Value marginal shop space on what it earns through one complete cycle of letting, void and re-letting, not on its headline rent, and the conversion threshold falls by two thirds.
Converting vacant retail space is worth it when the alternative use is worth more than the space earns as retail through one complete cycle of letting, void and re-letting. On an illustrative 2,000 m² upper-mall unit that lets at 60 per m², the cycle nets −8.43 per m² a year, a value of −210,714, so a conversion costing 450 per m² breaks even at an alternative rent of just 33.84 per m². Valued on its headline rent, the same space would demand 103.65.
Worked in full in Retail Real Estate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The unit is illustrative: secondary space on an upper level of a shopping centre, the kind that lets, empties and re-lets on a short cycle. Rents and costs are per m² a year unless stated.
| Input | Value |
|---|---|
| Area | 2,000 m² |
| Achievable rent | 60 |
| Lease length / void between lettings | 5 years / 2 years |
| Rent-free on each letting | 12 months |
| Empty costs while void (irrecoverable service charge, rates, insurance) | 70 |
| Landlord's works on each re-letting (one-off, per m²) | 150 |
| Letting fees, % of first year's rent | 15.0% |
| Capitalisation yield for retail income | 8.0% |
Rent collected = 60 × 2,000 × (5 − 1 year rent-free) = 120,000 × 4.0 = 480,000
Void costs = 70 × 2,000 × 2 = 280,000
Works = 150 × 2,000 = 300,000; fees = 15.0% × 120,000 = 18,000
Net over the 7-year cycle = 480,000 − 280,000 − 300,000 − 18,000 = −118,000
Steady-state net income = −118,000 / 7 = −16,857 a year, or −8.43 per m²
Value as retail = −16,857 / 8.0% = −210,714
The rent roll shows 120,000 a year whenever the unit is let, which is five years in seven. It never shows the two years in which the unit costs 140,000 a year to keep empty, or the works and incentives that buy the next tenant. Averaged over the cycle, the space subtracts from the centre. The rent at which the cycle merely breaks even is 75.32 per m², a quarter above what the unit can achieve.
The alternative is to convert the unit to a use with deeper demand, such as a clinic, a gym or a last-mile store, at 450 per m² of capital cost, one year of empty costs while works are done, and a 15.0 per cent letting fee. The converted space lets at 55 per m² on a long lease and is capitalised at 7.5 per cent.
Capitalised alternative rent = 55 × 2,000 / 7.5% = 110,000 / 7.5% = 1,466,667, deferred one year = 1,364,341
Less capital cost 900,000, holding cost 140,000 and fees 16,500
Value of converting = 1,364,341 − 900,000 − 140,000 − 16,500 = 307,841
Break-even alternative rent: solve value of converting = value as retail, giving 33.84 per m²
| Measure | Amount |
|---|---|
| Value as retail, on the headline rent of 120,000 at 8.0% | 1,500,000 |
| Value as retail, through the cycle | −210,714 |
| Value of converting at 55 per m² | 307,841 |
| Conversion gain against the cycle value | 518,555 |
| Break-even alternative rent, against the cycle value | 33.84 |
| Break-even alternative rent, against the headline value | 103.65 |
Against the headline value, a conversion would need an alternative use paying 103.65 per m², far more than the 60 the space achieves as retail, and it would be rejected. Against the cycle value it needs 33.84, and an alternative use at 55 wins by 518,555. The decision turns entirely on which retail value is the right comparison, and only the cycle value is.
| Void between lettings | Rent 50 | Rent 60 | Rent 70 |
|---|---|---|---|
| 1 year | −4.58 | 1.83 | 8.25 |
| 2 years | −13.93 | −8.43 | −2.93 |
| 3 years | −20.94 | −16.12 | −11.31 |
The void is the variable that decides it. With one year between lettings, the unit at 60 per m² just about pays its way. With two, even 70 per m² leaves it negative. The void assumption should come from this unit's own letting history, not from the centre's average, because marginal space re-lets more slowly than the prime mall.
The cycle average is undiscounted and assumes the next cycle repeats the last. Discounting would bring the costs, which fall at the start of each cycle, forward and make the space more negative still. Treat −210,714 as a generous figure. The converted use, by contrast, is capitalised on a long lease with no further voids; if it too would re-let on a short cycle, run it through the same cycle before comparing.
Value marginal retail space on its net income through one full letting cycle. On this unit it is −8.43 per m² a year, so a conversion at 450 per m² pays at any alternative rent above 33.84. The right-sizing test, with the alternative-use rent solved exactly, is in the free workbooks for this book; for the same question on a whole centre, see how to value a shopping centre.
Yes, when the costs of a full letting cycle exceed the rent it collects. A 2,000 m2 unit let at 60 per m2 on five-year leases, with a two-year void at 70 per m2 of empty costs, 12 months rent-free, 150 per m2 of works and 15 per cent fees, collects 480,000 and spends 598,000 per seven-year cycle: -16,857 a year, -210,714 capitalised at 8.0 per cent.
Solve for the rent at which the rent collected, after rent-free and fees, equals the void costs and works. On the illustrative unit, with five years let, a two-year void and 12 months rent-free, that is 75.32 per m2. Any unit whose achievable rent is below it is subtracting from the centre's value even though the rent roll shows income.
Because headline rent capitalised at 8.0 per cent puts 1,500,000 on space that is worth -210,714 through the cycle. Against that inflated value, a conversion costing 450 per m2 needs an alternative rent of 103.65 per m2 to win. Against the cycle value it needs 33.84 per m2, and a 55 per m2 alternative use wins by 518,555.
This article is one calculation from Retail Real Estate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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