the maximum project cost the investor/developer can incur to achieve the benchmark threshold at given rents.
Cost Markup. The cost markup is the relationship between profit and project cost expressed as a percent. Profit is the difference between net market value and project cost. Net market value is the market value minus the cost of sale. Cost markup is calculated by dividing profit by project cost. (See the Cost Markup Model.)
The rent constant is the relationship between the market rent constant and the cost rent constant. The market rent constant is calculated by dividing the projected first year net operating income by the net market value of the asset (similar to the calculation of a cap rate). Net market value is the market value minus the cost of sale. The cost rent constant is calculated by dividing the projected first-year net operating income by the total project cost. The rent constant benchmark is the spread between the net market rent constant and the project cost rent constant. The difference between the cost rent constant and the market value rent constant represents the margin for risk and the profit for the investor/developer.
These models, combined with the Excel-based CCIM Financial Feasibility Workbook, allow for a detailed analysis from total project cost to all factors to consider in a go/no-go decision or a go-decision with specific modifications.
Editor's note: This article was adapted from the course “Feasibility Analysis for Commercial Real Estate.” In additional to the CCIM Strategic Analysis Model, the course provides an Excel spreadsheet for in-depth analysis using a real-world case study. For more information, visit www.ccim.com/education.