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What is an Outparcel in Commercial Real Estate?

Nicki & Karen » May 3, 2022

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An outparcel is a simple plot of land located around a commercial shopping center that’s set aside for the eventual construction of notably smaller buildings. Also referred to as pads, it’s common for commercial shopping centers to use outparcels to add value to the land as well as their shopping center. There are many different types of buildings that can be considered outparcels, which include pharmacies, restaurants, and similar retail stores.

The businesses that are used as outparcels will typically be located in the vicinity of the shopping center, which means that they won’t be an addition to the main building. Outparcels are commonly placed on the outskirts of a mall or shopping center because the buildings could operate at different hours. It’s also possible that the standalone business requires a drive-thru or would make higher revenues when positioned away from the main building.

The main benefit that a business has when choosing to buy or lease an outparcel is that it will be situated alongside the primary road that leads to the shopping center, which means that anyone who wants to stop by the shopping center will first see the outparcel. While there are many different types of businesses that tend to use outparcels for their operations, two of the more common types includes restaurants and banks. As such, people who visit the mall will be able to grab a bite to eat or make a withdrawal at the bank without needing to leave the shopping center area.

While outparcels were once viewed as areas that contained fringe buildings that were afterthoughts to the main attraction, they are now believed to be an effective means of increasing profitability. If a business is considering leasing an outparcel or building on one, it’s important to understand that there are pros and cons to doing so. This article offers a more in-depth look at outparcels and how they are used for commercial real estate.

outparcel store

Advantages of Outparcels

There are many distinct advantages of using outparcels to expand the value of the land surrounding a shopping center. In fact, many shopping centers make use of outparcels because they believe that the benefits far outweigh the potential limitations.

Can Minimize Project Risk

Likely the most risky aspect of creating a retail center or similar commercial development that contains retail space is that construction can take an extended period of time to be completed. While local zoning requirements and other regulations determine how the land can be used while construction is ongoing, the property owners are unable to earn income while they wait for the shopping center to be built.

This risk can be mitigated almost entirely by developing outparcels for retail buildings. In this situation, it’s possible to earn a substantial amount of income since the inline tenants will be required to pay rent on a monthly basis. Even though these payments won’t cover all of the shopping center’s expenses, they can somewhat reduce the costs of development while also lowering project risk.

Ground Lease Is an Option

If a shopping center chooses to outfit the land with outparcels, it’s possible to negotiate with the developer or tenant about using a type of ground lease, which will be applied to each outparcel. When a ground lease is attached to an outparcel, the shopping center or property owner is paid to lease the ground that the outparcel is located on.

The business or entity that chooses to lease this site will use their own assets to develop the building that they will operate out of. As such, the shopping center obtains income without needing to take on the risk that occurs when developing a new building.

Several Methods for Profitability

When outparcels are placed around a shopping center, there are three distinct methods that the property owners have to increase profitability. Along with leasing the outparcel site, it’s possible to sell the outparcel to develop on the location. Each of these methods allows the property owner to enhance profitability. However, each method of boosting profitability has its pros and cons, which is why it’s essential to weigh every option.

Option to Sell

One option that the property owner can use with their outparcels is to sell these sites to other businesses or entities that can develop them. The proceeds from selling the outparcels can be used to lower the property’s interest expense and cost basis. When the property owner no longer owns the site in question, they will be able to reduce the amount of debt that they owe, which allows the property in question to become much more profitable.

Easy to Develop Outparcel

It’s very easy to develop an outparcel. Since the property owner owns the land that the outparcel is situated on, they can develop these sites without needing to add any basis to their cost. After these sites have been developed, the buildings can be leased to various businesses, which will increase the income that the property brings in.

Tenant Base is More Diverse

Shopping centers that use outparcels can benefit from having a diverse tenant base. If there are at least several outparcels situated around the primary shopping center, it becomes possible to add a wide variety of different types of businesses to the outparcels, which gives property owners the opportunity to provide customers with a more convenient shopping experience.

Let’s say that a property consists solely of a grocery store. Even though the grocery store may bring in a large amount of business, customers must travel to several destinations for all of their errands. On the other hand, a large shopping center with ample space for outparcels can add a bank branch, coffee shop, drug store, and grocery store to their premises, which allows the customers to run every errand they have in the same location.

Property Values Increase

Property values invariably increase when using outparcels on the land. When taking commercial real estate into account, the metric that this real estate bases their income on is net operating income. This is calculated by identifying the property’s income without any expenses. Developing, leasing, or selling an outparcel results in more net operating income. In this situation, property values increase and investors obtain better returns from their initial investments.

Access to National Retailers

Many national retailers love to place their businesses in outparcels. Along with national banks and fashion stores, it’s also common for national convenience stores, gas stations, coffee shops, and fast food restaurants to choose to place their businesses in outparcels. The national retailers that choose outparcels are usually “credit tenants”.

This term indicates that independent rating agencies have taken a look at the company’s financial condition and determined that there is a low risk that the company will default. When the property is eventually sold, the ones that contain national retailers usually obtain higher offers.

shopping mall

Limitations of Outparcels

Even though outparcels are beneficial for many reasons, there are also a few limitations that should be taken into account.

Local Regulations Could Create Issues

There are always going to be local regulations that must be adhered to when assessing the viability of outparcels. For instance, municipal regulations could be in place for standalone buildings. If a property owner is in this situation, it’s possible that the height, size, and architectural designs will need to meet local regulations and guidelines. If they don’t, the building could be torn down alongside fines being levied.

Visibility and Traffic Count are Potential Problems

There’s also the potential for visibility and traffic issues depending on where the outparcel is situated. Any business that considers buying or leasing the outparcel will need to ask such questions as:

  • How many people are able to see the building?
  • Do the outparcels have enough parking?
  • Is the egress/ingress area marked properly?
  • Does the area have enough demand to support business operations?

May Choose Wrong Anchor Stores

While outparcels are kept separate from the main shopping center, any anchor stores in the area can negatively or positively affect the traffic that reaches the shopping center. As such, it’s important to place the outparcels at a good enough distance away from the main store while also making sure that the businesses are suitable when paired with the shopping center.

a&w outparcel

Conclusion

Outparcels are integral aspects of commercial real estate that can provide property owners with many tangible benefits if properly utilized. These parcels of land exist on the outskirts of retail shopping centers and are commonly used to entice those who drive by to go through the entire shopping center and stop by more than one store. Shopping centers have been using outparcels for years to ensure that visitors are provided with a one-stop shopping destination.

By leasing and selling outparcels to the right retail stores and businesses, consumers should be able to run every errand they have in a single location. Property owners benefit from several methods of profitability, an increase in property value, and more access to national retailers. Over the past few decades, outparcels have proven to be invaluable for the long-term success of shopping centers.

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