Article Date: 12/1/2010

Malls vs. Free-Standing Buildings
practice location

Malls vs. Free-Standing Buildings

Before you decide where to locate — or relocate — your practice, consider these critical variables.

Allan Barker, O.D., Rocky Mount, N.C. & Greg Stockbridge, O.D., M.B.A., Smithfield, N.C.

In business, there is no such thing as a “sure thing.” However, in certain instances, we can make an educated decision that improves our chances for positive outcomes. One such instance is the decision of whether to leave a mall location for a free-standing building. By evaluating the benefits and costs of each, you can locate — or relocate — your practice to the most effective location.

The downside of malls

Let's look at some of the challenges optometrists face when they rent in a mall.

Burdensome leases. It's not uncommon for mall lease agreements to run more than 100 pages and include such fees as merchant association dues, common area maintenance (CAM) charges (which may include costs for heating and air conditioning repair, as well as annual facilities maintenance). You might even be charged for annual tax increases incurred by the landlord. Often, the landlord may collect overage charges based on a percentage of your receipts. So the more you earn, the more you may pay. In addition, the lease typically ensures that the landlord will win any disputes … and may even require you to pay all court costs.

Malls like it large. Mall management often operates under the impression that consumers make special trips to the mall to visit large anchor tenants — not the small renters. Thus, when “sweetheart” rent deals go to the large tenants, the small tenants pick up higher relative costs than their rental space warrants.

Tenant loyalty issues. No matter how attractive the rental agent makes the initial leasing agreement, once your lease expires, the landlord can literally put you on the street, or even replace you with a competitor who is willing to pay more rent.

Have malls lost their luster? Malls continue to lose business to consumers who prefer other venues, such as super centers, big box stores and Internet retailers.

Patients may view mall eye care as a commodity. Consumers may feel malls are conducive to buying a new dress or pair of shoes, but not making appointments for medical services.

The mall's upside

Certainly, there are benefits to a mall location. These include:

Instant traffic. This is especially important if a doctor decides to open a practice cold. A mall practice will generally grow more rapidly thanks to the high volume of consumers walking through its corridors.

High visibility. Patients have no problem finding a mall location. This is another reason mall practices may grow faster than a cold start practice in a less commercial setting.

Malls draw people from great distances. Patients routinely travel as many as 50 miles to visit a mall practice. They can engage in multiple shopping activities in one place, including possible eyecare purchases.

Income from a mall practice can pay for a future move. A true advantage of a mall practice may be the fact that when your practice experiences rapid growth, you will earn enough capital to invest in another location, such as a free-standing facility, should you choose to move.

Comparing locations

How do these benefits compare with the challenges? One way to answer this question is to examine the numbers generated by eyecare offices that moved from mall locations to freestanding buildings. Here, we review data from eight practices that made such a move between 1999 and 2009 (see Table 1).

Most moves did not produce a drastic failure or success in year one. However, by year three, average revenue increased by 24% vs. that of the last year in the mall. The average net revenue for year three was almost $1.33 million per practice.

Yet, in year one outside the mall, net profits doubled (after paying O.D. salaries). And by the third full year outside the mall, the numbers increased to an average profit of $177,857.

By year three, two of the eight practices showed decreases in profits when compared with the last year in the mall. Yet the decreases were slight, while the increased profits of the other six practices were more dramatic.

Practice owners should also consider the issue of rent. (Table 2 presents data collected on the eight practices from 2009.)

While the cost of mall space varied, payments averaged 17% more than the bank payments for free-standing buildings. As a percentage of revenue, payments for space in a free-standing building decreased each ensuing year after the move from the mall. Square-foot costs also improved in the free-standing facility.

Additional costs for mall and free-standing buildings (taxes, maintenance, insurance, marketing, etc.) were comparable.

Free-standing advantages

We have found 10 other advantages of practice in a freestanding facility:

Rent is not dictated by the landlord. Fixed mortgage rate loan payments remain constant. However, mall landlords typically raise rents 3% per year to adjust for inflation. Today's $50,000 per year rent would cost $75,630 in 15 years, and $930,000 through the 15-year period, compared with $750,000 through the same period for a fixed payment of $50,000 per year.

You can avoid future moving headaches. If your landlord increases the rent or fails to maintain the property, you may quickly find yourself looking for a new location.

Depreciation. Depreciation benefits real estate investors because a building is depreciated through 39 years. A $780,000 building will have a paper loss of $20,000 per year. This loss helps you avoid paying taxes on $20,000 of net income today and defers it to the time of sale.

You can get a “deal” in a poor economy. As vacancies increase during a slow economic period, ultimately cap rates increase and property values decrease, which makes prices more attractive for the buyer. And, as the sole tenant in your building, your vacancy rate is zero, making your property more valuable.

Appreciation of property. Historically, real estate values have risen faster than inflation. But even if real estate keeps up with the average 3% inflation, then a property purchased for $750,000 will be worth approximately $1.16 million in 15 years.

Hedge against Inflation. Fixed mortgages remain constant, but in times of inflation rents rise along with construction costs and the value of the physical assets. Inflation could create a rebound in commercial property values as inflation readjusts property values.

Improving your investment property increases its selling price. Upgrades to the appearance and improvement in the functionality of your commercial real estate can significantly increase the value of the property at the time of sale.

Paying down the mortgage improves your equity position. As the mortgage gets paid down, equity, which can be used for other investments, increases.

Leverage. Historically, leverage or the use of other people's money, when used wisely, can create wealth. Commercial real estate allows individuals to take advantage of such leverage.

Current tax advantages. When you sell a building and use the profits to purchase a building of equal or greater value, you delay payment of capital gains. Also, when you place investment properties into a trust and leave those investment properties to surviving children, you soften the effect of inheritance and/or capital gains taxes.

Ownership challenges

Ownership does not guarantee success, and the challenges of ownership include:

Changes in tax law could make ownership less attractive. Changes in the capital gains law and demand for commercial real estate may drop, possibly resulting in further decreases in property values. Also, changes in the estate or living trust law or the like-kind-exchange law could negatively impact commercial values.

Tax on equity. As the mortgage gets paid down, the interest expense, which is tax deductible, decreases. So more taxes are paid later in the life of the loan, which can be problematic, especially if the property is not appreciating.

Local neighborhood falters. You could be stuck in an area that is negatively transitioning and, therefore, become unable to find a willing buyer for your building.

Downward economic turn. Selling in an economic downturn is not desirable. As the commercial real estate market tends to follow the residential market and unemployment figures, savvy investors have an easier time predicting commercial downturns and can sell when warning signs arise. However, if your practice resides in the building you own, you add a complicated variable to your decision of whether to sell.

Over leveraged. As we all have learned from the current financial crisis, over leveraging can lead to a very quick and painful reckoning.

Opportunity cost. With tighter regulations, commercial mortgage lenders require as much as 20% to 25% down. When you tie up more capital in the down payment, you defer other investments.

Even when considering the disadvantages, you should have no fear of moving your practice from a mall to a free-standing building. Of course, you need to have a reasonable geographic proximity to the mall when you move. Also, aggressively notify your patients of your move. By your third year you should be happily congratulating yourself for both building equity in your own property, increasing your profit and not having a landlord as part of your future. OM

Dr. Stockbridge graduated from New England College of Optometry and received his M.B.A. from Duke University. Dr. Stockbridge completed a residency in Hospital-Based Optometry at the Kansas City VA Medical Center.
Dr. Barker is president of Eyecarecenter and serves as immediate past president of the North Carolina State Optometric Society. Both Drs. Stockbridge and Barker are practicing optometrists. E-mail to comment on this story.

Optometric Management, Issue: December 2010