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Good News for Strip Malls: Small Stores Are Coming Back Strong

By Reuben Gregg Brewer – Dec 15, 2021 at 10:45AM

Key Points

  • Anchor tenants tend to get a lot of attention in the strip mall sector.
  • Small tenants pay higher rents but are more exposed to economic ups and downs.
  • The pandemic hit small shops hard, but they are starting to make a comeback.

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Strip malls have generally held up well because of strong anchor tenants; now, the rest of the business is picking up too.

The strip mall is a staple of American life with consumers regularly visiting the grocery stores that often anchor these properties. That helped real estate investment trusts (REITs) which focus on this area, such as Brixmor Property Group (BRX -0.39%), Kimco Realty (KIM -0.33%), and Regency Centers (REG -0.55%), to weather the 2020 pandemic in relative stride. However, there's another positive trend going on that investors should be aware of beyond the anchor tenants.

A simple business

Brixmor, Kimco, and Regency all focus on owning open-air shopping centers with grocery stores as anchor tenants. For instance, roughly 70% of Brixmor's rent roll comes from properties that contain a grocery store while Kimco and Regency properties are in the 80% range. The reason is pretty simple: People need to eat, and buying food brings consumers back to a shopping center on a regular basis.

A person with a full grocery shopping cart in front of an open car trunk.

Image source: Getty Images.

The only problem is that grocery stores understand the importance they play as reliable tenants. So grocery stores and other big-draw stores often pay the lowest rents and take up the most space. But it's still just a small portion of the overall mall. For example, grocery stores, warehouse clubs, and pharmacies (an even broader subset of reliable tenants) only make up around 18.5% of Kimco's total rent roll.

The rest is coming back

Thus, a key piece of a strip mall's business are the shops that fill in around the anchor, which include everything from hair salons to restaurants. The scale of these businesses can vary from mom-and-pop owners to national chains, but they are a key driver of long-term returns as they benefit from the foot traffic brought in by the anchor tenants. These smaller locations generally pay more per square foot, making them highly profitable. 

The downside is that that smaller stores can be highly economically sensitive. Eating out, for example, is one of the first things people cut from their budgets in a recession. And when the pandemic spread, a lot of the smaller stores in strip malls got hit hard. That's easy to understand since social distancing meant less eating out, less time in the office (so no need for dry cleaning), and less reason to get one's hair done, among other things. Occupancy levels by the smaller stores fell as you would expect. 

That, however, is changing. For example, Regency's chief operating officer Jim Thompson noted during the company's third-quarter conference call, "What I want to make sure doesn't get lost is the really vast improvement and the demand for leasing and for space in our properties because we did lose occupancy."

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James Taylor, CEO of Brixmor, was more specific, noting during the company's quarterly earnings call: "I'm particularly pleased by the acceleration in small-shop leasing, where occupancy grew 140 basis points year over year to 85.7%."

Meanwhile, Conor Flynn, CEO of Kimco, noted on his company's conference call, "Leasing demand continues to be robust across the portfolio with the bright spot being the rebound in demand for small shops." Small-shop occupancy at this REIT grew 180 basis points in the quarter to 87.3%. For comparison, the company's anchor-tenant occupancy was flat at a higher 96.9%.

No doubt, small-shop occupancy will be an important driver of performance -- and that side of the business appears to be picking up again.

The next leg up

In 2020, the saving grace of the strip mall sector was the strength of anchor tenants. However, now that people are starting to get out of the house again, the smaller shops that fill out strip malls are coming back. And that will be a huge tailwind for strip mall landlords across the board.

Regency, Kimco, and Brixmor -- some of the largest names in this niche -- are just some easy examples. As you examine strip-mall landlords for potential investment, make sure you pay extra attention to those tiny tenants, because they could end up being big for business. 

Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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